Q: Do insurance companies benefit from payment delays?
A: Yes, they do. Payment delays are directly proportional to profits: the longer is the delay–the higher is the profit. In some cases, half of their profit margin originates on the float, such as Aetna in 2006:
- Premium 7%
- Interest on Premium 7%
- Total 14%
Insurance companies have often accused doctors of submitting incomplete and inaccurate claims and justified the delays because of the time needed to discover fraudulent claims. But some states found plans guilty of and penalized them for intentionally delaying payments in order to profit from the “float”. For instance, as early as in 1999, United HealthCare paid Georgia $123,000, and Coventry HealthCare of Georgia (formerly Principal Health Care of Georgia) and Prudential HealthCare Plan of Georgia – nearly double that amount.
A quick review of basic insurance financial performance metrics helps understanding the above dynamic. An insurance company offers clients a premium based on the expected cost of caring for them, plus a markup for administrative costs and profit. Accordingly, most analysts use three metrics to measure payers’ financial performance:
- Administrative Cost Ratio (ACR): The ACR is the ratio of administrative and sales expenses to the total income from premiums.
- Medical Loss Ratio (MLR): The MLR is the ratio of medical expenses to income from premiums.
- Investment Ratio (IR): The investment ratio is equal to net investment income divided by revenue from premiums and fees.
For example, Aetna showed the following performance in 2007:
- Premiums and fees $25,500 million
- MLR 72%
- ACR 21%
- Combined Ratio 93%
- Implied Operating Margin 7%
Note that other factors also influence profitability, especially legal fees. But an insurer can actually turn a profit even if the cost of administration and insurance claims exceeds the premiums it collects. It does so by investing income on the float in stocks and bonds between the time when a client pays a premium and the time when the client needs payment for his or her medical expenses.
In the above example, adding up MLR and ACR, we see that without any investment, Aetna would earn 7% profit on its premiums alone. Nonetheless, Aetna does take advantage of the float, and earns about 7% net interest income on the premiums, bringing its total profit margin to around 14% (ignoring taxes and other revenue sources).
References:
- Annual financial statements (wikinvest.com/stock/Aetna_(AET) September 24, 2008)
- Wayne J. Guglielmo, “Prompt-pay laws are finally getting teeth,” Medical Economics, Jan 22, 2001).
