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Profit and the Insurance Industry

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Marcy Wheeler wonders why I don't talk more about insurance industry profits and the costs they impose on the system. So let me show my work on that at a little more length.

There are two basic ways that insurers could increase costs. One is by being inefficient and requiring huge administrative costs. Another is by sustaining huge profit margins. I've pretty much concluded that insurance companies don't do either, or don't have to do either.

The insurance industry is not a particularly profitable industry. To be more specific, they're the 86th most profitable industry as measured by profit margins, with an average margin of 3.3 percent. That's lower than drug manufacturers (16.5 percent), health information services (9.3 percent), home health care (8.4 percent), medical labs and research (8.2 percent), medical instruments and supplies (6.8 percent), biotech firms (6.7 percent), generic drug manufacturers (6.6 percent), and much else. That's not to pretend that 3.3 percent is nothing, but it's hard to see how that's a primary driver of health-care spending, much less the growth in health-care spending.

Even if they're not profitable, they might be very inefficient: maybe the profit motive, or some other incentive unique to the private insurance industry, is generating immense inefficiencies. Administrative costs are frequently named as the culprit here. When I looked into this, though, the primary determinant of administrative costs didn't appear to be whether an insurer was private or public, but big or small. Insurance plans covering large firms had administrative costs comparable to Medicare (which isn't a huge surprise, given that much of Medicare's administrative functions are outsourced to private insurers). Plans covering small businesses or the individual market had extremely high administrative costs. But those small plans will disappear into the health insurance exchange and become big plans instead, so that problem should largely be obviated.

What the profit motive does do is create an incentive for cruel practices such as rescission and risk selection. Those practices, it's important to note, almost certainly save the system money in the aggregate. They are not why costs grow. But they are bad practices and should be stopped. The insurance market regulations and risk adjustment provisions, however, pretty much take care of this problem.

That said, the current insurance market does drive cost growth in two main ways.

The first is that it's fractured among thousands of plans and competitors and business arrangements, and that fracturing is inefficient. Medicare negotiates better rates because Medicare has a large customer base, giving it power in those negotiations. An insurer covering a bunch of small businesses in Iowa does not.

The second is that the insurance market is broadly parasitic on the employer-based market, which as I've argued before, allows everyone to pass costs onto someone else and tricks individuals into thinking they're getting a good deal when they're really getting a terrible deal.

The answer to these problems, at least to my way of thinking, is not so much the public plan (though I think it would be a good inclusion) but the health insurance exchanges. And I do talk about them. Often. Loudly. In all different ways.

Expanding the exchanges is where insurers — both public and private — get the size for administrative efficiency and negotiated discounts. Expanding the exchanges moves us towards a system where people see how much of their money is being spent on health care and thus understand the need for cost control and the damage being done by the status quo. Expanding the exchange is even the key to a strong public plan, because the public plan is nothing without a large customer base to give it strength.

Obviously, I can't do much about how this post will be read. Marcy wrote earlier that I'm engaged in "a struggle to talk about how cool insurance companies are," and my hunch is this will be filed in that category. For what it's worth, I don't think the private insurance industry should exist. But I don't think that fight will be won anytime soon, and at this point, I don't think assaulting it is the key to getting health-care reform right. In fact, I worry that it's become something of a distraction, and the relentless focus on whether the insurers are winning or losing in health-care reform has allowed the administration to skate by with some pretty bad compromises (closing down the exchanges to larger businesses, for instance) and permitted other industry players to escape the scrutiny they deserve.

Photo credit: By Matt Rourke — Associated Press

By Ezra Klein  |  September 9, 2009; 4:46 PM ET
Categories:  Health Reform , Health Reform For Beginners  
Save & Share:  Send E-mail   Facebook   Twitter   Digg   Yahoo Buzz   Del.icio.us   StumbleUpon   Technorati   Google Buzz   Previous: President Clinton's Health Care Address to the Joint Session of Congress
Next: The Incoherence of Compromise

Comments

First of all, let me say that it's heartening to see you give a relatively balanced commentary on health insurers. Coming from someone on the left, it's especially surprising and refreshing.

Moving on:

1) The Public plan is dead. No need to waste time talking about it anymore. It's been dead for months and only progressives don't seem to realize this.

