How profitable are health insurance companies?

by on September 2, 2009 at 12:55 pm in Economics | Permalink

Here is one report:

Health insurers, in fact, ranked below many other industries in
profitability, including other health sectors, according to the latest
Fortune magazine rankings. While pharmaceutical companies were the
third-most profitable industry last year, with a 19.3 percent profit
margin, health insurers ranked 35th, with a 2.2 percent profit margin.
Health insurers also ranked lower in profitability than medical
products and equipment makers, pharmacies and medical facilities.

Here is a related list on relative profitability.  It's true that profits are up a lot in percentage terms since 2000 but that doesn't mean profits are high.  Of course it is possible these accounting measures of profit are lies or misleading.

Here are the share prices of Aetna over time and make sure you notice the splits.  It's not clear we can infer anything from this data (for instance if the monopoly position were evident from the beginning, equity returns would be quite modest), but if you wish you can peruse Yahoo Finance for evidence.  I don't find it.  Recent low equity returns may be the downturn at work but the original question is how profitable these companies are in absolute terms.

I'm very willing to "Cry Uncle" on this one because all I've done is some blogger research using Google.  But I would genuinely like to know: if you favor a public plan, or if you think insurance companies are holding strong monopoly positions, what is your evidence for their extreme profitability?  If you go to the second link you'll see lots of people claiming the companies are very profitable and should be squeezed in some manner.  Or do you simply think the companies are not very profitable?

I thank Robert Olson and several other MR readers for related queries.

Phil Steinmeyer September 2, 2009 at 1:07 pm

To support a reduction in the role of private insurance companies (either via a public option, or even single (government) payer, it is not necessary to show that insurers are excessively profitable.

While that *could* constitute a reasonable argument, there are other possible reasons for a more public approach, including the possibility that private insurers don’t add much value. i.e. If a large percentage of the revenue that goes to insurers is spent on sales and marketing marketing, claims battles with providers and customers and similar stuff (i.e. not health care itself), then it *might* be possible to significantly reduce such costs without reducing the quality of health care provided, in a more government-centric system.

Mind you, I don’t know if this is true (that insurers spend lots on sales, marketing, claims battles, and the like), and even if they do, it is possible that at least some of that would still be necessary, perhaps in a slightly different form, in a government system.

(And the above also regards an array of arguments for and against more government involvement in health care that don’t necessarily go directly to cost structure.)

The Incidental Economist September 2, 2009 at 1:10 pm

The health economics literature suggests that providers, not insurers, have the upper hand in the market place. Findings are that greater health insurer market concentration is not associated with monopsony power and suggests that insurers use their power to offset monopolistic providers.

More at http://theincidentaleconomist.com/who-has-power-health-insurers-vs-providers/

Memnon September 2, 2009 at 1:27 pm

Profit margins are misleading in this sense, ROEs should be used instead — health insurance companies have much less capital

Andrew September 2, 2009 at 1:37 pm

I don’t like profit margins and comparing them to other medical companies doesn’t make much sense either. I’d compare them to banks. I don’t think you are wrong, but maybe I have done even less research than you did. I concluded you really really don’t want to own a bad insurance company. I’ll take a bad drug company any day.

“the larger issue is whether or not insurance companies are making health care decisions based on profitability. It would be beside the point if they were (or were not) immensely profitable.”

In that case, the real issue is whether the government would NOT make healthcare decisions based on (non)profitability, would they act any differently. And, considering the fact that their main selling point (and actual motivation) was cost cutting, I think the answer is no.

sash September 2, 2009 at 1:41 pm

I’m not sure profitability is relevant. Isn’t it possible that management extracts the monopoly profits for itself in the terms of salaries and percs?

