Insurers' profits story deeply flawed

The Associated Press article on the profitability of health insurance companies is deeply misleading and should probably not have been published, especially considering its polemical tone. The author of the article has not understood the elementary fact that profitability as a percentage of total revenue in manufacturing has meaning, whereas in the financial industry, it does not.

Of the total amount of premiums paid in to a health insurer, the major part is paid out as claims to health care providers. This money is not part of the insurer's business: it is just in their custody. The proper way to evaluate the profitability of a health or casualty insurance company (life insurance is different) is to compute the ratio of net profits to the difference between premiums paid in and claims paid out.

You will then find that a more realistic figure for the profitability ratio in the industry is at least three or four times that in the article. In a similar vein, a bank's profitability is not evaluated on the amount of money flowing in and out of customer accounts, which depends on the dollar amount of the deposits made and the checks written by account holders.

In this case, the proper denominator for evaluating profitability ratios is the sum of the balances in the accounts: this is the money that banks lend out to other customers, on which they make their profit. Let me emphasize that this is not a matter of ideology or even opinion, it is accounting and economics.

Per Flaatten

Warrenville