I feel like often people don't understand the difference.

In attacking Oil and now the Health Insurance industries we hear these claims of massive profits and how they must be punished.

But what they typically leave out is they are talking dollar value, not profit margins, a company can have a very small profit margin but large profits if they have a wide customer base, lets make up a product.

THE MAGICAL WIDGET

Costs to produce, market, sell, etc, all costs associated with 1 Widget is $1. Widget Co., sells them for $1.01.

Now lets say they sell 1 billion widgets in 2009. They would take in 1,010,000,000 in revenue, have costs of 1,000,000,000 and a profit of 10,000,000.

So people say wow they have a 10 million dollar profit, they are screwing us!. Except please tell me how they can reduce that? Stop being successful? Stop selling so many Widgets? If they reduce the price to $1.00 they now have a profit of $0.

I say this because the health insurance profit margins aren't insane, or out of line, and many industries have higher margins, yet Obama keeps talking about their "profits" when he's bad mouthing the industry and trying to drum up support.

So I thought I'd just try and help educate about the difference between profits and profit margins.

I agree attacking a raw number in profits is silly.

However, I believe the primary legitimate criticism towards health insurance companies refers to their ill-gotten gains, such as denials of coverage for shaky reasons, and a culture promoting denial of coverage as a method to improve those profit margins.

This is especially dubious when you consider that private health insurance is perfectly viable in countries where these practices do not occur, a primary example being Switzerland.

Thanks for the informative post, but I don't think that's the crux of the matter. What really pisses people off about health insurance companies is the fact that they are making all that money without having produced any tangible product. The money instead comes from cleverly worded agreements that take advantage of the propensity of customers to gloss over the fine print and take the company's word that they will be fully covered in the event of calamity, when the truth is that they will instead be left out to dry. If customers were fully educated about what a poor bargain they were making then they would seek other alternatives and the health insurance companies would be out of business.

Yes well said, now is the solution for government to force the companies to change the product, or should the onus be on the person purchasing the product?

Based on your post above I am curious as to whom you believe to be the responsible party going forward:

1. Government: regulate the industry
2. Industry: self govern and change the product and its marketing
3. The consumer: educate and purchase the product that suits the need

Tangible product?

Please define.

Yeah, tangible products, !@#$%^&*. Insurance companies provide security to people. While, yeah, costs should be lower, if you don't have insurance then the price of breaking a leg will be far worse.

All parties bear some share of the responsibility. I wouldn't really trust the industry to self-govern, since there are few example of that having worked in the past, and there will always be foolish people out there to be preyed upon. So that leaves government regulations as the sole remaining recourse. Both Democrats and Republicans in Washington are currently in favor of stricter regulations, but the disagreement is over how strict they should be. Nobody is proposing that the government do nothing, and nobody is proposing a government takeover of health care either.



A widget is a tangible product. You can see it, touch it, and use it to do whatever widgets do. A health insurance policy however is a contractual agreement between an individual and a company, that the individual will pay a certain amount to the company each year in exchange for a guarantee that the company will cover a certain portion of the individual's medical expenses should they get sick. What I am saying is that through deceptive business practices health insurance companies lead their customers to believe that they will have far more coverage than they will actually have, and thus the individual is willing to pay a much higher premium than they otherwise would.

Where I would go on that is if they are actually falsely advertising, then you hit the insurance companies, but if its through the consumers lack of trying to fully understand the policy its the consumers fault.


Also my overall purpose of the thread was really the attacks on profits, not necessarily healthcare, I was just using that as an example. Obama does attack how they get their money, but he also has said many times how "profitable they are" That they get a lot of money and that lead to my overall point of profits vs profit margins.

So to expand on this a little bit, how much can we attribute the current situation to this, and more importantly, how can we expand on this vein of thought for the solution?

My position is rather simple, purchasing insurance should be an individual choice and a business transaction. Health, and the insurance of it should not be the charter of the state but the individual. That being said I believe the state has the ability and charter to punish the insurance company if they are not being forthright with the product at the expense to the consumer.

I want to see more personal responsibility by the consumer, i think we have made it far to simple to be "bailed out" by the government, and I want to see more regulation on insurance companies on how they provide service and how they sell the service. Health insurance is not a right to be guaranteed by the state, but rather an individual choice by the consumer. In the end no one is responsible for my health but myself, so have at it, sell me a product to compliment my need.

get my drift?

I am not seeing personal responsibility consuming enough of the conversation on health care, and thats bothersome.

That is because little words like "responsibility" and "accountability" scare the kids. Shush with that kind of talk.

And the idea of profitability extends far further. You can have huge profits in an absolute sense just by having a TON of assets, but those assets may not be used efficiently at all.