Glenn Schafer September 2, 2009 at 1:51 pm

Lets do another exercise. Lets eliminate all of the profits of all of the health insurers in the US and compare that to the total spent on health care including Medicare and Medicaid. I haven’t done the exact math but the number would be around a 1% reduction in health care costs. It hardly solves the problem. By the way another interesting statistic is that projected medicare fraud exceeds all of the profits of all of the health insurers. Looking at the problem this way brings it into prospective. You can do this for lots of industries for instance if you eliminated all of the profits of the oil companies you could reduce the price of gasoline about 10 cents a gallon out of a $3 dollar cost and then of course we woul have no gas.

Ben September 2, 2009 at 2:00 pm

Return on Equity (ROE) is also somewhat misleading, as it is distorted by how a company chooses to finance itself, say, with either a lot of debt or a little debt. Higher debt will increase ROE if things are going well, and decrease ROE if things are going poorly. Either way, it is a financing decision for management and doesn’t tell you about the underlying quality of the business.

For that, you want to learn at Return on Invested Capital, best to look at it pretax in order to wash out the tax noise. Calcuation is EBIT/Invested Capital.
EBIT = Earnings Before Interest & Taxes
Invested Capital = Asset less non-interest bearing current liabilities. Basically, this is the amount you would have to put up in order to run the business. The reason to use Invested Capital vs. Assets is that owners can current liabilities to finance business. Example: Company has $500m in assets and $200m in ongoing Accounts Payable, Invested Capital is $300m, as company is being financed by vendors (accounts payable line) at no cost for $200m.

So return on invested capital comes down to two things: profit margins and asset turns. A company like Costco will have very slim margins, high asset turns, and an excellent ROIC.

Generally, the people making arguments about profits margins know better and are just trying to muddle the issue. Example, Exxon runs ads every know and then comparing their margins vs. software companies (worthless) and the other day the WSJ had an op-ed on health insurer margins (equally worthless).

jpq September 2, 2009 at 2:11 pm

Their margins may be low, but their ROE (as others have mentioned) and their total profits are quite large. And how many quarters in the last ten years have large pharmaceutical companies posted a loss? At least a few. How many quarters have the large insurance companies posted a loss? That would be none.

Insurance companies rarely ever lose money, they just lay off their staff and start denying claims. That’s what has people upset, not the relative profit margin but rather the consistent profits.

hibikir September 2, 2009 at 2:17 pm

There’s no question that the extremely high profits are further down the line: All you have to do is see the size of the invoices received by the insurance companies for treatment, and compare them to European equivalents at private practices. As an example, I just saw that my kid’s 4 month pediatrician visit, which included 3 vaccinations, cost my insurance company $700+ for 45 minutes and the vaccinations, which cost the pediatrician a little under $200.

Emergency room visit for mild anaphilaxis? $1000 for an hour. requiring a simple IV.

That said, the advantages of a public plan are still there, but they are not economical: What we get is guaranteed coverage, and no denied benefits because someone forgot to fill out an allergy in their application. It’s up to you to come up what’s the value of that.

Andrew Edwards September 2, 2009 at 2:31 pm

I should also have noted that most of an insurance company’s “costs” are actually accounting costs (expected future payouts need to be set against the current year’s premiums that incur those future costs). Most firms, of course, do their honest best to get it right, and actuarial tables are pretty good on this stuff I imagine, but “profit” is still a very different concept from “how much more money our owners have this year than they did last year”, in ways very particular to the business of insurance.

MBP September 2, 2009 at 3:12 pm

While true that it’s not necessary to believe that health insurers are monopolistic as a prerequisite to favor a public plan, this is the argument that Obama and Democrats have been making lately in favor of a public plan. I think many of the comments here miss this point.

I agree that profit margin is probably not the most relevant measure of monopoly power or attractiveness of a given business. I also prefer ROIC. And the average ROIC for the 7 largest publicly traded health insurers (AET CI CVH HNT HUM UNH WLP) was 8.0% in 2008. This compares to the average ofr big pharma of 14%, for drug distributors of 11%, for medical device co’s of 16%, or big biotech of 14%. Obviously managed care companies returns are not superior to most other companies in the health care sector. Isn’t that a sign that they do not hold monopoly positions?

