Good Business Models and Bad Business Models.

You may have received a refund check in the past few months from your health insurer. This is not your individual reward for staying healthy; it is your insurer’s punishment for making too much money because you did.

Obamacare includes what the health care technocracy calls the “MLR rule” – minimum requirements for medical-loss ratios – or the percentage of premiums collected by health insurers that must be spent on medical care or refunded. The inverse of the MLR is the percentage spent on administration and marketing, and earned as profit. Obamacare sets minimum MLRs of 80 percent for individual and small group plans, and 85 percent for large groups.

Aside from its obvious populist appeal, this profit regulation mechanism signifies a belief, now enshrined in legislation, that health insurance markets do not work. Without such a rule, the architects of Obamacare believe, insurers can name their prices, however inflated, and we all just pay.

In the short term, that is true. Most health insurance plans price only once per year, are subject to long delays in cost trending information and multi-year underwriting cycles, and endure the meddling of a carnival midway’s worth of employee benefits tinkerers, agents, brokers, consultants, and other conflicted middlemen. But in the long term, over multiple annual cycles, premiums do rise and fall, and the health insurance industry’s fortunes with them.

The MLR rule may well put an end to these admittedly slow, imperfect self-correcting market forces. Under Obamacare, the industry is transfigured from an inefficient, barely competitive mess that tries, against the laws of health care gravity, to control medical costs, to a non-competitive, profit-regulated utility rewarded with 15 to 20 extra cents for every dollar it allows its medical costs to rise.

What would any rational firm in a slow-motion marketplace do when it faces a new lockdown rate on its administrative and marketing costs and profits? First, find ways to let the cost basis for the lockdown rise, i.e., let medical costs inch up. Then acquire competitors to minimize friction for the strategy. Finally, buy up suppliers – i.e., those generating the bulk of medical costs, namely hospitals and doctors – so as to capture what would have been capped margins upstream of the insurer’s MLR calculation.

Retail Therapy for Anxious Insurers

Such acquisitions constitute the deal flow of health insurers since the weight of Obamacare started to hit their income statements this summer. As an encore, they are also dumping billions of shareholders’ capital into all manner of adjacent businesses, believing they can cross-sell products and services to their customers free of the MLR regulation, e.g., Wellpoint’s nearly $900 million purchase in June of 1-800 Contacts.

Health insurers are reacting to Obamacare the same way they did to the last assault on their profit margins, managed care in the 1990s, with lockstep acquisitions – of each other, of providers, and of businesses with often tenuous relevance to their core competencies. Last month, Wellpoint agreed to pay $4.5 billion for Amerigroup. Last week, Aetna purchased Coventry for $5.7 billion. This is probably just the ante; the stocks of health insurers have taken a pounding since the Supreme Court upheld Obamcare, making them easier targets, and when more than one major insurer moves, many follow.

In addition to such horizontal consolidation, which will further reduce competition and the pressure to lower medical costs, insurers are also buying “vertically” – purchasing hospitals and physician practices around the country. There is much happy talk surrounding these deals about “care integration” and “accountable care” – the same sort of hooey that accompanied these such deals in the 1990s – and they will inevitably blow up in execution because of the same strategic and cultural conflicts. The most spectacularly messy version, so far: Highmark BlueCross’ purchase of the second biggest hospital system in western Pennsylvania, a deal in all manner of trouble before it even closed.

The real goal of these deals: the health insurer wants to shift profits out from under the MLR rule, and pick them back up on the provider business – essentially re-locating margins from the regulated to the unregulated part of their portfolio. Good luck with that new hospital business under the current regulatory regime and imminent Medicare financing meltdown.

If health insurers wanted to protect their shareholders long term under the new Obamacare order, they would invest not in these desperate fantasies of market control, but in their own operations. “Managed care” may have come and gone but the myriad problems in the medical delivery system it tried to fix have not.

Where to start? Today’s scandal au courant in dangerous medical excess is coronary stents – tiny wire devices implanted in coronary arteries – a cash cow business for hospitals that pose great risk to patients, many of whom, it turns out, do not need them. Where else? Though the media has tired of talking about it, the related epidemics of obesity and diabetes rage on. And all the perennial problems associated with sprawling cancer treatments, under-medicated diseases, over-medicated nonsense, and needless interventions at both the beginning and end of life are screaming for the rationalization that only a health insurer can bring to bear on a money-driven delivery system.

And yet the insurers put their considerable capital and talent into what? Acquiring each other. And contacts lens companies. Wow.

The insurers would be better served minding their real business: managing the medical costs and health status of those they insure. There are no fancy tricks or world-beater press releases for this – just lots of hard work adjudicating claims, rooting out fraud, aligning payment with evidence, managing provider and patient adherence to the evidence, tracking outcomes, and steering people toward the better hospitals and doctors. These are the mostly untried but still true great ideas from the past two decades that everyone likes to talk about, but almost no one gets around to executing.

Perhaps because such execution is hard work. Buying and selling businesses has always been more fun than creating, growing, and running them – especially when confronted by market-distorting garbage like the MLR rule, which is designed specifically to punish those businesses for their success.

J.D. Kleinke is a Resident Fellow at the American Enterprise Institute. He is a medical economist, a former healthcare executive, and the author of three books about healthcare and medicine. This post first appeared on Real Clear Markets.