2) Medicare does not "negotiate". It sets prices. It sets prices for many services (especially in hospitals) below the actual cost of providing those services. For other services, it allows outsized profit margins (oxygen, home health). It is able to set prices below costs because the private sector subsidizes Medicare for many services. You know this and have written about it before.

3) Not sure what you mean by, "the insurance market is broadly parasitic on the employer-based market". If you're referring to the tax deductibility of health care costs shielding employees from being more cost conscious and driving up overall health care spending, then I agree with you. But health insurers have no say in this arrangement and none of the proposed health care bills would do anything to fix this.

Posted by: mbp3 | September 9, 2009 5:18 PM | Report abuse

"I've pretty much concluded that insurance companies don't do either, or don't have to do either."

I'm not sure from where you drew the conclusion that insurance companies are not inefficient. A quick look at overhead costs of Medicare versus a private insurer indicates otherwise. Of course we're comparing apples to oranges here since the government doesn't pay for lobbyists, marketing, sales, bonuses, etc., but that's exactly the point.

Posted by: slantedview | September 9, 2009 5:24 PM | Report abuse

A couple of thoughts, but from the "anti" insurance company perspective.

-- Fragmentation is more than just about deleveraged purchasing and administrative efficiencies. The complexity or payors also leads to increased inefficiencies on the provider side of the business. See Woolhandler et al.- that's where the "30% is administrative waste" rationale comes from. I personally don't buy that number, but there is some additional provider administrative costs due to the complex payor landscape. AHIP has actually offered up some standardization/simplification elements as their "cost-savings" to the system, but there's more to be done here.

-- Beyond the administrative inefficiencies on the provider side due to complexity, insurance companies further contribute to provider administrative inefficiencies by trying to eek out a little additional profit on the interest float on their accounts receivable. Meaning, if they can haggle with a provider for reimbursement for 60 days rather than 30 days, than they get to make interest off premiums for an additional 30 days. The cost isn't just the 30 days of unjustified interest, but the costs levied on the system among providers, either spend time or money (there are services you can hire to do bill adjudication) to deal with these hassles. We need better regulation on this front.

-- This same theme could also be applied to patients, where payment delays due to illegitimate questions (recnognizing that many of these question are legitimate) on network coverage, preauthorization issues, etc.-- all to delay payment a little longer to pick up incremental float. Again, the system costs aren't just the illegitimate float (seen in their low profit margins), but the time and hassle of everyone else in order for the to squeak out that additional profit. Again, better regulation needed here.

--I'd love to see the methodology behind that profitability ranking. So many health care companies are diversified across a number of those dimensions in the health care field, I'm not sure how they get accurate "pure play" numbers.

Posted by: wisewon | September 9, 2009 5:35 PM | Report abuse

One other thought...

--"the relentless focus on whether the insurers are winning or losing in health-care reform has allowed the administration to skate by with some pretty bad compromises (closing down the exchanges to larger businesses, for instance) and permitted other industry players to escape the scrutiny they deserve."

Just recognize how large a role the Democratic party has played in this dynamic. Just last year-- and you can read your own post/my repsonse on this from back then-- you wrote about how "smart" the Dems were in using physicians against insurance companies to cut down on Medicare Advantage (preventing physician reimbursement cuts by cutting insurance company revenues). As I wrote then, the Dems were simply further bolstering the cause of docs, by demonizing their favorite demon, the insurance companies. Perhaps some more honest political demagoguery, coupled with a better understanding of health care economics among those in DC would have prevented this dynamic. You can't blame Republicans for this one. This is all Dems, baby.

Posted by: wisewon | September 9, 2009 5:36 PM | Report abuse

So one last thought...

"That's not to pretend that 3.3 percent is nothing, but it's hard to see how that's a primary driver of health-care spending, much less the growth in health-care spending. "

But if you believe this rationale... prices aren't the cause of spending growth either. So how is a Medicare/government option then a good way to cut costs? All it offers is the ability to cut prices 10 or 20%. They haven't addressed the utilization issue at all. Less than the private sector.

Posted by: wisewon | September 9, 2009 5:38 PM | Report abuse

Paradoxical that we don't think it's right to profit off other essential public services, like police, fire, water, military protection, or judicial services. But profiting off sick people is somehow glorious. Why isn't the care of the sick like other essential public services?

