Is your health plan's 'expense ratio' too high?

This article was posted November 1, 2015.

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Most successful retirement investors seem to understand that costs matter. There is a wide gap between the lowest cost retirement plans (e.g. expense ratio of 0.027% for the Federal Government Employees Thrift Savings Plan) and the 2.000% per annum that Wall Street trims from the average investor. Keeping mutual fund costs low and any fees you may be paying to a financial advisor under control is vital to the quality of your retirement.

The same logic applies to your health plan. You want as much of your premium dollar as possible going to pay for health care services rather than unnecessary and bloated corporate overhead. (With expenses of 1.20% of program spending, fee-for-service Medicare is the benchmark for low administrative costs in health insurance plans.)

In commercial. for-profit insurance plans an important metric is the so-called Medical Loss Ratio (MLR) (i.e., the percent of premiums collected that is spent on actual health care services for policyholders.) What's a benefit to you is a loss to your insurance company. Insurance companies do what they can to deny policyholders the benefits they've paid for and decrease their MLR. We've defined what's left after the insurance company does it's best to deny benefits to it's customers as the "Skim Rate".

Two months ago I got a $53 rebate from my health insurer because they failed to spend at least 80% of the premiums they collected in 2014 on actual health care services for their policyholders. Limiting insurers' "Skim Rate" to 20% was one of the major reforms enacted through Obamacare. (Businesses with more than 100 employees covered by their health plan get an even better deal. Obamacare limits their "Skim Rate" to 15%.)

Prior to Obamacare, there was no Federal limit to how little a health insurer could spend on actual health care services for its policyholders. In 2008, Business Week reported that United Healthcare famously had a health plan aimed at college students with a 10% Medical Loss Ratio (MLR) -- an astonishing 90% "Skim Rate". Organized crime must be envious.

A few states placed their own limits on minimum Medical Loss Ratios ranging from 80% in New York to 55% in North Dakota, with the resulting "Skim Rates" ranging from 20% in New York to 45% in North Dakota. But since the insurance industry has "bought & paid for" many of our elected representatives at both the state and Federal levels, even this kind of minimal regulation was rare pre-Obamacare.

Note that the 2015 average annual cost for a family health plan is $16,800 per year. That 18.80% difference between Obamacare's 20% "Skim Rate" and the 1.20% lost to administrative costs in Medicare amounts to almost $3,200 per year in excess overhead charges to the insurance company -- more than a family of four with a median income pays in Federal income tax. It's astonishing more people aren't screaming about this.

Obamacare Cuts to Medicare?

As you can see from the table above, Medicare Advantage and Medicare Part D Drug Plans have their "Skim Rates" capped at 15%. But that's still more than ten times the administrative costs we see in fee-for-service Medicare (i.e. 1.20%). The Obamacare law requires Medicare to cut subsidies to for-profit Medicare Advantage plans (which cost the Gov't 14% more than fee-for-service Medicare as of 2009) over a 10-year period. However progress has been slow to date as the cuts are heavily lobbied by the insurance industry and the Congresscritters they've bought and paid for. For 2015, a 1.9% cut magically became a 0.4% increase for the insurance industry.

Medicare Part D Drug Plans have some provisions that close the "donut hole" for beneficiares with high drug costs. But the cost of this is borne by the pharamaceutical industry in the form of rebates on the astronomical prices charged for medications. There's nothing in the law that reduces the "Skim Rate" captured by insurers on Medicare Part D plans beyond the 15% limit.

How to get the best deal on your health insurance?

Since the game is rigged, there's really no way to shop for a health plan with a low "Skim Rate". Most insurance companies seem to be taking their full 20% -- indeed almost 7 million policyholders got rebates in 2013 because their health insurer tried to take more than the 20% limit.

If you are retired and living off an investment portfolio, there are a number of things you can do to reduce your Modified Adjusted Gross Income (MAGI) and maximize the size of your refundable Obamacare tax credit. Retire Early outlined that strategy in an article last year (See, Why I'm Not Worried About Obamacare Premium Increases. ) Over the past several years, I've been carefully reallocating my retirement portfolio away from dividend paying stocks to focus on capital gains. For 2016, I expect to have an MAGI of about $20,000. That qualifies me for a Silver HSA Plan with a premium of $150 per month and a maximum annual out-of-pocket cost of $1,500 -- even if I'm hit with a $1 million medical bill. I didn't have a policy this good (i.e., low deductibles, co-pays and maximum out-of-pocket costs) when I was working for Exxon.

Resources for more information

How to Think Clearly about. Medicare Administrative Costs: Data Sources and Measurement. by Kip Sullivan. , Feb 15, 2013

JAMA Forum: Are Health Insurers’ Administrative Costs Too High or Too Low? , April 24, 2013

Medicare Is More Efficient Than Private Insurance , September 20, 2011

Medicare Trustee's Report , July 22, 2015

Chart of the day: Medicare’s administrative costs, explained , February 18, 2013

Politifact: Medicare overhead is far lower than private insurers' overhead , May 30, 2011

Final Rule on Medical Loss Ratio for Medicare Parts C&D , July 23, 2013

Medicare Advantage, Kaiser Family Foundation , June 29, 2015