The Health Insurance Profit Formula
For as complex as the US healthcare system is, and I’m going to gloss over a lot of complexity here, the formula for health insurance companies to make money is pretty simple:
Profit = Premiums - (Premiums * Medical Loss Ratio) - (Premium * Admin Ratio)
Members pay monthly premiums to their insurers, and insurers pay out a percentage of those premiums in claims to cover members’ medical expenses (Medical Loss Ratio, or MLR) and another percentage to cover administrative expenses, essentially SG&A (Admin Ratio) . Together, the MLR and Admin Ratio are the Combined Ratio.
There are other things in here – like reinsurance costs and risk adjustments – but I promised not to bore you. Just know those costs come out of direct and assumed policy premiums before getting to the “premiums earned” number that’s used in the ratio calculations.
Anyway, if the Combined Ratio is less than 100%, the insurance company makes money; if it’s more than 100%, it loses money.
Adding just one layer of complexity, the ACA requires insurers to pay out at least 80-85% of premiums in claims (80% for individual and small group insurers and 85% for large group insurers), and then refund any leftover money to members if they don’t.
So the name of the game is to get your MLR as close to 80-85% as possible, and keep administrative costs relatively low. When margins are capped, it’s all about scale. (View Highlight)
Note: When the margins are capped - it’s all about scale
