November 18, 2019

Capping health insurers’ profit margins

Did Obamacare regulations bring down premiums? Probably not.

Efforts to contain insurers' profit margins may not bring down premiums, but they could still help policyholders by increasing coverage, according to a paper in the American Economic Journal: Applied Economics.


In 2013, a little-known rule in the Affordable Care Act had health insurers terrified, reported the Washington Post. The Obama White House bragged that the so-called 80/20 rule was holding insurance companies accountable and saving Americans billions of dollars in premiums.

As the ACA’s ten-year anniversary draws near, it’s now clear that this particular rule did almost nothing to bring down premiums, according to a paper in the American Economic Journal: Applied Economics.

Authors Steve Cicala, Ethan Lieber, and Victoria Marone found that the policy, which aimed to cap health insurers’ profit margins, only resulted in higher claims costs. What this meant for consumers is more ambiguous. 

The Obama administration’s drive to bring down premiums came in part from a belief, with good reason, that health insurance markets in the US are not competitive. Many locations only have one or two insurers to choose from.

“There was a sense that insurers were gouging customers,” Cicala told the AEA. “I think politicians were looking for some regulatory instrument to try to protect consumers.”


Painful premiums
US health insurance premiums have continued to grow faster than wages. The chart below shows the percentage increase in individual premiums and average earnings since 2007. 


In the simplest terms, the 80/20 rule requires that insurance companies spend at least 80 percent of the premiums they collect on medical claims, effectively capping their profit margins. If insurers fall under this threshold, they must rebate the difference to policyholders.

At first, those rebates were a boon to insurees. Many companies were not able to comply with the rule in the short run, so they had to issue over a billion dollars in rebates within the first year. 

That situation didn’t last though. Rather than lower premiums, insurers searched for other ways to come into compliance. Initially, there were efforts to relabel some administrative costs as “quality improvements”—like lobbying to count spending on nurses’ hotlines as part of the 80 percent.  

But the easiest route to meeting the requirement was simply to let medical claims increase. That companies opted to do this, instead of lowering premiums, didn’t come as a surprise to the authors.

“An instrument like this looked very familiar to me from my work on utility regulation,” Cicala said. “And it was kind of incredible that something like it had been adopted [by the ACA].”

The electricity sector, for instance, uses regulations similar to the 80/20 rule, but there are regulators that monitor utilities and sign off on “legitimate” costs—a key difference. There was no such oversight for the health insurance industry.

According to Cicala, the regulations gave insurers little incentive to keep costs down. There were two ways companies below the 80 percent threshold could let medical claims rise: they could pay higher prices to doctors, hospitals, and pharmaceutical companies, or they could expand coverage for policyholders.

Good intentions aren't enough. You have to think carefully about the incentives created by regulatory design. 

Steve Cicala

Regardless of exactly how costs increased, the authors found hard evidence that companies came into compliance by increasing claims and not decreasing premiums.

The researchers analyzed data from the National Association of Insurance Commissioners and federal agencies. Their approach relied on a technique called “difference-in-difference,” which compared insurers above and below the threshold, before and after the ACA rule went into effect.

They estimated that the medical loss ratio—the amount spent on claims divided by premiums—increased by 7.3 percentage points for insurers not in compliance. This amount was roughly equal to their average distance below the regulatory threshold, about 8 percent.

While the 80/20 rule clearly failed to bring down premiums, its impact on policyholders was murkier. Depending on how claims increased, either through higher prices paid to providers or better coverage, there could still have been benefits for the insured. 

“There was a massive increase in claims,” Marone told the AEA. “To achieve that massive increase, in all likelihood, some of that was lowering . . . out-of-pocket costs for consumers.”

Future research is needed to resolve those questions, but the authors’ paper offers a stark lesson for policymakers.

“Good intentions aren't enough,” Cicala said. “You have to think carefully about the incentives created by regulatory design.”

Regulating Markups in US Health Insurance appears in the October issue of the American Economic Journal: Applied Economics.