I can't even begin to count the number of times I've read on LinkedIn or heard in live presentations that the BUCAH carriers are actually incentivized to have rates/costs go up.

The argument is based on the ACA's MLR provision that requires that carriers spend at least 80 percent (individual and small group) or 85 percent (large group) of collected premiums on claims. That means that the carriers are limited to between 15 percent and 20 percent of collected premiums to cover their administration costs, including their profit.

Kevin Trokey is founding partner and coach at St. Louis-based Q4intelligence.

The argument then goes that the only way carriers can increase their level of profit is to "allow" (or some say "intentionally drive") total costs/premiums to increase. After all, if profit is limited to a fixed percentage of the whole, the only way profit goes up is if the size of the whole increases.

It's an easy argument to buy into, right? Maybe too easy.

I'd like to explore this idea further and am writing this as an honest question rather than to refute one particular argument.

Testing the argument

Let me establish a hypothetical scenario to see how this would play out. These are not actual numbers (or scenarios), but should allow for a simpler analysis of this argument.

Let's assume that total spend for health insurance in the U.S. is $1,000,000,000,000 (one trillion).
Let's also assume that the five major carriers have equal shares of that spend, or $200,000,000,000 in premiums.
Let's assume that the average MLR percentage across the spend is 82 percent (combination of small group and large group). This gives each carrier $36,000,000,000 (18 percent x their respective $200,000,000,000 in premiums) to cover all of their administration costs.
Let's assume the actual profit margin is 5 percent (of total premium) for each carrier, which translates to 27.78 percent of the administration dollars (5 percent profit margin / 18 percent total admin spend). This gives each carrier a profit of $10,000,800,000 (27.78 percent of $36,000,000,000).

How the argument is typically made

The argument is that if the carriers reduce their costs, their profit listed above (driven by the percentages/formulas) will go down.

Conversely, the only way for them to increase profit is to increase the starting number, the total health insurance premium spend.

In other words, if they allow for a 10 percent increase to premiums, their bottom-line profit goes up by 10 percent. Work in the magic of compounding and it's an enticing formula.

When you read about the waste and fraud and abuse in the system, this actually becomes an easy argument to buy into. And maybe it's entirely correct. But from a purely economic standpoint, it seems to me the only way this holds up is if there is collusion among the five major carriers. I know, many of you are saying, "No s**t, KT! Of course there's collusion!"

But that's not the whole story.

Unfortunately, however, it is as much of the story as I can fit into this month's column space. Tune in next month to hear my counterargument.

Read more:

Instant Insights /

MLR vs market share, part 1: The argument

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