Insurance Industry Profits are an Insignificant Part of Total Health Costs

Advocates of increased government involvement in health care frequently cite the profits of private health care providers as a major part of the costs of health care. The numbers, however, show that health insurance and managed care industry profits are 0.36% of the national bill for health care. If the compensation of industry executives is added as part of the alleged problem, then the industry accounts for 0.37% of total costs. The notion that industry profits are responsible for rising health care costs is a fraud.

An example of the criticism is that of Representative Anthony Weiner (D-NY) on the Rachel Maddow show, who said, speaking of proposed legislation that would heavily tax the health insurance industry:

“Well, the one behavioral change we are clearly not going to see is the insurance companies aren’t going to suddenly start saying, ‘You know what, we are going to stop making 30 percent profits and cut it down to 10 percent or 5 percent because of this bill.’ “

So are the insurance company profits really 30%, as claimed?

Fortune magazine rated the health insurance industry as the 35th most profitable of 53 industries surveyed for 2008:

Health Care: Insurance and Managed Care 2.2%

In 2006, in better economic times, according to CNN, health insurance company profits were 7.1%. In the Yahoo Finance ranking of industries (they divide industry into more categories than Fortune) by profitability, “Health Care Plans” rank 84th, with a profitability of 3.3%.

Total insurance company profits were $12.87 billion in 2007 and $8.40 billion in 2008. Total health care spending in the United States was $2.2 trillion in 2007. Insurance company profits were therefore 0.59% of total health care costs in 2007. Since total costs have been rising at about 6%, the insurance company profits would be about 0.36% of total health care costs in 2008.

Ten companies account for the health insurance company profits. The highest paid executive received about $11 million, and the others much less, going down to a few million. In each company the top guy gets by far the largest compensation. The pattern I’ve seen is that the top person at any large company gets about half of the total pay. To be generous, I will suppose that the average top pay is $8 million, and that it is only a third of the total executive pay. So that would make the total for the industry 10 x $8 million x 3 = $240 million. The industry profits were $12.87 billion and $8.4 billion, so $0.24 billion would be added using Con’s definition of profit. that would make the contributions to total health care costs rise from 0.59% and 0.36% to 0.596% and 0.37%, respectively. Even if one were to indulge fantasies that executive compensation were much higher than I had supposed, it would not approach being a major part of health care costs.

Critics counting the numbers from public records for top execs claim that compensation was about $115 million in 2007 and less in 2008. That’s much less than the $240 million I’ve estimated. My estimate includes a factor for second-tier execs.

It’s worth noting that executives earn their pay by reducing costs. In Medicare, some put fraud as 20% of the programs costs. That would be 20% of $440 billion, $88 billion. Private insurance companies police fraud, so their losses to fraud are much less.

The hard numbers do not support critics arguments, so they avoid the numbers by spinning percentages. Percentage increases in profits do not mean the profits were significant. If your business made $10 last year and $100 this year, that’s a 900% increase, but it doesn’t imply you are ready to retire on the Riviera. Insurance companies have made billions, but as we have seen, the billions are not a significant part of the trillions involved in health care.

The health insurance industry profits rose “from $2.41 billion in 2001 to $12.87 billion in 2007.” Thus, I included the highest profit year, when the profits were 0.57% of total spending. Critics uniformly ignore the decline in profits since 2007. The profits in health insurance vary between about 2% and 8%.

To make a more dramatic story, critics ignore the 2008 data. It’s likely 2009 will be even worse, so of course that will have to be ignored as well. What the large percentage changes mean is that the industry is volatile. Anything that can go up rapidly is subject to coming down just as rapidly. Profit margins of 2% to 8% are well below the 9% average for the market as whole, so the picture is not particularly attractive.

Critics also try to spin the profit percentages by claiming that reserve funds keep by insurance companies should not be included in basis for calculating profits. That’s nonsense because the main way that insurance companies make money is by investing the funds held in trust. That’s true of life insurance and virtually all forms of insurance. An insurance company may actually pay out in benefits more than it receives in premiums. A large part of profit comes from investing the reserves, and an insurance company that does a better investment job earns more profit. That’s what they do for a living.

Besides, using a definition of profit that is not shared by anyone in the financial community is a scam in the first place.

Note that changing the definition of profit changes the percentages with respect to the company, but not to the total cost of health care. Even if it is deemed a million percent company profit, it is still $8.4 billion of the $2.2 trillion in health care costs. That’s 0.36%, an insignificant part of the total cost.

Explore posts in the same categories: Economy, Opinion

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