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Health Plans mark it up and pass it on

Buried in a quick notice in BusinessWeek was this paragraph:

Health insurance companies have plenty of critics. Now they have one more: Leemore Dafny, an assistant professor at Northwestern University’s Kellogg School of Management. Insurers argue that because they compete against one another, they keep prices down, saving everyone money. Not necessarily, says Dafny in a March paper, "Are Health Insurance Markets Competitive?" Dafny looked at data from 1998 to 2005, provided to her by a benefits consulting firm, that tracked the behavior of 200 major companies to see whether they shopped around to find the cheapest insurers. Dafny found that when these big companies made more money, their insurance providers raised their premiums. But instead of dropping the carrier to get a better deal, Dafny writes, companies generally stuck with their health insurers and paid more. "Carriers can and do take advantage of a firm’s increased profits and extract higher prices from them," she says.

Here’s how this works:

Health plans keep a percentage of the premiums paid by employers (and
the government) in health care costs. And
if they’re really clever, they can increase the percentage they keep, a process
known as reducing medical loss ratios. During the period Dafny studied,
health plans got very, very good at that. (Here’s the Aetna story if you needed reminding).

Of course, the notion that health plans are just another supplier to
their employer customers is wrong. Messing with the employees’ health
care arrangement is about the last thing employers want to do. Also, beating
up on suppliers who don’t look after the CEO’s  children or spouses tends to lead to less pain for the relative gain. So in the end
most employers don’t make too much of a fuss about health care,
especially when times are generally good. Most plans, therefore, mark up the costs they pass through from providers as
much as they possibly can.

I’ve been saying this for a long time, and now a Northwestern academic actually agrees with me! Here’s Dafny’s paper (pdf) if you want to check the details

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  1. There is a lot to chew on in this study, but in the end it’s not clear what it shows, or that it really shows much of anything.
    I agree with everything you say in this paragraph, Matt:
    “Of course, the notion that health plans are just another supplier to their employer customers is wrong. Messing with the employees’ health care arrangement is about the last thing employers want to do. Also, beating up on suppliers who don’t look after the CEO’s children or spouses tends to lead to less pain for the relative gain. So in the end most employers don’t make too much of a fuss about health care, especially when times are generally good. Most plans, therefore, mark up the costs they pass through from providers as much as they possibly can.”
    However:
    1) The author doesn’t clearly state in what portion of the market his effect is found, but piecing it together from other statements, it appears to be very small. First, we’re starting with commercial insurance, which is a little over half of the total insurance market. Let’s say it’s 60%. Second, he only looks at large publicly-traded companies. I’ll be very generous and say that this is half of the commercial market, or 30% of the total number of insured. This is important because insurers don’t necessarily know the profitability of non-public companies, and so this effect would be greatly diminished or absent for the rest. Then, he says that his effect is only found in markets with 6 or fewer insurers, which amounts to 23% of the companies he studied (or, company sites). I interpret this to mean that we’re down to about 7% of the total market (30%x23%). Then, he points out that most of the companies in his sample self-insure, so they don’t pay any premium. In fact, 74% self-insure, leaving 26% to pay premiums. If these were evenly distributed among the regions with more/less than 6 insurers, then we reduce the 7% of all insured to something like 2% of cases where this effect can take place. And finally, of course, you need the company buying insurance to have a high profit margin that can be milked by the insurer, which I presume is less than half the remaining cases. So are we really only talking about an effect that occurs in 1% of all cases?
    My interpretations may be shaky, and I’m happy to be disabused of any mistakes. But if this effect happens in more than 10% of cases I’d be very surprised.
    2) The author rightly notes that insurers have a net profit of less than 5% of premium. It might have been a good idea to just stop there and conclude that whatever market power some insurers may have in some circumstances, the health insurance industry as a whole has very weak market power when it comes to premiums charged. The profit margins of insurance are similar to highly competitive industries with weak market power like mass market retailing. Compare this to the enormous market power of big pharma when it can exploit the patent system or instill a demand for brand name me-too drugs. Big pharma has typically had net margins in the area of 15% or more. Now that’s market power.
    Matt’s example of Aetna as a health plan that boosted margins and lowered the medical expense ratio a few years back is more confirmation than counterexample to my point. When Aetna decided to relentlessly focus on the bottom line, it did so because it was making massive losses and was not in control of its pricing. Then, in order to become profitable and raise prices on some accounts quite a lot, it had to shed millions and millions of members because those groups wouldn’t pay for the large increases. Losing 40% of your business when you jack up prices enough to cover your costs plus 10% (which, going by memory, is roughly what Aetna did around 2002-04) is not in the least the sign of a company with market power.
    Having said all of that, of course health plans primarily just pass the buck. That’s what insurance is: a method to redistribute the financial pain into more manageable burdens spread out over a larger number. Matt rued the decline of real, progressive care management in that long-ago post on Aetna, and rightfully so.

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