During the health care reform debate, there was a great deal of talk about insurance company profits, and the portion of premiums actually spent on health care expenses. Politicians worked hard at convincing Americans that insurance companies charged too much and paid too little in claims for the premiums collected.
So what is the loss ratio? Look at it this way, if an insurance company collects $100 in premium and pays out $80 in claims the loss ratio is 80. Loss ratios range from 60 to nearly 100 with an average of between 80 and 85. In other words, 80 to 85% of all premiums collected go to pay the insured’s medical claims. The other 20 to 15% goes to administration, overhead, compensation for employees, advertising, etc.
Loss ratios are much lower in other forms of insurance such as property and casualty and auto insurance. In other words, less of your premium goes to paying claims than under health insurance.
If a large company employs you, the chances are loss ratio does not matter because your employer is likely self-insured and does not pay premiums to an insurance company. Rather the employer pays the actual claim costs and a negotiated fee to the administrator of the plan – many times a large insurance company. About 70 million Americans are covered under such plans.
Under the Patient Protection Affordable Care Act, the federal government gets into the act of limiting the loss ratio. Depending on the type of plan, under the new law insurance companies must return 80 to 85% of premium in terms of health care costs. That sounds simple until you begin to think about how various expenses are classified. That is, are they directly related to the health benefits or are they simply insurance company expenses (and profit)? As with many things in PPACA, there are unintended consequences. A good opinion piece in the Wall Street Journal goes into more detail on this issue, but here is the essence of it.
It is clear that paying hospital and physician bills are claim costs that belong in the 85% loss ratio, but what about a nurse hotline that helps patients understand their care or what questions to ask the doctor? What if your health plan has a program that manages health care by trying to avoid unnecessary services, is that beneficial in holding down costs and improving the quality of health care? Should it be part of the loss ratio? The government will decide the answers.
So what are the consequences? If an expense shifts from the 85% side to the 15% side, why should the insurance company bother doing it? If a company charges $1,000 in premium today and keeps 15% for profit and all expenses and that $1,000 rises to $1,200 because there is less management of health care, does the insurance company care as long as the amount for profit and expenses rises to $180 from $150? Of course, one could argue that if that occurs the premiums it charges will be less competitive, but what if all insurance companies are in the same boat and all become equally efficient, who loses then. The answer is the people paying the premiums.
On the other hand, if there were no government requirements wouldn’t insurers have to become more efficient to be competitive in the new exchanges starting in 2014? Who would choose a plan that costs more than others cost and has minimal benefits?
Just as many new mandates under PPACA result in higher premiums, this regulation may have the unintended consequence of raising health care costs. What our members of Congress repeatedly ignore is that the problem we have in health care is not with premiums, it is with the cost and utilization of health care and the notion that it is good to lower the patients out of pocket costs to the point where there is no such thing as real insurance.
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