Unintended Consequences: The Downside of Limiting Health-Insurance Overhead

The major insurance companies are spending less on patient care than the new Affordable Care Act requires, according to a Senate report. As a result, they may have to rebate hundreds of millions of dollars to consumers. State and federal regulators can deal with the expected fancy accounting insurers will undoubtedly employ to keep up their margins, but it's only one of the unintended consequences that this provision could create.

Under the healthcare-reform legislation, the carriers must spend at least 85 percent of their premium revenue on medical care in the large-group market. For individuals and small firms, the health plans must spend at least 80 percent on patient care. The Senate Committee on Commerce, Science and Transportation, headed by Jay Rockefeller (D-W. Va.), reports that, on average, the six largest insurers met the 85 percent threshold for large-group insurance in 2009. However, they spent only 74 percent of premiums for health care in the individual and small-group markets. UnitedHealth Group (UNH) fell below the minimum in all three segments; Coventry (CVH) sank below it in the small-group sector; and only Cigna (CI) made the grade in the individual insurance market.

The law specifies that the insurers must rebate to their policyholders the portion of premiums that falls below the threshold. Thus, for example, if an insurer spent only 78 percent of premiums on medical care in the small-group market, it would have to rebate 2 percent to its customers on a pro-rated basis.

There are a few flaws in the report's analysis. For one thing, the researchers considered only fully insured plans, and most large companies insure themselves, hiring insurance firms to administer their plans. Also, the report's authors seem surprised that insurers spend so much more on administration and profits in the individual and small-group markets than in the large-group segment. Obviously, it's much more difficult and costly to administer a lot of different health plans for individuals than one plan that may cover hundreds or thousands of employees.

Some insurers, such as WellPoint (WLP), are already reclassifying certain administrative costs as medical costs so that they don't have to pay rebates. The National Association of Insurance Commissioners is working on a standard definition of what constitutes an administrative or a medical expense for purposes of calculating the "medical loss ratios" of insurers.

That term alone tells everything you need to know about what insurance companies think about paying medical expenses. In their view, every dollar paid out in claims is one dollar less for administration, profits, or reserves. One analyst estimates that insurers will have to "shift" their medical loss ratios by at least 5 points through creative accounting to maintain their profits.

I don't think the government will allow this. But insurers have another way to protect their profits besides playing accounting games: they can simply raise their rates. While they'd have to spend more on patient care, they'd also earn more on the expanded revenues. Whether they do this, or pass more financial risk to providers, or reclassify their administrative costs, they'll find some way to maximize profits and reward their executives and shareholders. The government can't reduce their profitability by decree -- unless it's willing to eliminate private insurance.

Image supplied courtesy of Wikimedia Commons.