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Premiums and Profits

Trying to reduce health-care costs by soaking insurance companies is a prescription for trouble.

12:00 AM, Sep 10, 2009 • By STANLEY GOLDFARB
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The president's plan to reduce health-care costs mostly depends on reducing the cost of the premiums of those "villainous" insurance companies. This plan is premised on the idea that insurance companies have large profits and administrative expenses that can be pared down without any real impact on the payments to those who provide health care. It also assumes that health-care costs have risen because of the rise in insurance premiums. Unfortunately, logic and data do not support either contention. If Obama's plan passes, the country may spend the next five years vainly waiting for reduced insurance premiums to control health care costs.

The first obvious problem with this plan is that every incentive exists for for-profit insurance companies to maximize profits, hence their designation as for-profit companies. No publicly traded for-profit company can survive if it loads up on administrative costs to keep down profits. If the profits of health-care insurance companies were very high, then obviously an argument could be made to utilize those windfall profits to underwrite the cost of insuring the uninsured. In fact, the health insurance segment of the insurance business is just not terribly profitable.

The health-insurance industry ranked 86th among U.S. industrial sectors, according to Yahoo finance. The average profit margin for the industry as a whole was a mere 3.3 percent of revenues. Certainly there is some money to wring out of this margin, but to "bend the curve" of the growth of 17 percent of the U.S. economy, reducing these profits will not suffice. Reducing premiums will instead reduce the payment to physicians and hospitals, as that is the largest expense to these companies, somewhere between 80 to 95 percent depending on the particular firm. Reduce the premium and reduce the payment--or drive the company out of business. And perhaps this is the ultimate goal.

This is not to say there are not abuses--exclusion of coverage for pre-existing conditions, underpayments to providers, inefficiencies, fraud, neglect, etc. It is just that these are all at the margins of the activities of the health insurance business. Reducing premiums alone will not solve the problem of rising health care costs.

The other strong evidence arguing against Obama's contention comes from the growth in costs of the Medicare program. The rising cost of Medicare is not just about increasing numbers of beneficiaries. The cost per beneficiary is rising at 3.5 percent per year above the rise attributable to inflation. That means a doubling every 20 years even if there were not a demographic meltdown coming down the road as the current ratio of workers to recipients of Medicare falls from the current 5 workers to 1 recipient to 2 workers to 1 recipient by 2050. Since Medicare has no profit motive and has legendarily low overhead (mostly because it does little but pay claims) the 3.5 percent growth per beneficiary is due almost entirely to health care cost growth. Medicare cost growth belies the notion that increased insurance company profits are the driving force behind increasing health care costs.

So why are insurance companies supporting the Democrats' reform proposal (even though the industry has been the subject of scathing attacks)? Why are physician groups, pharmaceutical companies, equipment companies, hospitals, and other industries in the health care marketplace supportive of a plan that guarantees less payment for their services? The answer is that they do not expect less payment for their services. They expect that the increased numbers of patients brought into the health care system will provide a new source of revenue. For hospitals, it will mean no more "free care." For pharmaceutical companies it will mean increased sales of both core medications as well as more expensive medications for serious illnesses. But none of this will save health-care costs.

There is no possible explanation for how bringing 45 million, 30 million, or however many million people into the health care-system will lead to cost savings. It may be possible that at the initiation of so many new insurance plans, premiums will initially be reduced. But this is unsustainable unless the cost of health care, not just the cost of insurance, is also reduced. What will initially appear to be a success if the reform plan is passed and insurance premiums are reduced, will soon result in a new crisis as the cost of care continues to rise. If price controls are introduced by this reduction in premiums, failure is inevitable, as has always been the case when price controls were introduced in other markets. Rationing of care is the unavoidable consequence of price controls in health care insurance.

Stanley Goldfarb MD is associate dean of clinical education at the University of Pennsylvania School of Medicine and a nephrologist.