Profitability of Private Health Insurers

In the current environment you have to be very careful about the ideological motives even for supposed scientific research.  The Kaiser Family Foundation generates a lot of very good information but also has a very clear political bent, which is on full display in one of its latest research efforts.  As the Medicare for All debate heats up, the organization has released a brief analyzing the profitability of private health companies across their group, individual and Medicare Advantage business lines.   (KFF Brief)   The backdrop of course is the claim that private plans have immense profits that if eliminated would help pay the grotesque cost of the Medicare for All proposals.  Just to give you a quick headline on how ludicrous that is, according to the KFF analysis, gross profits (I will get to the use of that measure instead of net profits in a minute) averaged $20 billion a year from 2016 to 2018.  That won’t pay for one week of Medicare for All.  Now, let’s talk about gross margins or profit versus net ones.  Gross margins are how much money is left when you subtract the cost of goods from revenue.  It doesn’t include any sales, administrative or other costs.  In the context of a manufactured product the concept is easy to understand, but in the case of services it gets trickier.  For an insurer, revenue is the premiums collected.  The cost of goods is treated as the claims paid.  According to the Kaiser analysis, in that 2016 to 2018 time period, insurers averaged $1608 in gross margin for each Medicare Advantage member; $799 for each person in the individual market and $855 for each group market member.  They described these margins as “high”.  Really?  Across industries, including other parts of health care, like medical devices, pharmaceuticals and many health systems or other health care providers, they are quite low.  In one place, the authors acknowledge that gross margins don’t have much to do with anything, but claim they are indicators of financial performance.  No, they aren’t.

And it is very misleading to use gross margins.  Net margins or even after-tax profits is the only thing that tells you how much money a business really makes, and actually a pure cash flow concept is the best way to measure what the return from investment in a business is.  Looking at how much money on a percentage basis goes to cost of goods in the health insurance business means examining how much of revenue goes for medical expenses.  In the Medicare Advantage market the average is 86%, for the individual market, 84% and for the group market, 84%.  Those are very high cost of goods numbers.  The remaining 14% or 16% must cover all other expenses, which includes administrative costs and taxes, and health insurers pay a lot of premium taxes, and what is left is actual profit, on which more taxes are levied.  On an after tax basis, a health insurer would be doing tremendously well to have a 2% or 3% profit.  And those profits, or the cash flow related to them, has to pay for capital expenditures, which don’t show up as an expense.  And even the calculation of what is a medical expense versus an administrative cost is tricky–insurers pay a lot of money to help manage medical use, build provider networks or to improve quality, or in the case of Medicare Advantage, to provide supplemental benefits like transportation or even meals.  Those should be treated as medical or benefit expense.  And most importantly, you are missing the whole point if you don’t look at what is happening to medical expense.  All that really matters is controlling medical expense.  And the more money you spend doing that and the better you are at limiting medical use to that that is necessary, appropriate and low-priced; the higher your administrative expenses are going to be as a percent of premiums, but those premiums are going to be lower.  What would you rather have–a $1000 dollar a month premium with 8% administrative expenses; or an $800 a month premium with 10% administrative expenses.  The answer is obvious to everyone but blinded ideologues.  If KFF wanted to do a fair piece, they would explain that.