Posted by: cmpnwtr | September 9, 2009 5:39 PM | Report abuse

I'm pretty sure no progressive decided to call it "health insurance reform" out of nowhere. To the extent there's a distraction of focus in the debate, that comes entirely from the top. Please don't be lazy and attribute that elsewhere.

There's also a difference between profit margin and net profit, and I wish you'd set out the differences. The health insurance industry gets about 17% of the economy to pass through it. 3.3% profit margins translate into a lot of money at those numbers.

I appreciate the linking of the insurance market to cost growth in the ways you lay out. And I agree on the importance of the exchanges, and by association the public plan, since that's where the exchanges would sit.

Posted by: dday212 | September 9, 2009 5:42 PM | Report abuse

"But they are bad practices and should be stopped. The insurance market regulations and risk adjustment provisions, however, pretty much take care of this problem."

Last time I checked, petty fraudsters, passers of bad checks, and other swindlers don't get access to a new source of income in return for promising not to do bad things again.

Posted by: pseudonymousinnc | September 9, 2009 5:45 PM | Report abuse

One thing I don't get into in the post but does bear on the question of provider-side admin costs and fragmentation: you have to ask whether the reforms at hand would change the situation. I don't think adding a public plan into the exchange mix would change the issue Wollhandler points out, as that problem is basically the product of having a multipayer system. So I didn't include it here. Single-payer, however, would fix that problem.

Posted by: Ezra Klein | September 9, 2009 5:53 PM | Report abuse

Ezra, it is Marcy, not Marci!

Posted by: tggault | September 9, 2009 6:03 PM | Report abuse

While 3.3% is lower than I expected, it's a huge amount of money. Executive compensation would be an even smaller figure I'd imagine. To get an idea of the size of the fortunes we're talking about I found a list (http://blogs.webmd.com/mad-about-medicine/2007/08/ceo-compensation-who-said-healthcare-is.html) which had a figure for five years of compensation for 23 CEOs. The five year total for just 23 people was 14.9 billion dollars. That's 2.98 billion per year. 10% of that number could insure 37,000 families.

What in the hell do these guys do that entitles them to this kind of "compensation." And this is just the top level, there are hundreds of other executives at these corporations.

Give me a public plan. I don't make enough to pay for health care and support these guys too.

Posted by: dickc2 | September 9, 2009 6:16 PM | Report abuse

Come on, Ezra. You know there are more ways to hide official profits than congress has earmarks. The point is that the profits come at the expense of dropping people who are sick from their rolls just as they need coverage. Or identifying a pre-existing condition that the patient didn't even know they had before obtaining the insurance.

This is muddying the waters unnecessarily. A public option gives the government a way to dictate prices to the health care industry. That's where the real savings will come from, and the insurance company is just the vehicle to deliver that control to the health care providers. I don't see another way to do it.

Posted by: keilprti1 | September 9, 2009 6:19 PM | Report abuse

Provider costs for extracting payment from the insurance plans are 6.9% of total spending for physician and clinical services according to the Robert Wood Johnson foundation.
http://www.rwjf.org/about/product.jsp?id=42728

Posted by: J_Bean | September 9, 2009 6:59 PM | Report abuse

"That's not to pretend that 3.3 percent is nothing, but it's hard to see how that's a primary driver of health-care spending, much less the growth in health-care spending. "

Wait a second. Profit margins tell you absolutely nothing about increasing revenues or expenses.

That's a gigantic red herring.

Posted by: SteveCA1 | September 9, 2009 7:02 PM | Report abuse

“First of all, let me say that it's heartening to see you give a relatively balanced commentary on health insurers. Coming from someone on the left, it's especially surprising and refreshing.
Moving on:
1) The Public plan is dead. No need to waste time talking about it anymore. It's been dead for months and only progressives don't seem to realize this.
2) Medicare does not "negotiate". It sets prices. It sets prices for many services (especially in hospitals) below the actual cost of providing those services. For other services, it allows outsized profit margins (oxygen, home health). It is able to set prices below costs because the private sector subsidizes Medicare for many services. You know this and have written about it before.
3) Not sure what you mean by, "the insurance market is broadly parasitic on the employer-based market". If you're referring to the tax deductibility of health care costs shielding employees from being more cost conscious and driving up overall health care spending, then I agree with you. But health insurers have no say in this arrangement and none of the proposed health care bills would do anything to fix this.”