And honestly, i see absolutely no evidence that they have any monopoly power. About half of all people who have insurance are insured through non-profit companies (many Blue Cross plans, Kaiser, Harvard, etc). These plans do not have the same uses for their excess capital (ie share buybacks and dividends), thus they tend to return excess capital to policyholders in the form of lower rates — which exerts downward pressure on the rates that can be charged by publicly traded insurers.

The only barrier to entry for insurers is access to capital. If the health insurance business had monopoly profits why wouldn’t it attract more capital from either start-ups or companies like Met Life, Prudential, GEICO, etc that already operate in other insurance businesses?

Health insurance isnt as commodified as life insurance or P&C, but no single company has significant pricing power. Employers will switch insurers for a 100-200 bps.

It seems to me that the only “evidence” that is ever cited about monopoly power is something along the lines of, “Blue Cross of Alabama has 70% market share in the state”, therefore it has monopoly power. First that’s misleading, because it certainly doesnt mean that the company insures 70% of the people in the state. Almost all large companies self-insure, meaning for example that Coca Cola probably contracts with a national insurer to administer its plan in AL. Second, as others have said, providers (especially hospitals) are much more monopolistic than insurers — especially in rural areas. Third, it seems almost laughable that people would accuse a non-profit (such as Blue Cross of AL) of being a monopoly.

Joe September 2, 2009 at 3:17 pm

David,

Pharma is extremely competitive, but margisn are still high(but shrinking: those insurance companies no longer want topay for drugs that are not that effective, ie they are rationing as they should, and making the consumer pay more cash for newer drugs). Sure, each product has a patent, but then there are multiple patented drugs in a class and price still does not come down. See the 1990s for numerous exapmles (statins, PPI, ACEI, ARBs, Antihistamines, antibiotics, and actually insulin prices have increased with more competition!!!)

athelas September 2, 2009 at 3:39 pm

I agree with sash, monopoly rents may show up in inefficient business practices, or be extracted by management or staff. By the way “monopolistic insurance companies” doesn’t necessarily imply public plan; it could also be used to favor Republican plans to delink insurance and employment and trade insurance across state lines, introducing more competition.

Floccina September 2, 2009 at 3:44 pm

If all the people who object to the way that the health insurers act, minimized dealings with the insurers by buying very high deductible (upwards $30,000 per year)insurance, I think we would be better off.

fusion September 2, 2009 at 4:17 pm

The question is not the profitability of insurance companies. The question is cost to the consumer with a public option.

It’s possible, for example, that insurance companies spend a lot on activities that bring no value to healthcare consumers, such as attempts to deny claims.

rpl September 2, 2009 at 4:34 pm

Bead,

I don’t think it’s as “simple” as you make it out to be. If the government plan promises coverage regardless of existing conditions, then it’s going to incur a lot of costs. Where will it make up those costs? Or will it just be really expensive? As for losing your insurance when you lose your job, we can fix that without a public plan. All we have to do is eliminate the privileged tax status of employer-provided plans and allow shopping for insurance across state lines. It is, to borrow your phrase, simple.

For the people arguing that ROIC is more appropriate than net margin for this discussion, doesn’t net margin provide a valid measure of how much savings you can wring out of the system solely by eliminating profits? I think that was the point of introducing margins into the discussion.

MBP September 2, 2009 at 5:05 pm

Too many commenters are letting their views on reform color their posts here, I think. Obama and some Dems have accused the health insurers of being monopolistic and has used this as support for a government run public plan. Based on this, 1) Are health insurers monopolistic? 2) If they are, how is this manifested in their financial results? or 3) Tyler seems to assume that monopoly power leads to some kind of financial gain, but if it does not, and you still believe that they are monopolies — then please provide evidence.

Again i submit that ROIC suggests no monopoly power in product pricing, no monopoly power over cost of inputs (many of which operate at higher ROICs including pharma, med-tech, bio-tech). I’d also note that health insurers are consistently UNABLE to raise their prices above increases in medical inflation.