8 replies »

  1. Why are health insurance companies allowed to be for-profit, publicly traded entities to begin with? The very structure of the organization puts it at odds with its purported mission.

  2. Hmm, this seems to confirm a general suspicion I had about the minimum MLR when I was completing my masters thesis on the subject. I think we are finding ourselves in yet another rousing episode of America’s fasting growing game show I like to call “regulatory whack-a-mole”. The brilliant *sarcasm* health advocacy groups had been yelling about MLRs since the 90s and they finally got their wish. They are contented now to just dust off their hands and say “job well done!” and harp about their “triumph” against the big bad health insurance industry in campaign speeches. One small problem…this likely wont matter one bit for their real margins.

    All the health plans need to do is some clever corporate restructuring, acquisitions, and accounting to walk right around the MLR. Take for example I have been curious about how excessive transfer pricing disparities by service subsidiaries of a health plan would be reflected in their minimum medical loss ratio figures. In meeting their MLR threshold regulatory requirements, would be they be able to skirt the issue by clever corporate structuring? For instance, UHG has Optum. Would Optum, as a service subsidiary, be able to have a very large margin on its services which it “sells” to the larger UHG corporate umbrella and not have those high margins incorporated into the MLR calculation? Would they have to account for potentially large margins of external suppliers in the same way for their MLR?

    Unintended consequences in public policy are not a “mulligan!” sort of affair with a cheesy 1980s soundtrack in the background and we all share a laugh. People’s livelihoods are at stake, markets distorted, incentives misaligned, future bubbles blown, etc. When you are operating on a utilitarian basis passing regulations “for the common good”, you have stripped away any inherent morality and the only thing that matters are the results. The writing is one the wall for this one already. Let’s make some new mistakes for a change…

  3. Because money in the bank still is. Welcome to the new float? And with baseline interest rates detectable only with magnifying glasses? Wow! If I hadn’t lived through the “clean claims” payment wars in the 90s, this would seem farfetched. “Managed care” means managed money.

  4. JD, Agree with most of what you wrote with a couple of exceptions.

    First, you seem to presume that health plans can simply pass on or articfically increase premium increases to employers (and eventually to consumers when health insurance exchanges get underway in 2014.)

    Not likely — plan pricing has been and will continue to be an area of intense scrutiny and competition. There has been and will continue to be pushback.

    The need to keep plan prices competitive also drives a need to lower medical costs as part of that equation, and thus to engage in care coordination and other accountable care practices with providers. As you mention I don’t disagree that there are countervailing pressures to ignore costs, but let’s see how this comes out in the wash.

    Second, the idea of health plans wanting to capture provider margins is a stretch. You write: “Finally, buy up suppliers – i.e., those generating the bulk of medical costs, namely hospitals and doctors – so as to capture what would have been capped margins upstream of the insurer’s MLR calculation.”

    Under this line of thinking, health insurance plans will start collecting and recycling aluminum cans to extract the margins currently being “captured” by the homeless guy down the street.

    It does make sense for plans to acquire or partner with doctors, but not for the reason of capturing their margins. Through the power of their ordering pen, docs control 70% + of health care costs — something plans clearly would like to influence in the direction of efficiencies and reducing unnecessary utilization.

  5. The politicians thought the MLR requirement would create a ceiling on insurance profits. Instead it has created a floor: Every company prices to the 80/85% level or even to the point of owing a small rebate. Why? Because a growing number of politicians and state boards are interfering with (excuse me…reviewing) the rate setting process. Maine tried to set a zero percent profit level, California is notoriously difficult, and Obamacare is encouraging more states to do this. As a result, it is now better to set pricing too high and pay a rebate (especially before more state boards get set up) rather than risk pricing too low and not being able to catch up again down the road. Many people discussed this possibility during the debate, as well as it being an arbitrary number for an industry that already operates at a much-below-average profit margin.

  6. Right you are, Gregg? ACO = IDN / PHO / MSO = SOL. IMHO.

    Three Kaisers per major market – and two in smaller markets – is the obvious solution for actually integrating care, but it would put too way too many middlemen, bureaucrats, pretenders, and charlatans out of work. Why else would so many Americans have been convinced that its what they really don’t want?

  7. The insurance carriers are wonderfully benevolent to the patients and physicians alike.

  8. JDK: Good advice to the health plan crowd, i.e., stick to your knitting. Not likely, though! See post below for related context:


    Strategic gaffs are endemic to our craft, as ‘we’ demonstrate over and over again, the absence of institutional memory via event horizons crafted in 24/7 news cycles.

    We know what works, it just wasn’t politically feasible to shove staff model (or Kaiser like derivative) HMOs down the throats of mainstream medicine and their failed community hospital governance models – speaking of ‘bad’ business models.

    Boards delegating the stewardship of community hospital assets to voluntary medical staffs on the equivalent of a ‘commission based’ payment paradigm are incapable of managing the transition to a value vs. volume healthcare ecosystem. As ground zero in the health reform imperative, nothing happens until this micro-climate gets ‘religion’.

    Tough to stay focused on your core competencies when the ‘me too’ temptations are so hard to resist!

    Yet, I doubt there is as much purposeful clarity as you assign to the board rooms and c-suites of these evolving enterprises.

    The Affordable Care Act is an imperfect start. And as far as the MLR rule, cry me a river!