Ezra, I would really like to see you comment on the points quoted above.

Posted by: kingstu01 | September 9, 2009 7:39 PM | Report abuse

I understand what you're saying. However, I think that you're understating some of the cost that results from the existence of these insurers.

If we had a single payer system; issues would be much more straight forward, everyone would be covered by the same plan and pay a little more for additional coverage, there would be more cooperation and less passing the buck. We would not need to spend money on consultants who help decide what coverage options are best for each company. We wouldn't have an industry built around denial management. Doctors and other providers could spend more time improving outcomes and less time arguing with insurers over payment.

Perhaps most importantly, with a single payer system, information could flow more freely. What is paid could be public knowledge instead of buried in a medical service agreement that providers are not allowed to disclose. Doctors and other health care providers could be made to participate in peer review that would bring about the best practices.

Posted by: bcbulger | September 9, 2009 7:45 PM | Report abuse

"While 3.3% is lower than I expected, it's a huge amount of money."

I would argue that food is even more important than healthcare. Why are we allowing the farmers to make a profit, arguably more than the healthcare industry, off of the American people?

I'm calling for a public plan. The government needs to produce food. It will probably lead to a government takeover of the grocery business.

I call it the "single feeder plan".

Posted by: WrongfulDeath | September 9, 2009 10:54 PM | Report abuse

wrongfuldeath,


haha. My plan for medical insurance reform is called the "flip em over and see what drops out plan". take every year every single penny of profits. In 2006 as per the AFL-CIO website it would have been 15.3 billion dollars. A nice chunk of change. Even get the pay czar over there and make all the executives work for free. What do I care?

It'll be a band-aid on a gushing wound. Costs are still spiraling out of control even in the governemnt run plan that controls costs by setting price that if we had that as a public option would as many hospital administrators have said "would put them out of business". 7 Hospitals in NJ since 2007 have filed for bankruptcy and that's with them asking routinely for up to 100% increase in reimbursement from private insurers. how many will go out of business when a public plan sets rates at medicare or medicare +5%?

Posted by: visionbrkr | September 9, 2009 11:22 PM | Report abuse

"I would argue that food is even more important than healthcare--"

If your grocery bill puts a bigger dent in your bank account than your mortgage or rent payment, then you are either very very lucky or have a taste for caviar and vintage champagne.

The dunce corner awaits you. It's getting a bit crowded.

Posted by: pseudonymousinnc | September 9, 2009 11:38 PM | Report abuse

Nice post, Ezra. You might have mentioned that it's important to look at average industry profitability over the underwriting cycle. Profits in the health insurance industry are particularly prone to undulations with several years of low profitability (or outright losses) followed by several years of higher profitability. To look at the profitability of the industry for a single year or even several years running might lead one to draw a misleading conclusion.

Posted by: tbass1 | September 9, 2009 11:52 PM | Report abuse

pseudo,


Did you save him a seat in the corner with you?


still no response from you from the other post? I'm not surprised. I can tell you don't like to admit when you're wrong so i'm not holding my breath.

And I just so happened to check out Marcy Wheeler's comments on the blog it links to and couldn't believe she was so misinformed as to how much healthcare is being consumed.


She said:

"Now, I’m really curious if Ezra has hard data to prove that the increase in the rate of cost increases came from more open access to care in the last several years."

Here's a link i posted over there that shows that since the 90's American's are getting more MRI's than ever before. Gee, I wonder what's driving the costs??? UH UTILIZATION MAYBE???

http://radiology.rsna.org/content/236/3/920.figures-only

I for one would be more than willing to bypass getting extra MRI's so my good friend pseudo can get an MRI that he can afford.

You're welcome in advance!

Posted by: visionbrkr | September 10, 2009 12:13 AM | Report abuse

"If your grocery bill puts a bigger dent in your bank account than your mortgage or rent payment..."

MY GOD!!

pseudo has correctly pointed out that mortgage companies are making a *profit* off of us and landlords are also makinging profits! The nerve of these people!

This cannot STAND!

We need a government option...ya' know, government project housing like we had in the sixties. That worked out well, didn't it?

Posted by: WrongfulDeath | September 10, 2009 10:43 AM | Report abuse

I'm calling for a single housing option.

