If we are really going to make improvements to healthcare system in the United States, let me suggest that we start by stopping something. We are obscuring a huge reality when we refer to Aetna, Cigna, United Healthcare and their ilk as “healthcare insurance companies,” and we need to change that terminology in order to really understand what is going on.

The Securities and Exchange Commission does not call these guys “insurance companies,” by the way. For SEC purposes they fall into a Standard Industrial Classification (SIC) code entitled “Hospital and Medical Service Plans,” which is a much better descriptor. Nonetheless, media on all sides of the issue continue to use the “insurance company” label, and this just complicates things.

In objective terms, “insurance” in its classic sense of the word is far down the list of what these companies actually do as central of their “business model.” So, what do they really do? Here is my list of key pieces of their business model:

1. Payment aggregators and facilitators
2. Tax subsidy conduits
3. Provider network negotiators
4. Contractors for the actual insurance

Payment aggregators and facilitators

For most sizable companies, and even many smaller ones (in other words, “where the money is”) the role of Aetna, Cigna, and their competitors is to facilitate the collection of cash from employers and employees, and then to meter its disbursement to healthcare providers, while shaving off a sizable piece of the cashflow as administrative expenses and profit in the process.

Most of these contracting companies and organizations are really self-insured. That is, the money they themselves “pay in,” plus the money withheld from employee paychecks, goes into a segregated fund administered by the plan administrator in order to pay current healthcare claims for current employees. The rate charged per employee or per family is actuarially determined by the demographics and the health history of that group of employees to try to keep the fund solvent without dependence on any outside funding.

For a huge company like Proctor and Gamble, this comes close to “universal coverage” for a particular demographic, that being their thousands of employees and their families, spreading the healthcare risk across a very broad population (albeit, generally middle class and excluding seniors). However, I have been part of smaller organizations for whom a couple of cancer diagnoses among the employee families can threaten the financial viability of this shared pool and quickly drive up rates. Size matters a lot.

Germany has a successful employer-funded, shared-pool system not drastically different from the “Proctor and Gamble model,” which also adds a “public option” to cover those not employed or self-employed, but they call these pools sickness funds. Employers contract with one of some 130 sickness funds in order to broadly pool the risk and administer payments to healthcare providers. These funds are, however, non-profit organizations whose focus (in true German fashion) is the efficient processing of standardized universal coverage plans.

Let me suggest that “sickness fund” might be a better explanation of this part of the U.S. business model than is “insurance.” Adding a good public option and the efficiency of standardized plans would go a long way toward reducing the growth in healthcare costs in the U.S. system as well.

Tax subsidy conduits

The dominant U.S. business model for private healthcare “insurance” simply does not work without a massive and mostly unknown tax subsidy that goes only to private, employer-sponsored healthcare coverage.  As I wrote about in an earlier post, this “tax expenditure” is the largest in dollar terms in the U.S. Tax Code, costing over $170 billion per year in “uncollected” tax revenue. Any costs that a business incurs to provide qualifying healthcare coverage is tax deductible to them as a business, similar to employee wages, but is not counted as income to the employee, and thus is not taxed, even though it is directly for their benefit, and often actually in lieu of additional wages.

Source: Tax Policy Center

Let me suggest that without this annual $170 billion industry “tax welfare,” the business model of employer-sponsored healthcare coverage could not exist in its current form. This is an amount of money larger than the total budgets of the Cabinet offices of Energy, Education and HUD combined. By comparison, the total annual profits for United Healthcare, Cigna and Humana combined (three of the largest plan providers) are under $15 billion.

This tax subsidy, in other words, is a big deal and a huge amount of money, and it is not available to individuals or very small businesses purchasing insurance of paying for healthcare through other means. While the ACA has provided some tax subsidies for individuals below an income threshold (number 9 in the list above), those above that threshold are not eligible for this tax subsidy, and often pay upwards of $1000 per month for individual coverage (and much more for family coverage) for a very high-deductible plan. Take the subsidy away, and premiums on business plans would be much higher, and profits likely much lower as companies find the costs unsustainable and drop out of the plans.

In short, these healthcare plan providers exist in large part to monetize this tax subsidy and extract it in cash benefits and profit.