BKarn September 2, 2009 at 5:52 pm

“Other countries with many fewer resources than the US have higher life expectancies, lower infant mortality rates and simply better health care – for less.”

It’s my understanding that standardized life expectancies in other nations are not higher, and that lower infant mortality rates are largely a product of accounting differences. I know factually from a large number of studies on individual outcomes that the U.S. frequently outperforms competing nations, though it underperforms them on somewhat more abstract measures of ‘fairness’ of coverage. It would be very nice to see these issues addressed.

John Dewey September 2, 2009 at 6:37 pm

fusion: “It’s possible, for example, that insurance companies spend a lot on activities that bring no value to healthcare consumers, such as attempts to deny claims. “

Doesn’t that bring enormous value to consumers? If insurance companies paid all claims, wouldn’t fraud cost those companies many billions of dollars? If so, then wouldn’t that drive the cost of private health insurance even higher? Just as Walmart holds down costs by stationing receipt checkers at the door, so too do the insurance companies hold down costs by ensuring that claims are valid. In both cases, the consumer benefits from lower prices.

The problem with Medicare is that it doesn’t do enough to deny claims. Medicare fraud has been estimated to be as high as 20% of overall medicare expenditures, or $80 billion annually. Yet Medicare spends only $120 million annually on fraud investigation. We taxpayers would be far better off if Medicare were as diligent as private insurors at validating claims. Of course, if Medicare made life too difficult for seniors, Congress would immediately investigate claims of abuse.

Those who insure us act in our best interests when they ensure claims are valid.

kingstu September 2, 2009 at 8:05 pm

Profit margin is a perfectly fine measurement to illustrate relative market power. Look at industries with the highest margins (i.e. software and pharma). Notice anything about those two industries? They have a tremendous amount of market power because they are granted an intellectual monopoly by the government. Therefore, they charge monopolist prices.

Insurance is a highly competitive commodity product. Software and pharma have government granted intellectual monopolies. It isn’t too hard to see which industries have the most market power, just look at profit margins.

The other metrics mentioned previously (ROIC, ROE, etc) are much better at picking good investments but for measuring market power, profit margin is a good indicator.

James September 2, 2009 at 8:31 pm

Dan Carroll,

Your example seems to undermine your argument. Before the meltdown, Fannie and Freddie were publicly traded for profit companies. Perhaps you should try a more thoughtful examination of markets.

Robert Olson September 2, 2009 at 10:59 pm

Oooohhh, a shoutout. Thanks TC!

Profit margins are certainly relevant, since monopoly power is basically defined as being able to charge above your MC. Margins may not be comparable across industries (maybe insurers don’t contribute that much so margins should “only be” around X% instead of Y%) and Return on Equity may be a better indicator, but higher RoE can be accomplished just be levering up, which is inherently risky and is going to require a higher RoE to compensate.
But if we want to talk RoE, that’s alright:
Aetna RoE:
2008: 16.9%
2007: 18.29%
2006: 18.43%
2005: 15.4%

Target RoE:
2008: 16%
2007: 18.6%
2006: 17.8%
2005: 16.95%

I don’t really consider Target to be a monopoly. Some pricing power, perhaps, but Aetna is also running on a higher debt (22% equity/debt as opposed to 31%).

And private insurers may be absurdly inefficient, something I happen to agree with, but, IIRC, those Ezra Klein numbers show this is more of a returns to scale thing as opposed to a “greedy company” thing. Which puts the whole “companies losing health coverage” business in a different light.

I don’t think this is a conclusive analysis by any means, but I’d need to see some more data than what I have right now to place blame on insurance companies profits for ramping up costs.

Another key factor is, if it isn’t profits but just the way insurance works, you shouldn’t even bother with public options at all and just adopt single payer outright.

T J Sawyer September 3, 2009 at 1:38 am

Two points:

First, profit margins are a dandy way to look at the insurance industry since you readily see that eliminating them wouldn’t make a significant reduction in the total revenue stream. So look elsewhere.

