By Uwe E. Reinhardt September 25, 2009 7:24 am September 25, 2009 7:24 am
Uwe E. Reinhardt is an economics professor at Princeton.
In response to my last post. readers left several provocative comments on the profits earned by commercial health insurance companies — provocative in the sense that they provoke me to elaborate. I propose to do so in this and next week’s post.
In this week’s post, I shall walk the reader through the most recent income statement of WellPoint Inc. Before proceeding, readers may wish to click on this link shown above and print out the income statement. That statement is fairly typical of a large insurer selling mainly group-insurance policies to relatively large employers.
WellPoint Inc. was formed from the merger of two companies that were once known as Blue Cross and Blue Shield of Indiana and Blue Cross of California, both originally not-for-profit plans. It is now one of the nation’s largest commercial health insurers.
Income statements are part of the annual reports called a 10-K that every publicly traded company must submit to the Securities and Exchange Commission. The virtue of the 10-K is that it is fully audited by the company’s external auditors, formally approved by the board, certified to be accurate by the firm’s chief executive and chief financial officer, and strictly supervised for accuracy and honest disclosure by the S.E.C. — at least in principle.
A firm’s 10-K is a fascinating read in its own right, as it reveals much of the bowels of a company, including the business risks it faces and executive compensation.
Revenues. According to WellPoint’s income statement for 2008, the company’s total revenue that year was $61,579.2 million. Of that, 93.2 percent came from premium revenues. and 6.3 percent came from fees for merely administering the claims of employers who self-insure (that is, these firms set aside their own funds for their employees’ health benefits and bear full risk for them).
Revenue From the “Float”. About 1 percent of WellPoint’s total revenue came from a category simply called “other revenue.” For the most part this probably comes from interest earned on the “float.” An insurer’s “float” is the money temporarily on hand when premium payments come in earlier than the outlays for insurance claims covered by these premiums.
In times when interest rates are high, an insurer’s float can be a major source of revenue, which is why sometimes health insurers stand accused of deliberately dragging out claims processing, strictly to increase the size of the float at any point in time.
As the Federal Reserve has lowered short-term interest rates to close to zero, however, the interest earned on an insurer’s float is now trivial — as it is in WellPoint’s case — meaning that more costs must be recovered through premiums.
The Health Benefit Ratio (alias Medical Loss Ratio). WellPoint’s
payments for health benefits in 2008 equal the sum of what it calls “health benefits” ($47,742.4 million) and the “cost of drugs” ($468.5 million).
Together these health benefits came to $48,210.9 million. As a fraction of total premium revenue of $57,101.0 million in 2008, total health benefits amounted to 84.4 percent of premium revenue.
Traditionally, actuaries had called this fraction the medical loss ratio (M.L.R.), because it represents what insurers “lose,” so to speak, to doctors, hospitals and other providers of health care. Because that terminology comes across as indelicate, however, the preferred term now is the mellower health benefit ratio (H.B.R.).
Marketing and Administrative Expenses, or S.G.&A.. The firm’s total marketing (selling) expenses for 2008 were $1,778.4 million. General administrative expenses were $7,242.1 million. The sum of these two items goes by the acronym “S.G.&A.” One should relate these S.G.&A. expenses not just to premium revenue. but also to total revenue. In this case, S.G.&A. expenses amounted to 14.7 percent of total revenue in 2008.
The Profit Margin. WellPoint’s net income (profits) after all expenses and the provision for income taxes in 2008 was 4.07 percent of total revenue. In accounting jargon, it is called the “profit margin.” In 2007, that margin had been 5.47 percent. In 2006 it was 5.42 percent.
Were WellPoint’s profits in 2008 high? It depends how we look at it.
Profits were not that big a deal as a fraction of premium revenue. S.G.&A. expenses typically are a far bigger enchilada worthy of attention. It is here that the health insurance industry is being challenged to search for economies.
As a percentage of total assets of $48,403.2 million deployed by the company (measured at the reported book value on the firm’s balance sheet ), WellPoint’s profits in 2008 amounted to 5.14 percent in 2008 and 6.42 percent in 2007.
As a percentage of the equity shareholders had in WellPoint (also measured at the book values reported by accountants), WellPoint’s profits in were 11.62 percent in 2008 and 14.55 percent in 2007.
Relative to other industries, these are not particularly high numbers, nor are they particularly low.
By examining the income statements of other insurers, readers can verify for themselves that the percentages calculated above do vary for a given company over time and also among different companies at any point in time.
The comparable income statement of Aetna, Inc. (stock ticker symbol AET) can be found here. The link to the remarkably cryptic profit and loss statements of UnitedHealth Group (stock ticker symbol UNH) is here.
In next week’s post, I intend to explore how the add-ons for marketing, administration and profits on top of expected outlays for health care to set the insurance premiums can be astonishingly high for individually sold policies. Up to half the premium can go for these non-medical items. It is the reason why that market urgently needs to reformed.