Who Makes All The Money In Healthcare?

The US spends over $3.5 trillion annually on healthcare - (note that’s roughly the same as the entire federal budget) - or over $10,000 for every man, woman, and child in the US.

Everyone from pundits to political candidates to advocacy groups takes alternating potshots at insurance companies, hospitals, and pharmaceutical and medical device companies for price gouging and profit taking - claiming that the amount of money they make is enormous and unconscionable. 

However, that’s not always the case. When it comes to profit, some industries make more than others.

We’ll dive into average profit for companies in 3 healthcare related industries - insurance, hospitals, and pharmaceutical companies.

When we talk about profit margin, we’re referring to net profit margins which is post-tax and all other expenses. This is the returns to shareholders.

Before we begin, keep in mind that according to NYU Stern Business School the profit margin of companies across all industries is 8.89% (as of January 2019).

Health Insurance Company Profit Margin: 4%-9%

Despite what pundits and political candidates may say (and what it may seem like given ever increasing insurance premiums), health insurance industry profits averaged 4%-5.25% in 2017, or roughly half the average profit margin for US industries. Note that top health insurance companies do a little better, ranging from 4.5%-9%.

Health insurance is actually one of the least profitable types of insurance - the industry average is between 3% and 10.5%, led by insurance brokerages.

One of the reasons that profits are as low as they are is that the ACA mandates a minimum Medical Loss Ratio (or MLR) for insurance companies. The MLR is the percent of healthcare premium collections (the money you pay an insurance company every month for coverage) that are spent on actual health care claims and quality improvement. 

The ACA requires that insurance companies have an MLR of 80%-85% (depending on the type of insurance). This leaves only 15%-20% for administration, marketing, and profit. That means, health insurance companies can’t by law have a profit margin any higher than 15%-20% (and realistically - as we see - it has to be lower since running a company isn’t free).

Hospital Profit Margins: Less than 8%

A Navigant study on hospital operating margins from 2015-2017 showed them declining from a little over 4% to just over 2.5%. A study from Truecostofhealthcare claims hospital profit margins are in the order of 8%, while the above mentioned NYU study puts hospital profit margins at sub 1%.

While it’s tough to be absolutely certain which study is correct, it seems safe to say that hospital profit margins at the end of the day are less than average across all industries (remember average is just under 9%).

We talk a lot about price inflation and price gouging by hospitals - with patients sometimes getting charged over 10x the hospitals cost to provide service. However, at the end of the day hospitals don’t have huge profit margins - what gives?

A major reason for this is the amount of ‘bad debt’ that hospitals have to write off. That is, hospitals are writing off massive amounts that they charge but never collect on from patients (hospitals collect as little as 6 cents on the dollar from patients). Essentially there’s a toxic cycle of hospitals billing patients, patients not paying, hospitals sending the bills to collections, patients having their credit ruined (or even court judgements filed against them), and hospitals still collecting almost nothing.

On top of that - keep in mind that the majority of hospital revenues come from insurance payments - and insurance negotiated rates are always significantly discounted from the direct to patient rate.

Side note - we’re using operating margin instead of profit margin in this case because the data on operating margin is more robust than profit margin. A company’s operating margin is their profit margin from their core business (so excluding costs and profits from tertiary business lines). Since the core business of a hospital is providing healthcare, this provides a good view of what the profits from providing healthcare are.

Pharmaceutical Company Profit Margin: ~17%

Here is where we see significant profit margins (at least compared to broad company averages). According to a report released by the US Government Accountability Office (a non-partisan government organization) average pharmaceutical industry profit margins are around 17%.

It should be noted that these profit margins are heavily skewed towards Big Pharma. The 25 largest pharmaceutical companies had average profit margins north of 20% according to the report, while the smaller players (the rest of the industry) saw profit margins close of roughly 8.6% (or right around the broad company average).

Conclusion

As you can see - not everyone makes a killing in healthcare. Some industries are far more profitable than others, and it would seem that some industries are unfairly demonized by pundits and political candidates for profit-taking.