Many of my clients have been asking how health reform will affect them and/or what they should expect in terms of rate increases in the coming years. This presentation was made to explain the concept of health reform in a simplified approach.
Roborockets Manufacturing, Inc. is our sample company. They are a long-standing, family-oriented company that builds toy rockets for children. Their rockets are very basic toys, and they represent your current health plan. I realize that this is truly an over-simplification of health insurance, but this is done to help to simplify the issues at hand.
Roborockets makes their basic rocket to sell for $1. Again, this figure is used to simplify the illustration. In terms of local health insurance plans, an average rate of $350 for a single employee and $1,000 for a family is closer to the actual cost of employer-sponsored plans in Central Pennsylvania.
To breakdown that $1 sales price, we use the following illustration: 5% = $0.05 = Profit to Roborockets 20% = $0.20 = Labor / Sales Cost 75% = $0.75 = Material Cost This is similar to what we see in health insurance. A “good” plan in our area runs at the same proportions: 25% = Administration (Profit, Labor, Sales Cost) 75% = Claims Payments This makes-up a 75% “Loss Ratio” and this is considered to be a reasonable loss ratio for health insurance companies in our area.
Now imagine that the government came to Roborockets with a new rule – they can no longer spend 75% of the sale price for their material costs, they must now spend 85% of the sale price for materials. The president of Roborockets takes this back to his management team, and they begin to devise a way to make this new rule work. Here are the three options that they explore:
Option 1: Go Non-Profit Well, this doesn’t really work for Roborockets. They want to be a for-profit business, and the amount of the profit they’ve built into their sales price is not even enough to offset the new 85% requirement. They would still have to cut back on their staff or other administrative costs to make this work. In short, this idea is not going to work.
Option 2: Cut the labor / sales cost by half The management team of Roborockets feels that they are already working at a responsible administrative (labor/sales) cost. Cutting these costs will mean layoffs, less customer service, a smaller sales force, slower production times, etc. This really doesn’t work well to maintain the quality product that their customers have come to expect from them, so option 2 is out.
Option 3: Net-up the Cost of the Materials! Ok – now here is a solution that we can live with! Mind-you, we’re not thrilled with the prospect of raising our prices, but if we agree that we can’t go non-profit and we can’t cut our labor / sales cost by half, what we’re left with is making that same $0.25 equal 15% instead of the 25% that is used to make-up. In the end, we need $0.25 per rocket to maintain our business, so we’ll buy better wood, glue, paint, etc. to make-up the difference, or we’ll forgo some of the discounts that we’ve been offered by our suppliers. One way or another, we’ll net-up the materials cost so that our product meets the new guidelines. Our customers will be unhappy, but it’s not our fault! We didn’t make the new rules! So in the end, we will have a 67% mark-up on the cost of our rockets because of this one new rule. Ouch.
Wait! Hold the manufacturing line! We have another new rule! Now, in addition to making us run at only a 15% administrative cost, we also have to add special new features to our rockets! The old simple paint job wasn’t enough – now we need to add racing stripes! AND bells and whistles are also required on every rocket. Well, it’s good that we allowed some additional room in our materials cost, but wait – that wasn’t enough! We’re going to have to increase the price even more to provide these new improvements!
AND not only will the materials cost more, it’s also going to cost more to build each rocket! Those bells and whistles won’t install themselves! And what about all of the calls that we’ll receive into our customer service center asking how to use the new bells and whistles? We’ll have to get ready for that, too! Uh-oh! Now we’re up to $2.05 per rocket! That’s more than double the price that we started at! Will our customers still buy rockets at that rate?
No! Our customers are really angry with us! We’re just reacting to the law of the land, but our sales have sunk because people can no longer afford to buy our rockets for their kids. Other things like food, electricity and rent are more important than our rockets, and the cost of those things have gone-up too, so our sales are down and there is no improvement in sight…
But wait! There’s another new rule: Everyone MUST Buy a Rocket! Rockets are very important things, and all responsible people own rockets, so we’ll make a new law that says that all citizens of our country are required to buy rockets. That will help to bring down the production costs a little, because we’ll be able to take advantage of volume discounts on our materials and our workers can be more efficient in the production of the rockets. Awesome! We’re saved! Oh, but you say there’s a problem with that?
That law hits the courts and is found to be unconstitutional. Are you serious? You mean that in our country we can’t force everyone to buy a rocket? Really? Hmmmm… what does that leave us with?
Oh, yeah. That’s right – we’re left with a $2.05 rocket for those who can afford it. This is a problem. I thought we were solving a problem, but I think this problem is even worse! What now? I could expand this further to discuss employer mandates and no pre-existing condition limitations, etc., but I think you get the picture. We need to keep working on health reform – the answers proposed by our government so far will not solve the problem – they will eventually make it worse. Contact your elected officials today and let them know how you feel about health reform. Let them know that they need to “get it right”. Thanks!
A Simple Explanation of Health Insurance Reform
Proposed Health Insurance Reform An Over-Simplified Illustration By: Barbara Hostetler Hostetler Insurance Associates, Inc.
RoboRockets Mfg., Inc. Manufacturers of quality toy rockets for the enjoyment of our nation’s youth.