ANALYSIS: Blue Cross, Blue Shield get richer by borrowing playbook of corporate insurers

Introduction

I’ve written frequently in recent weeks about the eye-popping profits the big publicly traded health companies have been reporting. Last year—as the number of Americans without health insurance grew to nearly 51 million—the five largest for-profit insurers (Aetna, CIGNA, Humana, UnitedHealth and WellPoint) had combined profits of $11.7 billion.

But that was so 2010.

If the profits those companies made during the first three months of this year are an indication of things to come, 2011 will more than likely be the most profitable year ever for these new darlings of Wall Street.

But lest you think only those big New York Stock Exchange-listed corporations have figured out how to make money hand over fist while their base of policyholders is shrinking, take a look at the so-called nonprofit Blue Cross and Blue Shield plans.

Don’t think for a minute that the Blues are any more interested in your health and well-being than the companies that at least own up to being in business to make a hefty profit off of insuring the healthy and shunning the sick.

According to a report by Carl McDonald of Citi Investment Research and Analysis, last year was the most profitable year in history for the Blues plans, which enjoy significant tax advantages because of their claim to be nonprofit and terrific community citizens. Collectively, the Blues reported more than $5.5 billion in net income in 2010.

Not only that, but the Blues now have more than five times that amount in capital above what state regulators require. As McDonald noted in his report, maintaining such a huge reserve should make regulators think twice before approving rate increases in the future.

“Our analysis of the financial position of 33 Blue Cross plans suggests that their capital position has reached a level that’s difficult for the nonprofits to justify, and if sustained, will lead to significant tension between the nonprofit Blues, regulators and consumer activists,” McDonald wrote. “According to our data, the nonprofit Blues held a total of $52 billion in capital at the end of 2010, or more than $29 billion above minimum regulatory requirements.”

One of the ways the Blues have been able to amass such fortunes is by avoiding paying for care in exactly the same way the big for-profit companies do. They are rapidly moving their policyholders into high-deductible plans and spending far less on medical care—and far more on overhead—than they have in the past.

How much insurance firms spend on medical care is measured by what is called the medical loss ratio.

In 1993, the average medical loss ratio in the health insurance industry was 95 percent, which meant that insurers spent 95 cents out of every dollar they collected in premiums on medical care. In their quest for profits, all insurers, regardless of their tax status, have been spending less on care in recent years. The average medical loss ratio is now closer to 80 percent.

McDonald found that some of the Blues are spending far less than that these days. The medical loss ratio at the Texas Blues, for example, was just 64.4 percent last year.

Beginning this year, as a result of the health care reform law, insurers will have to maintain medical loss ratios of at least 80 percent. Had that provision of the law been in effect in 2010, McDonald says the Texas Blues plan would have had to price its policies for individuals about 12 percent lower than it actually did.

McDonald found that some Blues are much greedier than others when it comes to making profits and building up big surpluses.

It turns out that the Blues plans that have to compete with the big for-profit companies behave, well, just like the big for-profits. In other words, the competition actually works against the interests of policyholders. The profit margins and the size of the surpluses of the Blues in states where the for-profits have a significant presence were on average considerably higher than in states where the for-profits don’t have as much market share.

So much for the myth that competition among insurers results in lower premiums.

Health insurance is one part of the U.S. economy where the free market works beautifully for the insurers and a few executives (and shareholders of for-profit companies) but horribly for the rest of us.

The nonprofit Blues don’t have to reward shareholders, but they do lavish a big chunk of their premium revenue on themselves. Take BlueCross BlueShield of Tennessee as an example.

Last year was a very good year for the Tennessee Blues. It raised premiums an average of 6.5 percent, which was enough to increase profits five-fold over 2009 and boost its reserves to almost 50 percent more than the $955 million required by the state. Its medical loss ratio for individual policyholders was only 76.7 percent.

The company has been building up the reserves for many years, but instead of giving money back to policyholders in the form of rate reductions, it has built itself a veritable palace overlooking downtown Chattanooga.

Under pressure by lawmakers and consumer advocates a few years back to reduce its surplus, BlueCross BlueShield of Tennessee decided instead to spend $300 million on a new 950,000 square-foot headquarters. The building has a scenic view of the Tennessee River and is on historic Cameron Hill, where during the Civil War the Union built a fort and fired cannons at the Confederate army.

When the company’s 4,000 employees moved in 2009 to their new digs, they left vacant several buildings in downtown Chattanooga. City officials now realize it will be hard to find new tenants for those buildings, but that didn’t stop them from giving BlueCross an unprecedented 16-year, 50 percent tax break back in 2005.

Blue Cross plans in several other states have also recently built grand and shiny new headquarters buildings with money from policyholders that could have been spent providing care and insuring more Americans. But why would they want to do that?

The bottom line: nonprofits can be extraordinarily profitable if your nonprofit happens to be a Blue Cross plan.