Provider network negotiators

A major value proposition from these healthcare plan providers is that they are on the front lines for holding down healthcare costs by negotiating payment rates with healthcare providers. However in practice, as an excellent recent article from the New York Times reported, these negotiated rates defy rational analysis except through some sort of bizarre competitive and anti-competitive “economic game theory.” For instance, here is the range of the most comparable of procedures, a comprehensive blood test, comparing major metropolitan areas in the U.S.:

Source: The New York Times

Instead of an expected system of in-network discounts, the various “insurers” segment a metropolitan area among the increasingly-aggregated hospital and doctor networks, and into high-walled fiefdoms with rates that defy explanation. The “game theory” comes into the spread of low-to-high charge rates shown above, where some provider networks essentially create huge penalty costs for seeking care outside their captive networks.

In effect, these healthcare networks are cartels, and the plan administrators are often a key part of the price-fixing and gate-keeping that keeps their profits high, rather than lowering total costs for users.

What the chart above indicates is that this basic metabolic blood test likely has a true variable cost of about $15, but different strategies are used in different regions, depending on the market strength of these cartels, to recover fixed costs of operation where possible from out-of-network or, worse, uninsured patients, who frequently pay ten times the amount for a basic procedure, say an emergency appendectomy, as would an in-network patient.

I have personally been caught in this mess after visiting an “in-network” emergency room (farther from my home than a respected out-of-network alternative), only to find that the doctor himself was employed by a contracting practice that was not “in network.” I later learned that this is a common practice.

I wrote in a previous post about a similar “fixed vs. variable cost” issue with ambulance rides, which can cost upwards of $2000 for a short trip. Medical providers are often “high-fixed-cost and low-variable-cost” businesses, which is a classic recipe for “creative accounting.”

In short, the data does not support that these healthcare plan providers are holding costs down through negotiation. Rather, greater efforts are more likely aimed at denying claims for covered benefits when they can get away with it, and also “slow-paying” claims wherever possible. The people with power get good healthcare, and those without the power to “negotiate the system” bear the costs. By the way, I was able to negotiate my emergency doctor bill down, but only after a prolonged effort.

Re-insurers

Here is where “classic insurance” finally comes in. In classic insurance, actuaries define both statistical risk levels and the (usually) legal demographic determinators that are used to segment a market, in order to minimize costs and maximize profits for each given demographic segment. In automobile insurance, for instance, actuaries go to great lengths to find correlations between the characteristics of a particular driver demographic (say, your credit rating) and the claims history of this demographic. With the right numbers, you can make money off any demographic if you can set the premium price correctly.

Even when companies are, as noted before, “self-insured,” their healthcare plan provider will typically find a “re-insurer” who will, for a price, protect their segregated self-insurance fund against catastrophic claims. For instance, if ten new cancer diagnoses within a company could deplete the fund, then insurance against that unlikely event needs to be procured. Just as in auto insurance, there are insurance companies with the actuarial expertise to evaluate the risks of each employer fund and its insured population in order to come up with a profitable re-insurance premium. But this is a specialty business, and the cost likely makes up one of the smaller parts of the premiums you and your company pay.

The key point here is that the healthcare plan providers are usually not in this business, rather they farm this part of the coverage out to partner insurers. This also points out an existential threat that these insurers see in any plan for universal healthcare coverage. If, say, Medicare were to be designated as the “final backstop” insurer for all Americans whose healthcare costs exceed a certain threshold, and thus taking them out of conventional employer or individual plans (a very achievable alternative), this entire re-insurance business becomes redundant. It is no longer needed. Medicare would essentially become the “re-insurer.”

Likewise, what would happen if insurance plans became more “standardized,” as in Germany or, more practically, like the current Medicare “Part B” plans (where an “N” plan from one provider is basically the same as an “N” plan from another provider)? In this case, the need for human processing staff applying widely-varying and complicated policies for approving, denying, and paying for procedures would likely fall dramatically.

I have not been an advocate for a complete shift to “Medicare-for-all,” as noted in prior posts, but it is very possible to move, as at least a dozen other countries have done, to some model of sustainable universal public-private healthcare coverage for citizens. As the “demographic” expands to cover more and more people, however, the need for conventional “insurers” goes away. And I see that as a good thing. Some powerful people, however, do not.