Why Insurers Are Paying Out Rebates

Source: Aetna

Many health insurers are riding high this year thanks to membership growth tied to Medicaid expansion and Obamacare exchanges, but the industry's profit will be $332 million slimmer thanks to one consumer-friendly provision found within the Affordable Care Act.

Who gets what and why?
The Affordable Care Act doesn't allow insurers to price plans based on pre-existing conditions. Instead, insurers must base their pricing decisions on five things:

  • Your age. 
  • Where you live.
  • Whether you use tobacco.
  • Whether you're insuring yourself, or a family.
  • And whether you're choosing a bronze, silver, gold, platinum, or catastrophic plan.

Since the act limits the inputs insurers can use to determine pricing, lawmakers included an 80/20 provision to make sure that insurers don't over-price plans. This 80/20 provision mandates that insurers spend at least 80% (or 85% for large group plans) of the premiums they collect on their members' medical care. If they don't, then insurers are required to rebate the difference back to their customers; and those rebates are really adding up.

More than 6.8 million customers will receive rebates over the coming weeks, with the average family getting $80, but these aren't the first checks that insurers have sent to customers under the 80/20 rule.

According to the Department of Health and Human Services, this year's $332 million payment brings the total amount returned directly to consumers to $1.9 billion since the 80/20 rule went into affect in 2011. As shown in the chart below, HHS also estimates that complying with the 80/20 rule has kept a lid on premiums that saved consumers another $3.85 billion by way of lower monthly payments last year. In total, that means that between rebates and cheaper monthly premiums, consumers saved $4.1 billion in 2013.

Source: Centers for Medicare and Medicaid

Less costly care?
Rebates aren't being paid because health care is getting cheaper. Total health care spending growth has hovered under 4% since 2009 and while that's slower than the 6.9% growth averaged between 2000 and 2009, it still means payers are spending more, not less, on health care.

Although spending is trending higher, insurers may still be pricing their plans too high given the need for rebates, but that doesn't mean that the industry isn't getting better at figuring out how much to charge its customers. Overall, the industry's 2013 payout is less than it was the year prior, when insurers were told to return $504 million to customers -- as shown in the chart above.

That may mean that insurers are doing a better job at accurately pricing their plans, but it may also mean that insurers are doing a better job at controlling their administrative costs, which can't be included in the medical loss ratio used to determine rebates. Insurer spending on overhead has fallen from 13.1% of premiums collected in 2011 to 12.2% last year (see below).

Source: Centers for Medicare and Medicaid

Fool-worthy final thoughts
The amount returned to consumers will vary from state to state, but Floridians are set to get the most money back. Insurers are slated to return more than $41 million to customers in the sunshine state.

Although the payments from these insurers total well into the millions of dollars, they're not a surprise and investors shouldn't panic. Insurers are well aware of their medical loss ratios and the impact of rebates and despite having to pay them, many health insurers are still increasing, rather than decreasing, their profit guidance for this year.

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Todd Campbell

Todd has been helping buy side portfolio managers as an independent researcher for over a decade. In 2003, Todd founded E.B. Capital Markets, LLC, a research firm providing action oriented ideas to professional investors. Todd has provided insight to a variety of publications, including SmartMoney, Barron's, and CNN/fn.

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