Posted by: WrongfulDeath | September 10, 2009 10:44 AM | Report abuse

All that administrative paper pushing and bizarre selection of rates for services rendered and the fights over payment for covered expenses and the rewards going to those insurance employees who push the most patients off the cliff...

And so little profit as a result!

So then, what GOOD is health insurance in the dissemination of health care?

What, exactly, is its purpose and why does it seem that health care in America is so badly served by the health insurance industry?

Posted by: anne3 | September 10, 2009 12:49 PM | Report abuse

Tell me when you all find the "supermarket" for insurance. What is this the new blitz from the insurance lobby? Toss up a canard of percentages for a 500B+ industry that cares more about their stock price than they do health-care. Hardly surprising to find a Kudlow-like argument from fresh-water, market extremists that brought us such hits as "Washington Consensus", 5+ trillion bank recap, manufacturing accounting for only 9% of workforce [[[[Perry]]]], and 16%+ of gdp for health care.

Posted by: mikeVA1 | September 10, 2009 1:27 PM | Report abuse

wrongfuldeath, I see compassion is not your long suit.

The difference between food and health care are several orders of magnitude.

I don't see patients in my ICU beds due to lack of food, but due to lack of access to care. People rarely lose their homes, their cars, or file for bankruptcy due to food costs.

We have, as a nation, decided to help those in hunger with food stamps, WIC and other programs, we decided in 1965 that allowing the elderly to die and suffer without access to health care was no longer acceptable, and in 1935, we decided allowing the elderly to really suffer in poverty and hunger was not acceptable.

We are the only modern nation that still seems to believe, based upon our lack of action, that our poor do not deserve access to good quality health care on at least a comparable footing with the rest of us.

Go find a physician or a nurse and have a laugh with them with your comparison. Nearly all will be aghast at your callousness. You will find some who support you, but their numbers are thankfully dwindling. Those in the leadership of medicine KNOW that we must advocate for high quality health care for all Americans, not just those who can afford it.

I've compiled a list of physicians organizations advocating for health care, to give you an idea of how cold your statements are to those of us in the front lines actually taking care of those "undeserving sick":

http://cmhmd.blogspot.com/2009/09/organized-medicine-on-reform.html

And some anecdotes for you and your friends to have a laugh about:
http://cmhmd.blogspot.com/2009/09/daily-kos-few-anecdotes-about-medical.html


Posted by: cmhmd | September 10, 2009 3:12 PM | Report abuse

Everyday I become more and more convinced that the biggest problem (in terms of costs) in our health care system is the employer-based system. not only does it create a system where consumers dont feel the cost and therefore dont make sound competitive decisions but it also puts little pressure on insurers to reduce costs. the insurance companies dont really care what the cost of drugs etc is since they can pass those costs directly onto consumers who since they only pay part dont feel the full force of premium increases.


anyhoo, the big waste where it comes to the insurance companies is in executive compensation. it's not about profit margins it's about millions in executive compensation.

Posted by: PindarPushkin | September 10, 2009 3:19 PM | Report abuse

Why not offer Medicare, Medicaid, Federal Employees & Veteran Affairs health plans as FPPO - For Profit Public Options? You can require by law that the government set a price that will give it a higher profit margin than the health insurance industry as a whole. Furthermore, you can allow each state to decide if the plans may be offered within them. By adding 3.4% to the price of the policies you make it much harder for the Republicans to vote against it.

http://differentspeeds.blogspot.com/2009/09/easy-deal.html

Posted by: differentspeeds | September 10, 2009 7:05 PM | Report abuse

What numbers for the industry of insurance do show the creation of value and efficiency? Software gets twenty percent in a highly competitive and relatively open market. The world gets innovation and all the people win.

Insurance of the United States on the other hand in their political markets make all the people lose! Every year the industry wants more and more to fuel inefficiency and waste, and now we want them to write the bill? How about we pick a mode regulation or single payer and fix this winner and loser system that gambles with peoples health?

Posted by: mikeVA1 | September 11, 2009 10:32 AM | Report abuse

Well, the mechanics of auctions work fine. Congress people sell legislation all the time. Thanks Nancy, Rahm and Obama.

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Posted by: mikeVA1 | September 11, 2009 8:23 PM | Report abuse

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