Are health insurance companies making unreasonable profits?

People in suits throw money into the air and gather it from the ground
It's a common assumption that health insurer profits must be excessive. But they're actually much lower than most other industries. Michael Blann/DigitalVision/Getty Images

One of the common criticisms leveled at private health insurance companies is that they are profiting at the expense of sick people. But let's take a closer look at the data and see where it takes us.

How common is private health insurance?

According to Kaiser Family Foundation data, a little more than a third of Americans had public health insurance in 2014 (mostly Medicare and Medicaid). Another 10% were uninsured, but the rest have private health insurance that they either purchased on their own in the individual market or coverage provided by an employer.

Nearly half of Americans have coverage provided by an employer, although 63% of them have coverage that's partially or fully self-funded by the employer (that means the employer has its own fund for covering medical costs, rather than purchasing coverage from a health insurance carrier).

But many Medicare and Medicaid beneficiaries also have coverage that's provided via a private health insurance company, despite the fact that they are enrolled in publicly-funded healthcare plans. 31% of Medicare beneficiaries are enrolled in Medicare Advantage plans run by private health insurance carriers, and 39 states have Medicaid managed care contracts with private carriers to cover some or all of their Medicaid enrollees. Even among Original Medicare beneficiaries, nearly a quarter have Medigap plans purchased from private health insurance carriers.

When we put all that together, it's clear that a significant number of Americans have health coverage that's provided or managed by a private health insurance company.

And private health insurance companies tend to get a bad rap when it comes to healthcare costs.

Are insurer profits unreasonable?

A recent Huffington Post article details the author's attempts to find coverage after New York officials announced that Health Republic coverage would end as of November 30.

The article appears to conflate revenue with profits, which add to the confusion. Of course major health insurance carriers have significant revenue, given that they're collecting premiums for so many insureds (for example, Anthem has 38 million members).

But regardless of how much revenue carriers collect in premiums, they're required to spend most of it on medical claims and healthcare quality improvements. And although a common criticism is that health insurance companies pay their CEOs too much, that's more reflective of the fact that CEO salary growth in general has far outpaced overall wage growth over the past several decades. There are no health insurance carriers represented among the 100 firms with the highest-paid CEOs - although there are several pharmaceutical companies.

So while a seven or eight-figure CEO salary seems absurd to the average worker, it's certainly in line with the corporate norm. And health insurance company CEOs are not among the highest paid CEOs of large companies. The fact remains that salaries are part of the administrative costs that health insurance companies are required to limit under the Affordable Care Act's medical loss ratio (MLR) rules. And so are profits.

How much do health insurers profit?

If we look average profit margins by industry, health insurance companies are pretty close to the bottom, with an overall average profit margin of just 3.3%. For perspective, the banking and real estate industries have profit margins that average over 20%, and major drug manufacturers average profit margins of nearly 22%.

The ACA implemented MLR guidelines that require health insurance companies to spend the bulk of what they collect in premiums on medical claims. That automatically limits their administrative expenses - including executive compensation and profits - to no more than 20% of premium revenue.

But there's no similar requirement for hospitals, device manufacturers, or drug manufacturers.

Healthcare costs are the driving factor behind health insurance premiums. It's true that private health insurance companies pay their CEOs competitive salaries and they must remain profitable in order to stay in business. But their profits are very modest when compared with other industries.

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