Second, the whole “health care” debate was premised on this: “We pay too much for health care – 16% of GDP.” So to reduce that, you must reduce what is paid to doctors, nurses and other health care workers – that is the majority of the expense. Do you know any healthcare workers? Are they “wealthy”? Probably not unless they are doing plastic surgery in Hollywood.

But I could reduce health care expense by about 25% tomorrow. Just ask any clinic or hospital to tell you who receives their biggest weekly payment. I’d just eliminate all income and payroll taxes. There, done.

Oliver Rivers September 3, 2009 at 3:15 am

Well like you I’m relying data I’ve pulled off the internet in the space of two minutes, but it looks to me as though (at least some) insurers are doing pretty nicely, thank you. Rather than profitability, look at return on equity; are the companies generating a return on equity greater than investors’ cost of equity? Answer – yes:

United Health 17.0%
Aetna 13.5%
Cigna 13.0%
Wellpoint 11.5%

With the exception of Wellpoint, those are comfortably above the companies’ cost of equity and – as I hope we all know – in perfectly competitive markets firms should earn their cost of equity and no more.

So – the financial data simply do not support the assertion that health insurers are performing poorly financially (at least not these ones).

Though its conceivable that these spreads over long-term cost of equity could be attributble to managers doing clever stuff, it seems at least as likely that these returns are a consequence of health insurers exploiting quasi monopoly power to gouge their customers.

Al Brown September 3, 2009 at 4:00 am

wow. the public option. We HAVE already seen it in action. Over in the mortgage market.

Excellent point, Dan Carroll.

Could a private organization, unsubsidized by the government in any way, ever create the destruction that Fannie and Freddie have, even if it wanted to? Not to mention that the profit motive rewards you for creating assets and wealth, not for destroying them.

Roger, FCD September 3, 2009 at 4:37 pm

“Could a private organization, unsubsidized by the government in any way, ever create the destruction that Fannie and Freddie have, even if it wanted to?”
-Al Brown

For your answer to this, I respectfully point you in the direction of Wall Street.

mainliner September 18, 2009 at 7:42 pm

Is health insurance profitability calculated strictly based on insurance premiums collected vs expenses (salaries, claims paid, operational costs, marketing/advertising, lobbying activities, etc.)? But insurance companies also make huge investments with all the money they collect from premiums. How are these investment returns accounted for in their balance sheets?

Patrick March 9, 2010 at 3:45 pm

I hope we all agree that it is terribly important to all of us for the health insurance companies to be profitable regardless of your stance on the health care debate. What is important to recognize is the monopolistic hold they have over us and the net effect this has on health care in general. The current issue in California is a terrific example of the arrogance and irresponsible behavior exhibited by the health insurance companies. The least offensive insurance company in California denied 1 in 5 claims last year – so by simple analysis, even visits to primary care physicians were being denied payment. The worst offender in California – I want to say it is Pacific Health – denied a whopping 47% of claims. To add insult to injury, on average, these companies are raising premiums 39% this year. This makes losing customers a non-issue as the increase in revenue more than offsets the loss in customers. Pair this with the fact that there are but a handful of insurance companies and this whole thing begins to take on the shape of a price fixing conspiracy. There are currently 47 million Americans in this country who are either uninsured or underinsured. One of the biggest cost to health care providers is caring for and covering the cost of medical treatment for the uninsured. This forces them to raise their costs for the insured which in turn creates even more people who are incapable of paying these ever increasing premiums. Unfortunately, for too long the benefits have been going to the insurance companies, pharmaceutical companies and medical supply manufacturers. It is time to let the pendulum swing in the opposite direction with the hope that down the road we find a happy medium.

Dragomir May 22, 2010 at 12:50 pm

Insurance companies are very rich because they know how to protect their investments and they have the smartest and most capable people working for them. But because of that it’s hard to find affordable bcbs Georgia. With the new health care reform bill, maybe more people will be able to afford health insurance.

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