Health Insurance and Hospital System Financing at a Glance
Health insurers and hospital systems both have a mission to help ensure the provision of high-quality healthcare services. Yet the two types of organizations have very different financing structures and key performance metrics, reflecting the different ways they approach achieving this mission. Healthcare leaders should understand these fundamental differences both when evaluating the results of key metrics between these two types of organization, and in situations where there is a strategic plan to combine such organizations within the same larger health system.
Key Financing Differences
In addition to coordinating care and improving the health of populations, insurance companies pay for medical services and drugs after a premium is received from members, employer groups, and government entities. To ensure that insurers have the financial means to meet this commitment, regulators require them to maintain a level of liquid capital linked to their total premium to support the payment of these services. This capital requirement also comes with limitations on investment types to ensure adequate safety.
Although insurers are required to maintain liquid capital to support their business, they do not have to invest in high-cost, state-of-the art facilities to deliver care. In addition to minimizing capital expenses, this lack of physical capital allows them to more easily expand organically into new geographies. Growth allows insurers to spread their fixed investments in claims systems, provider network management, IT, and management over a larger membership base, allowing them to minimize per-member administrative costs. The relative ease of this growth and the benefits of scale combine to produce a competitive insurance market and lower margins relative to most other industries. The lower margins in health insurance are balanced by a relatively higher return on capital resulting from modest capital requirements.
Similarly, health insurers can earn much higher revenues and total margins per employee than can most provider organizations. This difference largely reflects the operational requirements between financing and delivering care. The activities required to run a health plan—such as paying claims, managing provider contracts, and pricing and distributing insurance products—are less labor intensive and produce more revenue than the activities needed to manage an organization as complex as a hospital.
In contrast, hospital systems have financing structures that require significant physical plant investment. Although hospital systems’ financial investments are not regulated, the organizations also have fewer organic growth opportunities and historically have experienced higher margins, a lower return on capital, and lower revenue and margin per employee.
A Hedge Against Risk
Overall, the financing differences between health insurers and hospital systems follow the function of each organization. Simply put, health insurers primarily provide services that help coordinate care and improve the health of large populations without the need for a significant capital investment, and they provide financial protection when a member has costly medical claims. In keeping with these goals, insurers maintain less physical capital than hospital systems and are required to maintain sufficient liquid capital to protect policyholders from instances when an insurer experiences financial weakness. Hospitals, on the other hand, operate highly complex facilities with substantial physical plant investment and a significant number of employees. Although this complexity and investment contributes to higher margins, it also lowers the return on capital and reduces revenue and margin per employee.
Beyond financial structure, health insurers and hospital systems have substantially different risk profiles. Insurers face short-term financial risk with inadequate premiums from higher-than-expected utilization and additional uncertainty associated with the status of important provider contracts. Hospital systems, in contrast, face risk with changes in provider payment from key payers, malpractice risk, and lower-than-expected utilization of provider assets. The best hedge against this risk is a combination between a health plan and a hospital system. With such a combination, the collective impact of the factors that contribute to risk—higher or lower utilization and changes in payments—are mitigated across the broader organization.