JAMA Forum: Where Does the Health Insurance Premium Dollar Go?

By Uwe Reinhardt, PhD

Uwe Reinhardt, PhD (Image: Jon Roemer/Princeton University)

In early March, America’s Health Insurance Plans (AHIP), the national association of private US health insurers, released an interesting report that presents, for insured patients younger than 65 years, financial statistics for 2014 of commercial and nonprofit health insurance companies.

According to the report, “Where Does Your Premium Dollar Go?,” an average of 79.7 cents per premium dollar is spent by insurers on health care proper and 17.8 cents on the insurers’ “operating costs,” leaving only 2.7 cents per premium dollar as profits.

What are we to think of these statistics?

We should note first that all of the AHIP’s numbers are reported to be simple averages. And that means these numbers can be misleading because in calculating them, every insurer, large or small, is given the same weight. A more representative figure would be a “weighted” average, in which each company’s numbers are adjusted, taking into account the company’s revenue as a percent of total revenue generated by the entire sample of companies.

The nearly 80 cents per premium dollar that insurers report to spend on medical expenses are known in insurance jargon as the “medical loss ratio (MLR),” because it is the portion of premiums collected health insurers “lose” to physicians, hospitals, and other entities who offer health care.

The Affordable Care Act (ACA) mandated an MLR of at least 85% for large insurance companies and of at least 80% for smaller carriers. By their own admission, insurers selling policies for individually purchased health insurance before the ACA went into effect tended to have MLRs in the 55% to 65% range. Should a repeal of the ACA entail elimination of the mandated minimum MLRs, the market might well revert again to these extraordinarily low payouts of premiums for health care.

As already noted, the AHIP reports that insurers had an average profit margin (net profits divided by premium revenue) of only 2.7%. The number seems low, perhaps because it is a simple average. Profit margins for the larger US health insurers, for example, actually were much higher  than just 3% in recent years, with 4.7% for Aetna, 7.0% for Cigna, and 4.6% for United Health Group in 2015 and 3.5% for Anthem in 2014. (These numbers, however, also include the Medicare Advantage program for older people.)

 

Premiums and Profits

But even a profit margin of 5% belies the frequent assertion that private health insurers divert huge fractions of their premiums to their own profits. Much more troublesome is the 18 cents per premium dollar reported to cover the insurers’ “operating costs.” These include the cost of marketing, determining eligibility, utilization controls (eg, prior authorization of particular procedures), claims processing, and negotiating fees with each and every physician, hospital, and other health care workers and facilities.

These operating costs are about twice as high as are the overhead costs of insurers in simpler health insurance systems in other countries. A 2010 study comparing per capita health spending in Canada and the United States, for example, found that administrative costs in 2002 accounted for 39% of the total per capita spending difference between the 2 countries. The differential amounted to US $616 per capita in 2002. If these costs had grown by a modest 3% per year since then, they would be close to $1000 per capita now.

Also worthy of note is that the 18 cents per premium dollar that insurers report as their “production costs” exclude 2 additional forms of administrative overhead. First, the number excludes the value of the time US patients must spend dealing with insurers, mainly over enrollment and over claims. It can be very time-consuming. Second, the insurers’ cost naturally excludes also the sizeable outlays that physicians, hospitals, and other health care workers and facilities make to negotiate prices for health care and to argue over medical bills.

A study of the cost to medical practices of interacting with health plans published in Health Affairs in 2011 found “that practices spent an average of $82,975 per year interacting with health plans. Duke University’s hospital system (with 3 hospitals) has 957 beds and about 1600 billing clerks. In contrast, as Harvard economist David Cutler, PhD, observed in a 2013 interview, “The typical Canadian hospital has [only] a handful of billing clerks.”

A more recent cross-national study of total administrative costs of hospitals, including also costs other than billing insurers, found that “the proportion of hospital costs devoted to administration was highest in the United States, at 25.3%” and that “reducing US per capita spending for hospital administration to Scottish or Canadian levels would have saved more than $150 billion in 2011” in hospital costs alone.  In its 2012 The Best Care at Lower Cost report, the Institute of Medicine estimated that excess administrative costs in US health care in 2009 amounted to $190 billion.

 

A Costly “Coding War”

A “must read” in this regard is a recent article by Elizabeth Rosenthal, MD, “Indecipherable Medical Bills? They’re One Reason Health Care Costs So Much.” Rosenthal describes a costly “coding war” in which physicians, hospitals, and others who treat patients seek to maximize their profits by hiring legions of consultants who know how to “upcode” procedures in their medical bills. For their part, insurers hire legions of coding consultants who know how to protect insurers from such upcoding. Rosenthal vividly describes how individual patients can get mauled in the process.

We can think of the extraordinarily high overhead imposed on insured individuals and patients in the United States as the price they seem to be willing to pay for the privilege of choice among health insurers and, for each insurer, among multiple different insurance products. US consumers seem so fanatic about this choice that to keep it, they have been willing to give up their erstwhile freedom of choice among physicians, hospitals, and other clinicians and health care facilities. Citizens of most other countries have made that trade-off in exactly the opposite direction.

One can only hope that for the high price US consumers seem willing to pay for choice among insurers, they get their money’s worth in extra benefits.

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About the author: Uwe E. Reinhardt, PhD, is the James Madison professor of political economy and of economics at Princeton University, where he teaches health economics, comparative health systems, general microeconomics, and financial management. Dr Reinhardt is also the codirector of the Griswold Center for Economic Policy Studies at Princeton University. The bulk of his research has been focused on health economics and policy, both in the United States and abroad. He is a member of the Health and Medicine Division of the National Academies of Sciences, Engineering, and Medicine (formerly the Institute of Medicine) and served on its Governing Council in the 1980s. He is past president of AcademyHealth, the Foundation for Health Services Research, and the International Health Economics Association. He is also a member of JAMA’s editorial board.

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