The Patient Protection and Affordable Care Act (PPACA) limits how much of insurance companies' income they are allowed allocate to overhead and profits vs. to benefits payouts. Starting two months ago in January, insurance companies are limited to spending 15% of their revenues on overhead and profit, and must return 85% of their income as benefits. (1)
Give me leave to use a bit of arithmetic and I will demonstrate for you the perverse incentive insurance companies now have because of this to raise premiums ever higher and higher. Let me show you that not only do companies and their executives not care whether health care costs increase, passing along such increases to their customers, but in fact they will be reaping gobs and gobs more profit every time rates increase.
Here's why.
Say Behemoth Insurance Company has a million customers all paying $300/month in premiums. Behemoth's revenue would be $3,600,000,000 (that's 3.6 billion dollars, 300 x 12 x 1,000,000), of which they would be allowed to allocate $540,000,000 (15% x $3.6 billion) to overhead and profits under the new law.
Now suppose premiums are 'forced' to rise to $500 per month (justified, of course, by the ever-rising cost of health care). Behemoth's revenue would now be $6,000,000,000 (6 billion dollars), of which they could allocate $900,000,000 (15% x $6 billion) to overhead and profit.
But wait! Does it take any more overhead to manage a customer base that is paying $500/month in premiums than it does to oversee the same customer base that is paying $300/month in premiums? Does it take more personnel? More computer time? More claims deniers? More office space (aside from the larger vault...)?
No, of course not. It takes exactly the same amount of overhead!
Congratulations, Behemoth executives and stockholders. Since there's no change in your overhead costs, all your additional perfectly legal monies allocated for overhead and profits can now simply be added to your profits. You've just increased your profits by $360,000,000. Can you say 'massive executive bonuses' ? What about 'pass the stock options and the caviar' ?
Here's a table showing in detail how it works, assuming that initially 10% of revenue is overhead and 5% is profit:
Effect on Behemoth's Profits by Raising Premiums
|
Before |
After |
| Premiums |
$300 |
$500 |
| Customers |
1,000,000 |
1,000,000 |
| Revenue |
$3600 million |
$6000 million |
| Benefits @ 85% |
$3060 million |
$5100 million |
| Overhead |
$360 million |
$360 million |
| Profit |
$180 million |
$540 million |
| Realized INCREASE IN PROFIT: $360,000,000 |
|
|
Of course the Behemoth executives generating these increase profits haven't expanded the company's customer base, they haven't managed to cut any costs or make operations more efficient. In fact, they've done absolutely nothing.
All that has happened to generate this extra $360 million in profit is that the cost of medical care has risen.
Okay, one might raise a small objection. If your prices go up, the law of supply and demand dictates that less people will buy your product. So what if 30% less people buy their insurance from Behemoth? Let's just assume, for the sake of being conservative, that overhead won't go down (even though it obviously would).
Here's a table showing what happens assuming a 30% loss of customers:
Effect on Behemonth's Profits Raising Premiums with 30% Customer Loss
|
Before |
After |
| Premiums |
$300 |
$500 |
| Customers |
1,000,000 |
700,000 |
| Revenue |
$3600 million |
$4200 million |
| Benefits @ 85% |
$3060 million |
$3570 million |
| Overhead |
$360 million |
$360 million |
| Profit |
$180 million |
$270 million |
| Realized INCREASE IN PROFIT: $90,000,000 |
|
|
Even losing 30% of Behemoth's customers results in an additional $90 million profit -- surely enough to increase Behemoth's lobbying efforts in Congress, increase their dividends and
still have enough left over to give their executives million dollar bonuses for such a marked improvement in their company's bottom line.
If Behemoth Insurance Company had been making $180,000,000 in profit prior to a rate increase, why, exactly, should they make more than that same $180,000,000 profit after a rate increase? Why should they be receiving a percentage of revenue from a non-expanding customer base, rather than making a profit that is commensurate with the company's size and the amount of service they provide?
I don't know. But it's all perfectly legal. And not only is it legal, but the health care law all but demands that companies and the executives who run them do their damndest to raise health care costs to make sure their profit per customer continue to rise.
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Note: I may be slow on the uptake, but I have never seen this phenomenon discussed in print before. It popped into my addled brain late last night for reasons unknown.
(1) The percent allocated to overhead and profits is actually 20% for individual and small group plans, making the effect I demonstrate here even more pronounced.
