Think Again: Health Insurers Have No Reason To Reduce the Price of Health Care

If the mega-mergers among health insurers are allowed to go through, it will create insurers with more bargaining power that can hold the line on prices paid to doctors and hospitals.

At least that’s been the standard rationale given in the business press for why Anthem Inc. is trying to buy Cigna Corp. and Aetna Inc. is trying to buy Humana Inc.

It’s also one reason why doctors and hospitals fear the deals. The American Medical Association cited lower prices as one key reason in its request for the U.S. Department of Justice to block the Anthem-Cigna deal.

“When mergers result in monopsony power and physicians are reimbursed at below competitive levels, consumers may be harmed in a variety of ways,” wrote Dr. James Madara, CEO of the American Medical Association, in a November letter urging the U.S. Department of Justice to block both the Aetna-Humana and the Anthem-Cigna deals.

But this fretting over price negotiations is a side show, as everyone in the finance departments of health systems knows—or ought to know.

That’s because health insurers like Anthem and Aetna have little to no incentive to hold down the price of care. Rather, they directly benefit when the price of care rises.

Let me explain how.

First, remember that two-thirds of people Anthem and Cigna count as members of their health plans are actually insured by an employer. These so-called self-funded health plans have the employer pay for all medical claims up to a catastrophic threshold, after which stop-loss insurance kicks in.

The role of Anthem and Cigna in these self-funded arrangements is simply to process the medical claims, paying the hospitals and doctors but being reimbursed by the employers dollar for dollar.

For Aetna, 61 percent of its health plan members are covered by these self-funded plans, although only 17 percent of Humana’s health plan members are in self-funded employer plans.

Health insurers bear no risk in these arrangements. They simply charge an “administrative services” fee, which is typically a percentage of the total amount of claims incurred by that employer.

That means, the more an employer spends on health care, the more money Anthem or Aetna or Cigna gets.

So rising prices of health care actually generate more revenue for Anthem and Aetna and Cigna for two-thirds of their customers.

What about the other third, which involves Anthem and Cigna selling full-risk insurance to employers and individuals?

On that business, health insurers used to have an incentive to hold down the price of health care, as well as to hold back how much its customers actually used their benefits.

But now, thanks to Obamacare, that incentive is gone.

In the pre-Obamacare days, if health insurers could sell an insurance policy for $100, but only spend $50 on medical care, that resulted in huge profits. If I instead spent $90 on healthcare, that squeezed their profits sharply.

Some insurers certainly abused this incentive, by aggressively denying to pay for expensive conditions or erecting maddening hurdles to getting a claim paid that would wear out patients and their doctors. Those abuses were a key part of the rationale for passing Obamacare.

Obamacare now requires that health insurers spend at least 80 percent of all premiums they receive on medical care. (The threshold, called a medical loss ratio, is 85 percent for large employers.) If a health insurer’s customers in any one state spend less than that percentage of premiums, then the insurer must refund the difference.

That Obamacare rule has removed the incentive for health insurers to cut prices, even on their fully insured policies. If their profit margins are now limited to a maximum of 15 percent or 20 percent (and that’s even before counting any of the insurer’s overhead), then the only way for an insurer to expand its revenue is to raise premiums. And the only way it can do that, while still satisfying the Obamacare rule, is for the underlying price and utilization of health care to increase.

This is not to say that Anthem, Aetna, Cigna and Humana would be fine if hospitals and doctors suddenly hiked their prices by, say, 25 percent. That would cause consumer outrage. And, if it happened only at one of the insurers, but not the others, then the high-priced company would start losing customers to their competitors.

So health insurers do work to keep prices and utilization of health care services from sudden bursts.

But they have no problem with steady, year-after-year, price increases by health care providers. In fact, some of the contracts health insurers sign with large hospital systems are structured exactly that way, with pre-set price increases built in year after year after year.

In the long-run, therefore, health insurers exert almost no restraining force on health care price growth. (The classic Health Affairs article by Gerard Anderson, Uwe Reinhardt and colleagues—titled “It’s the Prices, Stupid”—would tend to reinforce this point.)

So if you think Anthem buying Cigna or Aetna buying Humana will lead to epic cage matches in which health insurers try to beat down hospitals and doctors on their prices, think again. Because what’s better business—for both hospitals and health insurers—is to just keeping raising prices.


J.K. Wall is a health care reporter at the Indianapolis Business Journal and writes The Dose blog on the business of health care.

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7 replies »

  1. You identify the incentives adequately, but you seem to avoid the empirical literature on the subject.

    Sometimes insurers do have an incentive to keep down prices. Other times they don’t. It depends on local market conditions.

    See http://www.nber.org/papers/w19401: “Overall, the impact on negotiated prices is heterogeneous, with increases or decreases of up to 15% across markets.”

    That doesn’t tend to flow into lower premiums. But that’s neither here nor there. To say that insurers don’t use bargaining power to keep health care prices because of some simple incentives that you’ve identified is simply untrue.

  2. In the silly season (commonly called a Presidential election year), there will be a rising chorus of screeching about something or other being a “job killer.” No one will screech about the biggest job killer, employer-sponsored (health) insurance, or ESI. I’m unsurprised – at a surprising level – by this, but it appears that most of the Sabbath gasbags aren’t even aware that ending ESI, albeit difficult, could finally pave the way for real universal coverage, rather than the Frankenstein we’ve got know.

    ESI + ACA exchange plans = [neg]$$$ for all *but* the insurance sector. The ACA – a start on a very necessary change, but only a few inches on the long march toward real reform – was a fat, wet kiss on the lips for the insurance sector. Jury’s still out on the ROI for the rest of us, beyond the 10 Essential Benefits …

  3. Excellent points! The self insured world, just like fully insured plans/carriers, fail to do their job on many fronts. In the same manner, brokers and employers duck their responsibility. Yes, everyone wants more and more claims related revenue. There are few reasons for the industry to face the behavior challenges that leads to so many unnecessary medical claims and conditions. There is too much money in unhealthy behavior. Further, most TPAs and carriers pay little deep attention to waste, fraud and abuse.

    • Peter, I really like how you phrased that: “There is too much money in unhealthy behavior.” The big subsidization of health insurance and health care, for all its benefits, does create moral hazard for those in the industry, incentivizing them to focus on providing care instead of creating health.

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