How much more does insurance cost when it covers primary care?
We saw in Part 1 of Paying for Primary Care that using insurance to pay for primary care inflates the cost because the primary care practice has lots of extra expenses if they deal with insurance and other third party payers. They have to do extra tasks such as pre-authorizations and quality reporting, and they must use a complicated and expensive EMR system to keep track of everything that third party payers require. These expenses inflate the cost of the service by nearly 30%, and keep in mind that none of these extra tasks and extra expenses mean you’re getting better care.
Now we turn our attention to another set of extra costs that occur when you use insurance to pay for primary care.
The first thing to understand is that in aggregate over a large number of people and a period of time, say, a year, the premium the insurance company charges must cover all of the claims paid out plus additional amounts to cover the insurance company’s expenses and return some profit. For this illustration we’ll use an 85% loss ratio, which is the minimum loss ratio for most employer sponsored group insurance as defined in the Affordable Care Act. The loss ratio is the ratio of claims paid to premiums for a policy or a group of policies. It’s a little more complex than that due to things like the timing of how claims and premiums come in and go out at the insurance company, but that’s the basic idea. In other words, an 85% loss ratio corresponds to the insurance company paying out 85% of premiums as claims, and the other 15% pays their expenses and (hopefully) leaves some profit.
Using insurance to pay for primary care means you have to pay people at the doctor’s office and at the insurance company to do extra things that have nothing to do with the care you received.You’re paying more than 50% extra!!
Since premiums paid into the insurance company have to cover claims they pay out, let’s look at what happens to our primary care visit when we use insurance to pay for it. To make things a little simpler, we’ll assume the insurance company pays the primary care practice the $96 that they need to cover the expenses related to your visit and their overhead and profit, continuing our example from Part 1 of this blog post. (In reality, there’s a whole big song and dance between the doctor’s office and the insurance company where the doctor’s bill for your visit is inflated because they know the insurance company is going to apply all sorts of rules (about network fee schedules, appropriateness of treatment, etc) which ends up paying the practice less than what was billed. For simplicity we’ll assume after their song and dance, the practice receives $96.) The insurance company has to collect $96 in premiums so it can pay out the $96 for your visit. But they also have to pay their expenses. This is where the 85% loss ratio comes in. They have to charge $113 in premium to pay the $96 claim and cover their expenses and profit. You’re paying the insurance company an extra $17 that you wouldn’t be paying if you paid the primary care practice directly.
To summarize what we’ve discovered in parts 1 and 2, using insurance to pay for primary care causes you to spend $113 for the same visit that you could pay $75 for directly. Using insurance to pay for primary care means you have to pay people at the doctor’s office and at the insurance company to do extra things that have nothing to do with the care you received. You’re paying more than 50% extra!! That would be like paying $75 for a steak dinner at Fancy Frank’s Restaurant because they have extra people in the back who are doing paperwork and keeping detailed inventory records on an expensive computer system. You can get the same steak and the same service at Simple Sam’s Restaurant for $50. Which would you choose?
The fine print – why this happens
There is some fine print that we need to talk about regarding how insurance works. Let’s take a simple example of insurance that pays you the value of your home if it’s a total loss in a fire. (In reality, of course, homeowners insurance covers lots of perils in addition to fire, and it pays you less than the value of your home if the fire doesn’t completely destroy your home, but stick with me here.) For ease of calculating, let’s say your house is worth $300,000 and the insurance company has policies for hundreds of similar homes. To figure out how much premium is needed to cover the loss of one of these homes due to fire, we need to know how likely such a fire is. Let’s say the chance of a house burning down in a given year is 1 in 275. Now we can calculate premium for our simplified example. We multiply the size of the loss and the probability of loss, and add some for insurance company expenses and profit. Let’s say we come up with a premium of $1,250. Most homeowners would be happy to pay $1,250 per year to avoid the chance that they’d have to rebuild their home out of their own assets because it burned down. Most people don’t have an extra $300,000 lying around just in case they lose their home to a fire. This example illustrates some actuarial principles, which are economic principles that apply to insurance.
Insurance generally makes sense for events that are unlikely to happen to a given policyholder, that the insured person has little or no control over, and that are so large that they could be financially ruinous if they happened to you. Such events are called insurable events. Our house example satisfies all 3 of these criteria. Only one home in 275 is lost to fire in an average year, and the homeowner has little control over things like lightning strikes and electrical fires which cause most house fires. (Loss due to arson is excluded in homeowners’ policies – if someone could pay $1,250 for insurance and then burn their home down to collect $300,000 some would be tempted to do it). The cost of replacing your home is large and financially catastrophic or ruinous. For more information about insurable events and actuarial principles, please check out this piece that I authored for the Concerned Actuaries Group.
Events that do not satisfy the 3 conditions listed above are not insurable events and it’s generally not a good idea to use insurance to pay for them because it will be expensive and inefficient. Let’s consider primary care in light of insurable events and actuarial principles. Primary care is not unlikely to happen, it’s not random (the patient has quite a lot of control of whether they see their PCP) and it is not expensive.
It’s key to notice that the homeowner has the option to spend $1,250 to avoid a loss of $300,000 only because the probability of the loss is small. Insurance spreads losses over a large number of policyholders so each one pays a small amount to avoid a large loss. That doesn’t happen with primary care because almost everyone uses primary care, and some people use quite a lot of it. Essentially, you cannot spread the cost of primary care over lots of people because almost everyone has the cost. There is variability in how much primary care people are using; a few people might have no visits or one visit in a year while some people will have a dozen or more visits. Even so, no one will be in a situation like that of the homeowner (paying $1,250 to avoid a loss of $300,000) because the likelihood of having primary care claims is high. Instead, the primary care situation is one of paying $75 for a $50 steak dinner. Using insurance to pay for primary care is expensive and inefficient because of the actuarial principle of insurable events. Because primary care is not an insurable event, using insurance to pay for it makes it much more expensive than if you’d pay for it directly.
Essentially, you cannot spread the cost of primary care over lots of people because almost everyone has the cost.
Upcoming in Part 3
The patient having a large degree of control over how much primary care they use means they can adjust their behavior to make things more advantageous for them and less advantageous for the insurance company. They can change their behavior regarding choosing to be insured, how much health care to use, and whether to choose healthy behaviors (which will impact how much health care they use). These behaviors and how they affect how much we spend on health care and health insurance will be discussed in the third and final part of this blog post, Paying for Primary Care. So far, we’ve discovered that using insurance to pay for primary care adds about 50% to the cost. Please join us to see how much more we spend by insuring primary care when people are able to act in ways that advantage themselves and disadvantage the insurance company.