Motley Fool versus Administrative Cost Caps

It’s kind of surprising for me to be bringing a column from the Motley Fool web site concerning a fairly arcane aspect of the health care reform debate: requiring carriers to spend at least 85% of premium dollars they receive on medical costs. This approach to tamping down escalating health insurance premiums is advocated by Governor Arnold Schwarzenegger, leading Democrats in the state legislature and, on the national front, by former Senator John Edwards.

It was Senator Edward’s recent speech calling for a 15% administrative cost cap which caught the eye Motley Fool writer Rich Smith. In an online column entitled “John Edwards’ Fuzzy Insurance Math,” Smith takes the Senator to task for proposing a reform which simply doesn’t add up.

Senator Edwards claimed health insurers currently spend 30% of premiums on administrative costs and profits. The Senator believes, as does the Governor and others, that no more than 15% of premiums should be spent on such things. In questioning the presidential candidate’s proposal (a candidacy the reporter claims to support) Mr. Smith cites statistics showing the actual number is closer to 21%.

But he goes on to say that a 15% cap would risk putting the insurers out of business, citing the margins enjoyed by some of the leading health insurance carriers:

    Gross Margin    
    Operating Margin    
    Net Margin    
Aetna

30%

11%

7%

Cigna

43%

11%

6%

Coventry Health Care

29%

10%

7%

Humana

18%

3%

2%

UnitedHealth Group

25%

10%

6%

 WellPoint

25%

9%

5%

Margins are trailing-12-months.

Since none of these major health plans currently enjoy the 15% operating margin necessary to fund Senator Edward’s 15-point reduction in margins, Mr. Smith notes that each of these currently profitable companies would begin losing money.

Mr. Smith notes this would encourage the carriers to achieve one of Senator Edward’s goal for his proposal: to make the insurance companies operate more efficiently. However, Mr. Smith also notes that when a company is forced to quickly become more efficient, it “automates some functions, outsources others, and lays off employees in droves.”

Of course, there’s another way for carriers to address a mandated percentage. It seems that every factor has a numerator and denomenator. So forced to achieve a medical cost ratio of 85%, carriers could eliminate disease management programs, reduce customer service staffs, fire some attorneys and reduce commissions. That would address the numerator. But they could also address the denominator by increasing premiums — or eliminating low cost plans. After all, the greater their premium the more they have to spend on operations. This approach isn’t what advocates of the administrative cost cap are seeking to accomplish, but it is a likely result of this approach.

So it’s not just fuzzy math reformers need to guard against. It’s also unintended consequences they should avoid. And they don’t have to take my word for it. They can listen to any ol’ motley fool.

3 thoughts on “Motley Fool versus Administrative Cost Caps

  1. Putting bureacratic federal officials in charge of the health system will bankrupt tax paying citizens. Once we go down that road you can bet the government will approve tax-payer funded spending on even more fringe related health or non-health issues. Congress cannot stop themselves from spending money as it is. Do you folks really want to give them control over your health care? I guarantee you that if this ever passes you will find Mexico doctors setting up across the border to gladly help those unable to get assistance from the government run health care system in the U.S. Meanwhile Michael Moore will just be returning in his private jet from Europe on a trip to see his private doctor.

  2. Thanks for the comment, David. As you note, the Governor emphasizes his health care reform plan contains gain and pain for all stakeholders. For carriers, part of that pain is the 85% administrative cost cap. My concern is that while the carriers may suffer, consumers will suffer even more due to the unintended consequences discussed in my posts.
    So what could replace the administrative cap? I’ve heard the Governor’s staff raises the spectre of supporting rate regulation as an alternative. That approach has it’s own set of problems.
    I think most folks would perceive the mandate to sell as an appropriate pain. By losing the ability to underwrite individual applicants, the carriers face huge risks of adverse selection. Of course, whether this is sufficient pain in the eyes of the other stakeholders is something I can’t answer.
    By the way, while the Governor claims there’s both gain and pain for everyone in his package, I can’t find the gain for agents. The pain is obvious: the purchasing pool siphons business away to a state agency from which agents are excluded; and the administrative cap leaves little room for carriers to pay a living wage. The gain is obscure. The Governor’s staff says agents will benefit from fewer uninsureds, but since most of the newly insured will be receiving premium subsidies, and since the Governor’s plan segregates consumers receiving subsidies into the purchasing pool, there’s no real gain there.

    As concerned citizens, I think most agents want to see the heatlh care system improved. That’s why CAHU came forward with Healthy Solutions — a realistic and comprehensive health care reform plan. But as stakeholders, I don’t see the benefits to earn agents support of the overall package.

  3. Alan – it does seem that the proposals for an admin cost cap on the carriers are widely considered to be foolish on a number of levels. There is one angle on this, though, that I haven’t seen much discussion on. The proposed Schwarzenegger reforms are essentially a political bargain between the various stakeholders, and the proposals seem to be deliberately arranged to provide a balance of pain and gain to all stakeholders. So for the carriers, the gain is the extra business resulting in the mandate to buy; the pain is the admin cost cap. My question is: if the admin cost cap requirement is removed, where is the pain for the carriers that will be required to keep all the other stakeholders on board with the overall package?

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