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Health Care Costs: A Look Into WellPoint's Profits

By TOM MURPHY   02/21/10 01:16 PM ET   AP

Wellpoint Profit

The Obama administration has seized on the issue to renew its push for an overhaul of the health care system.

At the heart of the debate is the question of what should be a fair profit for health insurers. WellPoint CEO Angela Braly will likely be grilled on the issue when she appears at a Congressional hearing Wednesday. Here are some questions that explore the issue.

Q: How does WellPoint make its money?

A: The Indianapolis insurer made about $4.7 billion in 2009, a total stoked by the $2.2 billion it received from the sale of a pharmacy benefits management subsidiary.

Outside that, WellPoint made most of its money through employer-sponsored group health insurance. It reported $2.4 billion in operating profit from that segment last year, which amounts to about 58 percent of its total earnings.

The insurer has said it gets only about 10 percent of its operating income from individual health insurance like the kind it sells in California.

Q: With that kind of money, why did WellPoint hike rates in California so high?

A: WellPoint says it lost millions last year on the individual health insurance policies it sells in California. The insurer underestimated the premiums it needed to collect in order to pay claims.

On top of that, WellPoint said hospital costs are rising an average of 10 percent a year and pharmaceutical costs are up 13 percent, and that must be factored into pricing.

At the same time, the tough economy is forcing more healthy people to drop their individual insurance. That leaves a higher concentration of sick people who generate medical claims in their risk pools. All this leads to premium increases that could average 25 percent.

Q: Can't WellPoint use money from a profitable business segment to cover shortfalls in its individual insurance division in California?

A: Each segment has to stand on its own in part because customers in New York wouldn't want their premium dollars being used to subsidize the California business. Likewise, a large company wants its premium dollars spent on coverage for its employees, not a subsidy for another line of insurance.

Q: WellPoint's a for-profit company. Do nonprofit competitors hike rates as high as WellPoint is planning?

A: Yes. They see the same customer turnover in individual insurance and they have the same capital requirements WellPoint has, although they don't need to generate shareholder returns.

Nonprofit insurers can raise rates in the range of 20 percent, said Gary Claxton, an expert on the private insurance market at the Kaiser Family Foundation. However, regulators in some states can require nonprofits to return some of their surplus to curb rate increases.

Q: What is a fair profit for health insurers?

A: This has become a stickier issue as medical costs rise. Insurers need to make a profit to generate a return on investment that makes their stocks attractive to shareholders, who supply the capital necessary to underwrite policies.

They have to use some profit to invest in technology to keep up with changing billing codes and pay claims quickly. Regulators also require them to set aside some of their earnings in case claims exceed the insurer's expectations.

Whether their profit margin should be 3 percent or 10 percent "is a much grayer area," Oppenheimer analyst Carl McDonald said.

By one measure, managed care companies make modest profits. Health insurers posted a 2.2 percent profit margin in 2008, placing them 35th of 53 industries on the Fortune 500 list. Drug and medical product companies both made the top 5.

"They're very much middle of the pack, but they've sort of been demonized in this health care reform debate," said Christopher Conover, a research scholar in Duke University's Center for Health Policy who has studied profit margins.

WellPoint's profits look outsized, in part, because it is a huge company. It had $65 billion in total revenue in 2009 and was the 32nd largest company on the 2009 Fortune 500 list, which is based on 2008 figures.

Some states have approval power over health insurance rates. But many, as is the case with California, do not. California and other states do, however, set a minimum percentage of premiums that must be spent on medical claims. California regulators require insurers pay at least 70 percent of the premiums they collect on individual insurance toward claims. WellPoint says it tops that percentage.

While insurers do aim to make money, analysts and actuaries say rising medical costs are the main driver of rate hikes. Many insurers are in competitive markets, and they have to be careful not to overprice, said health care consultant Dan Mendelson, president of Avalere Health.

"You wouldn't see a 35 percent increase in price because they're trying to make more profit," he said. "It just doesn't work that way."

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Filed by Ryan McCarthy  |