Medical Cost Ratios Should be Closer to 90% Rather Than 80%

Brad DeLong summarizes an interesting contribution from Arindrajit Dube:

Investors in Cigna, United Healthcare Group, and Aetna alone appear to believe that if they can block the public plan, then their investments in those three companies alone will be worth an extra $30 billion dollars. Arindrajit's calculation is simple. The Senate Group of Six's (Michael B. Enzi, Charles E. Grassley, Olympia Snowe, Kent Conrad, Max Baucus, and Jeff Bingamen) discussions and announcement reduced the InTrade probability of a public plan by 15 percentage points. The stakes for the insurers are huge. The investors in them appear to believe that the public plan is nearly a life-or-death issue for the companies: each 1% increase in the chance of a public plan chops 0.6% off of the long-term value of the totalprofits--not the health profits, the total profits--from their business as they have to compete for real against the government in the health insurance market.

Next up is a nugget from Cost versus Profit in Managed Care Today:

MCR is simply the percentage of premium money that is spent on reimbursement to providers for rendered health care services. At a time when we have the largest number of uninsured individuals, decreasing MCRs and increasing premiums have combined for record profits to insurers. That is, the profit margin comes not only from increasing premiums, but by lowering the amount MCOs spend on health care … Below, we examine ratios for four of the five5 largest publicly traded national managed care organizations. Looking at the three quarters ending September 2007, we can see how MCRs have decreased period to period.

This report noted in particular the MCR for UnitedHealthCare Group so I checked its 10-K for see how this ratio would look over the 2006 to 2008 three-year period – the answer being its average was 81.3 percent. The report also note recent MCRs for Aetna, Humana, and Wellpoint with the latter having MCRs less than 80 percent.

Wikipedia writes:

As a general rule, a medical cost ratio of 85% or less is desirable.

Let’s see – even if I’m so inefficient that my operating cost ratio is 14 percent (which is where UnitedHealth Group’s has been lately), I can make profits from underwriting HMO insurance equal to 1 percent of premiums on top of my investment income, which often also runs around 1 percent of premiums. OK, my business would have to receive a normal cost of capital even in a competitive world but then this 2 percent should do that. If I can get my MCR down to around 80 percent, which is what we are seeing now, then I get an extraordinary return to capital even with these high operating costs.

So what should we expect from real competition – as in having the public option and the government perhaps running their program with lower operating costs? If the private HMOs learned to run their shops with operating costs less than 10 percent of premium income, the medical cost ratio could be as high as 90 percent and still afford these private companies a normal return to capital. But I guess such efficiency is seen as a bad idea among Republicans and certain centrist Democrats.