For example, if you have two grocery stores, one may be earning $100,000 in profits with $1 million worth of assets, while the other is earning $200,000 in profits with $3 million on assets. The second supermarket does have larger profits, but it's a combination of selling more products, AND having to have a larger store in order to sell those products and generally not using their store space as efficiently as the first one.



But the real crux of the issue if return on equity, which is basically the profits divided by the amount actually invest in the company. In the supermarket example I just used, the first supermarket may have $1 million assets, but half of that is financed by debt and half financed by stock. The second supermarket may have $1 million in assets, but may have most of it in debt and the same $500,000 in stocks. So even though the second supermarket is still less efficient, per se, it IS more profitable because the stockholders are getting twice the profits for the same initial investment. The second supermarket can manage its cash flows and debt better, thus higher return to the stockholders. Which is true, real profit.

Health insurers do bad on profit margins, but they look a better when you look at the return on equity numbers, because insurance companies tend to have much less equity in them than other companies, so what profits there are tend to be concentrated on fewer stockholders. I dunno about the return on asset numbers, but those are probably pretty high, too.


But it's not completely out of whack. And while health insurers in many locations DO have monopoly power in theory, I really don't know what to extent they apply this against their customers. Health insurers and insurers in general are always living under the specter of increased regulation

The really funny part is, those monopolies are because of current government regulations, so in effect, the government causes monopolies, the companies abuse them and the government wants to punish them for it. Why not just change the regulation so they don't have monopolies.

Well, the insurers probably don't want it because it would hurt profits. In the grander sense, health insurers are big companies dealing with other big companies and you need to change both sides of the equation if you want an efficient market outcome, plus health insurers are much more vulnerable to direct regulation to keep them from exploiting consumers. I've also heard that the anti-trust exemption allows insurers to share information on setting insurance rates, basically spreading best-practices in risk management to all insurers...but that one I'm not so sure about

my biggest beef is the issues with interstate and intercountry insurance. this is what allows there to be only 1-3 providers for most people.... coupled with other issues, not much competition.

Here is my problem with Insurance Companies and their "profit." I am fine with the fact that they earn only 3%, however, I am not fine with the fact that this 3% is basically a lie.

My brother works with insurance companies and explained how they determine their profits, however, take what I say with a grain of salt, as I do not personally have any of the documents proving this, as they are government forms - so you don't have to believe what I say.

Insurance companies have expenses and profits, like everything.

Expenses are things like the amount of money they actually spent insuring people (paying back for accidents/whatever), wages, bills on things like buildings, etc.

Their profits, are a little more confusing. They have their profit, the thing they report as 3%, but they also have these other things that they consider expenses, but are really profits:

Possible Disasters (natural or man-made, katrina or 9/11), this really is profit, as they didn't spend it, but they put it in their expenses.

Possible random claims (can't really find a good way to describe this, but basically claims that might be put in)

things like that.

After deducting all that, THEN they get the "magical" 3% profit.

If something like Katrina does happen, they take it out of their profit margin, but consider it a LOSS, when really they have all the other profits on top of it, and that was part of the profit margin in the first place, so it's semi-misrepresented. However, due to the nature of the business, they are "allowed" (bad word for it, but you get my point) to do those things, within reason.

Again, take what I say with a grain of salt, but this is from things I've seen and heard from my brother, who worked in insurance a long time and works with insurance companies now as a government employee, so I believe them, but you don't have to, since you don't know me, nor my bro.

What you are describing is either a misunderstanding of a common practice or quite illegal. Banks, and probably other financial companies like insurance companies, build up reserves against potential losses. This is deducted as an expense in the period when the money is added to the reserve and shows up on income statements as an expense, and shows up on the balance sheet as a contra-asset (IE, it's on the asset side to reduce value from the value of whatever the loans/premiums are). If you do actually INCUR a loss, it's simply written off by reducing the value of the contra-asset and doesn't actually show up on the income statement again. Taking an expense AGAIN would probably be illegal.

The IRS doesn't like booking expenses like that.


EDIT: Though insurers probably work differently because they jet out a HELL of a lot of money every year. The most likely explanation is that they have required reserves that they are not allowed to write down, and therefore both show up as expenses, though I'm looking at the Humana financial statements and I can't find a reserve account expense. not sure I want to look through this whole damn thing...

I just don't see how the "tangible product" argument is relevant. Do car insurance companies provide a tangible product?

What about a consulting company that comes in and advises a company how to operate more efficiently? Or a lawyer who provides legal counsel?

If I get what you are saying. What they are doing is estimating the potential losses and book basically a reserve. While I don't know insurance company GAAP that well, I am an accountant and studying for my CPA and will tell you they are likely REQUIRED to do that, and it makes perfect sense. They need to show those losses as a liability, because thats what they are, they should be reasonably estimated but thats what actuaries do and why they get paid well.