Wharton’s Mark Pauly on health insurer mergers: worry not vs. worst of both worlds

We have a story in the works here at Managed Care on the mega–health insurers that may soon be roaming the land.

Yes, the deals may yet run into antitrust problems, but the way things stand now there will be three super-sized national companies: an Aetna-Humana behemoth, an Anthem-Cigna giant, and the already gargantuan UnitedHealthcare.

Wharton health economist Mark V. Pauly(link is external) is one of the experts that Susan Ladika, a Tampa-based freelancer, interviewed for our merger story.

I went to the Leonard Davis Institute(link is external) website recently and read a couple of blog posts that Pauly wrote these mergers (you can read them for yourself here(link is external) and here(link is external)). He provides some fresh (to me, anyway) insights into these deals and what they might mean for coverage and cost of American health care.

Pauly paints two seemingly contradictory pictures. One is the effect of the mergers may be blunted by the way insurance markets are currently structured and by some ADA rules. But his “on the other hand” position is that the mergers could result in higher premiums and higher health care costs.

Self-insured employers insulated

One important point that Pauly makes right off the bat is that many employers self-insure these days, so even if these mega-insurers gain the market power, that won’t affect self-insured employers directly. Says Pauly:

The worst that can happen is that there might be less competition among companies that supply administrative services, but that market includes firms that are not insurance companies, so it is likely to remain competitive.

The Wharton professor says even small- and medium-size employers may not be affected that much in markets such as Philadelphia where a strong Blues plan, Independence Blue Cross, is a major player.  Furthermore, some medium-sized employers could move to self-insurance if the mega-insurers premium hikes become onerous.

In Pauly’s view, it’s people who buy their health insurance on the ACA exchanges that may be the most vulnerable in the era of the mega-insurer. The ACA set out to bring some order and access to the individual market. These mergers may be a “counter-revolution,”  writes Pauly, reducing the number of competitors and increasing  profits, he notes.

Still, he says, the ACA medical-loss ratios limits (80% for individual insurance and 85% for Medicare Advantage) should provide some protection against excessive premiums.

So is the fear and loathing of these mergers off base?

Worst of both worlds

Not exactly, Pauly explains in a follow-up blog post.

The medical-loss ratio rules mean that in the individual market only 20% of the premium dollar can go toward administrative costs and profits.

But say these new companies realize all the efficiencies they are talking about. Where does savings go? Probably to company  bottom lines, explains Pauly. Do we celebrate that or denounce that development? Here’s Pauly’s take:

Most of us would probably applaud reduced administrative costs as a matter of principle—except that, in this case, all the savings from avoiding that paper-pushing waste would go the insurer, not its customers.

He goes on to say that some of those much-maligned administrative costs pay for insurer efforts to reduce health care spending. All that negotiation with providers, all that tinkering with incentives, all those intricate value-based payments schemes—they cost money. Pauly’s point:

So it would not be surprising if the shift from administrative cost to profits also led to higher medical costs—and, of course, higher claims.

Moreover, without competition, the medical-loss ratio rules may actually encourage higher costs and claims, reasons Pauly.

He explains his thinking this way: If 20% of the premium dollar can go toward administrative costs and profit, and an insurer manages to squeeze administrative costs so a larger proportion—say three-quarters—of that 20% is profit, then insurer has an incentive to let claims (and the underlying medical spending) increase. Why? Because 15% of a larger number means more profit than 15% of a smaller number.

The coating on Pauly’s concluding thought has no sugar on it:

There were some reasons, some of them plausible and some of them vindictive, for putting the medical loss ratio rules in place as part of the [ACA] legislation. But combine these rules with greater monopoly, and we have the worst of both worlds: higher insurance premiums and higher health care costs, to boot.


Pauly’s seemingly contradictory arguments (no big deal vs. worse of both worlds) are a little confusing (at least to me) at first. But if you pull back, you see that he is describing several of the many different crosscutting forces at play in American health care. Where we actually end up as result of these mergers depends on a long equation of highly contingent, interdependent factors. It’s a fool’s game to make hard-and-fast predictions.