Capping Insurer Administrative Costs: Good Intentions, Unintended Consequences

As the debate over health insurance reform plods along in the Senate, there are reports that Senators are considering a measure which would cap insurer administrative costs at about 10 percent of premium. The stated purpose of the proposal is to limit insurer profits, and to assure that 90 percent of premium dollars go to covering the cost of medical care and improved health.

Insurers are undoubtedly making defiant noises about such a proposal, but would accept it in a minute. Because doing so would require few changes in their actual behavior, nor would it impact how much money they make, in all but the most egregious circumstances.

Why? Because insurers play games with "averages." Most insurers will tell you that their administrative costs average 10 percent of premium or less. And strictly as a factual matter, that's accurate.

But it's not truthful.

Insurers typically provide services to individuals and to companies of various sizes. The larger the group, the lower the administrative cost ratio. Most state regulators currently exempt insurers selling individual (non-group) coverage from any regulations governing pricing, which is how insurers manage to sell individual coverage with administrative cost ratios of 30-40 percent of premium. It's why insurers have made such a big "bet" on non-group coverage.

In the group business, insurers can average the 5 percent of claims costs the charge to administer large, self-insured group plans with what they earn to run Medicare supplemental business, and with the 25-27 percent they charge small groups, and produce a "weighted average" of 10-12 percent of premiums.

If you're going to hammer down administrative costs, don't count on averages. Approach the problem by business segment, and include large group, small group, and individual coverage segments.

And when you're shopping for coverage, ask your insurer or agent specifically about the administrative costs they assign to your market segment (individual, small group, mid-size group, etc.). You'll usually get an assurance that your insurance company's administrative costs typically "average" 9-10 percent of premiums. Ask what percentage they charge for your segment, and you won't get an answer. Because by and large, agents don't know. And insurers don't tell.