This article, FACT CHECK: Health insurer profits not so fat, by AP writer Calvin Woodward, has turned up in a few places now. It is a well-researched piece that doesn’t begin to tell the truth. But it’s very convincing and well-argued. I think that is otherwise known as sophistry.
Here’s a few select quotes:
Health insurance profit margins typically run about 6 percent, give or take a point or two. That’s anemic compared with other forms of insurance and a broad array of industries, even some beleaguered ones.
Profits barely exceeded 2 percent of revenues in the latest annual measure.
…Health insurers posted a 2.2 percent profit margin last year, placing them 35th on the Fortune 500 list of top industries. As is typical, other health sectors did much better – drugs and medical products and services were both in the top 10.
The railroads brought in a 12.6 percent profit margin. Leading the list: network and other communications equipment, at 20.4 percent.
HealthSpring, the best performer in the health insurance industry, posted 5.4 percent. That’s a less profitable margin than was achieved by the makers of Tupperware, Clorox bleach and Molson and Coors beers.
Disraeli, Mark Twain … someone mentioned the three kinds of lies … lies, damned lies, and statistics. That’s never so well demonstrated as in this article.
That’s because profit margin, or the cents of each dollar of sales that ends up as net income, is not a particularly meaningful figure. Investors look at it, to be sure, but usually compare it to some standard – industry average, for example. Standing alone, it has very little significance.
The reason is that different industries have to achieve different levels of sales to churn different levels of net income. Some have to do more dollar volume to achieve a dollar’s worth of net income than others. Health insurance is one of those industries. Retail groceries are another. Safeway’s profit margin in 2008 was 3.6%. That small margin, however, was enough to return over 12% on its equity.
Investors want to know a whole lot more about a company than its gross profit percentage, as Woodward must surely know. They look at a whole spectrum of measurements, including EPS, or earnings per share, and EBIDTA, earnings before interest, depreciation, taxes and amortization. Warren Buffet has a mere twelve tenets of investing, one of which is indeed gross margin (a company must make some money for each dollar sales, he says), but certainly not the most important.
Here’s Woodward’s opening line:
Quick quiz: What do these enterprises have in common? Farm and construction machinery, Tupperware, the railroads, Hershey sweets, Yum food brands and Yahoo? Answer: They’re all more profitable than the health insurance industry.
It is true, Tupperware (34% ROI) and Hershey (98%) did very well last year. These are very small companies with outstanding returns. What relevance that has to the health care sector is beyond me. Why not instead look at the actual numbers for health insurance companies? Why the suspicious comparisons? (By the way, Yum Brands and Yahoo both lost money last year. So much for research.)
Does profit as a percentage of sales give us a meaningful picture for health care? I looked at three companies:
Wellpoint: It’s 2008 net income was $2.491 billion, it’s profit margin is 4.1% on sales of $61.251 billion. ROI: 11.6%.
United Health: It’s 2008 net income was $2.977 billion, it’s profit margin is 3.7% on sales of $81.186 billion. ROI: 14.3%.
CIGNA: It’s 2008 net income was $292 million, it’s profit margin is 1.5% on sales of $19.101 billion. ROI: 8.1%.
CIGNA might be considered anemic. Wellpoint and United Health are doing swimmingly well. Woodward’s point is rather hollow. He chose to look at a number, profit as a percentage of sales, that did not convey much information.
That’s how sophists do their sophistry.
Research project: Since 2005, public companies have had to report executive stock options as an expense on their income statements. Before that time, they were merely a footnote. Dollar Bill McGuire, former CEO of United Health Care, at the end of 2005 reported that he had accumulated $1.6 billion in options, making him perhaps the highest paid executive in history.
Companies were given the option of restating prior earnings to expense stock options. How many health insurance companies did so?How much of the reputed earnings decline mentioned by Woodward is due to stock options turning up as an expense?
Piece of Mindful 