Where Does Your Insurance Premium Go?
AHIP, the trade association for health insurers, has a nifty infographic answering the question: “Where does your premium dollar go?”
Obviously designed to defray accusations that health insurers earn too much profit, the infographic shows “net margin: of only three percent. A full 80 percent of our premium dollar goes to paying medical, hospital, and prescription claims.”
Fair enough. However, the elephant in the infographic is the 18 percent of premium that goes to “operating costs.” Lest you think that’s a synonym for “overhead” or “bureaucracy,” AHIP helpfully explains: “Operating costs include consumer-centric activities such as communicating with members, running customer service operations, quality reviews, and data analysis, among other activities.”
Well, readers have to judge how “consumer-centric” those operations are.
In 2015, average premium for a single worker in an employer-based plan was $6,251. So, $1,125 of that contributed to the insurer’s “operating costs.” How much health spending did the average insured person in an employer-based plan incur? $5,141, of which $813 was out of pocket. In other words, insurers’ “operating costs” added 22 percent to actual spending on health care.
Let’s compare this to auto insurance. For a sedan, annual cost of ownership amounts to $8,558 for a sedan, including $1,222 insurance. So, operating costs (excluding insurance premium) are $7,336 – 43 percent more than average annual health spending for someone in an employer-based plan. Yet, the entire premium of auto insurance is less than the operating cost buried in the premium of health insurance!
Another way to look at it: About 25 percent of the premium of auto insurance covers operating costs (see here and here). That would be $305 for a sedan – a mere four percent of the operating costs.
The reason? We do not expect auto insurance to cover almost every penny of spending we incur every year to run our cars. If only that were true of health insurance.
The real issue is not where our health insurance premium dollars go, but how much of our health dollars go to premiums.
Actually, the majority of lives with employer sponsored insurance (ESI) are in self-funded plans. These employers contract with insurers to administer their health insurance plans on an administrative services only (ASO) basis. When I was still working, my former employer paid its insurer $20 per month mainly to pay claims and provide a network for its active workforce and $40 per month for its retirees since they had many more claims on average. ASO costs as a percentage of total health plan spending was in the mid to high single digits, not 20% plus and it was a very profitable business for insurers as well at least in terms of profit margin as opposed to gross profit dollars. There is no need for underwriting or insurance commissions and most of the marketing is handled by the employer’s HR department during the annual open enrollment period. The bottom line is that ESI self-funded administrative costs are very low. By contrast, administrative costs for an underwritten individual market plan in the old days often exceeded 40% of premiums. Medical claims costs were quite low because only healthy people could qualify for enrollment.
As for auto insurance, most people don’t have many accidents and they don’t have more of them as they age at least until their eyesight worsens and their reaction time slows materially. In 54 years of driving, I’ve had three collision damage claims and two of those were caused by drivers who ran a stop sign and a red light.
I agree that health insurance probably should not pay for the equivalent of oil changes and new tires, but the fact is that if we added up the first $5,000 of claims for every individual with health insurance, including the high cost cases, we would only be looking at 25%-33% of healthcare costs. The big dollars are in the expensive claims including the total of smaller claims inherent in managing chronic disease. Experts estimate that managing chronic disease accounts for 75%-80% of U.S. healthcare costs which, of course, includes periodic checkups and routine testing.
Is that true? I thought most employees worked for small companies, which would seem to point to the opposite. Unless most of those are without ESI.
Not arguing, I’m just asking.
Bart — Many small employers can’t afford to offer ESI or, if they do offer it, the required employee contribution is higher than most are able or willing to pay.
The biggest publicly traded insurers including UNH, ATHM, AET, and CI break down their membership by MA, Medicaid, and commercial. Within commercial, they quantify the breakdown between full risk coverage and ASO (self-funded). The trend has been moving more toward self-funded for years and is now the majority of commercial.
The experts tell me that, on average, self-funding is 6% – 10% cheaper for the employer than full risk coverage.
Humana is primarily a Medicare Advantage insurer which is why I didn’t include them a above. Molina and Centene focus mainly on Medicaid and, more recently, the ACA exchanges with Medicaid-like narrow network HMO products.
John,
What a great and awful analogy all at the same time. Why would you compare price of ownership? ESI is only rented much like a leased vehicle. Both get utilized for a period of time and at the end of the term you get nothing. Does it make sense to rent from an employer something that could be the most important decision of their life? Also people are not renting sedans they at paying for corvettes! The difference is you cant drive it, in fact you hope you don’t use it, because, well, you are sick.
Sign up for Medicaid for the price of a new Corvette per year.
Don’t forget that when you participate in health insurance, you are paying a 25% premium over the cash value of the health care provided, and of that 25% that the insurer keeps, part goes to defending themselves against your lawsuit for their malpractice.
“a 25% premium over the cash value of the health care”
Jimbino, each time you beat that drum, you rely on an unstated assumption that one’s “health care” will never cost more than their insurance premium. That’s an obviously incorrect assumption.
If otherwise the purchase of fire insurance on a house that never burns down means paying an infinitely large premium over the cash value of the benefit. Which is absurd.
In either case, people who buy insurance are paying someone to insure them against risks they choose not to bear on their own, and are paying someone to administer that insurance. The risk and the admin are both costs. Those costs go into the premium. They make up the 25% you like to disregard.
You also like to assume that 25% is always the number for all policies. It’s not. The difference for some policies is as little as 5%, depending on economies of scale which are least for individuals and greatest for large employer-sponsored groups.
One more thing: health care is free or nearly free. It’s medical care that can get expensive. That’s what you meant – right, Jimbino?