Health Insurers Mislead on Profit Margins

Over the next few weeks, the endless debate on health care reform may actually move on to “The Next Hill” status. For people in their 40s, 50s, and early 60s, this is a critical issue. So for the next week, I’m going to talk about some aspects of the debate that have had me screaming at my television set. To start off, I want to talk about the health insurance industry.

President Obama has launched some fairly aggressive attacks on the health insurance industry recently. And why not? Health insurers are an easy target. They reported record profits for 2009 ($12.2 billion for the top 5 companies) but are still forcing unconscionably high rate increases on people who must buy their own health insurance.

Health insurers have responded to all this bad press with an expensive PR campaign aimed at convincing voters that their profits aren’t really that high. And it’s working. The major news media outlets have been doing a lot of stories lately about health insurance price increases, but those reports almost always conclude by repeating health insurer claims about the miserable profit margins in their industry.

The leading trade association for health insurance plans, the AHIP, has been telling anyone who will listen that health insurer profit margins are only 4-6%. That is barely enough to survive, they claim.

Just Enough Truth To Not Be A Lie.

There are several ways to measure a business’s profit margin. The net profit margin number that health insurers keep talking about is called return on revenues

Profit margin defined in this way is not exactly meaningless. It’s a very useful number for the managers of a business who need to track changes in operating efficiency from year to year. But any investor will tell you return on revenue is not the profit measure that matters to them. And it is certainly not a measure you should use to compare companies in different industries.

There are many businesses out there earning a 1% or 2% return on revenue that manage to earn princely profits for their owners and stockholders. And there are businesses that earn a 15% return on revenue while their owners are losing their shirts.

Health insurers’ real profit margins are actually quite good

If you are an investor, what matters is not return on revenues but return on investment. (Also known as return on equity or ROE.) The health insurance industry is doing quite well in that regard, thank you very much.

Recent data (Mar. 10, 2010) shows that while health insurers earned a 4.4% return on revenue, they earned a very healthy 16.2% return on equity. Humana, WellPoint, and CIGNA (three of the largest health insurers) all earned over 20% return on equity. I’m guessing it’s been a while since you earned 20% on your 401k or savings account.

You can find this data all over the web. One place is here.

Anyone who says health insurer earnings are low is deliberately trying to mislead you.

Among 69 industry sectors with over $100 billion in market value, Health Insurance Plans ranked 17th overall.

Among health care industries, for-profit hospitals and healthcare information services both did a little better than health insurance plans, but these are small sectors.

Only drug makers earn significantly better return on equity than health insurers. (And they had better, considering what can happen if a drug maker puts out a bad product or a drug trial fails. Drug makers are in a high risk business. Health insurers, not so much.)

So don’t feel sorry for those poor misunderstood health insurance executives when you see them on the Evening News. Their businesses are doing quite well, and so are they. Those execs are all pulling down seven figures as they double premiums for the poor people who have to buy their products.

Rate of Return in Health Care Industries

Industry Market Value ($Bill) Return on Equity (ROE) Return on Revenue
Drug Manufacturers – Major 988.6 21.6% 22.2%
Healthcare Information Services 14.8 18.3% 16.8%
For-Profit Hospitals 16.2 17.7% 3.4%
Health Insurance Plans 113.2 16.2% 4.4%
Home Health Care 7.8 16.0% 7.2%
Drugs Wholesale 74.8 14.1% 1.2%
Medical Equipment Wholesale 12.8 13.9% 3.1%
Medical Laboratories & Research 31.2 12.8% 7.9%
Medical Instruments & Supplies 241.9 11.8% 10.2%
Drug Manufacturers – Other 182.8 10.4% 11.1%
Accident & Health Insurance 44.7 10.1% 6.7%
Biotechnology 248.2 7.8% 10.7%
Drug Delivery 20.0 7.1% 5.6%
Drugs – Generic 13.4 7.1% 5.1%
Medical Appliances & Equipment 145.5 6.9% 5.8%
Specialized Health Services 17.8 6.7% 2.8%
Drug Related Products 16.5 6.3% 2.6%
REIT – Healthcare Facilities 32.6 6.2% 25.2%
Drug Stores 84.4 5.8% 1.5%

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