A compelling thesis for margin expansion in the health insurance sector has been gaining traction, recently articulated by commentators including the analyst known as ‘thexcapitalist’. The proposition is that a disciplined insurer could unlock operating margins well above 5% by 2027 through a dual strategy: reducing Selling, General, and Administrative (SG&A) expenses to 16% of revenue and, more ambitiously, lowering the medical loss ratio (MLR) to 80%. While arithmetically sound, achieving this represents a formidable operational challenge, navigating a fine line between efficiency, regulatory compliance, and member satisfaction.
Key Takeaways
- The path to superior profitability for health insurers requires executing a two-front strategy against both administrative overhead (SG&A) and claims costs (MLR).
- An 80% MLR target is particularly aggressive as it sits at the minimum threshold stipulated by the Affordable Care Act for certain markets, creating significant regulatory and reputational risk.
- Achieving these goals depends less on broad cost-cutting and more on specific strategic levers, such as digital transformation for SG&A and sophisticated value-based care models for MLR management.
- Success could lead to a significant valuation re-rating, creating a wide performance gap between hyper-efficient ‘platform insurers’ and their legacy competitors.
The Two-Front War on Costs
The pursuit of a 5% operating margin is essentially a campaign fought on two distinct fronts. Each presents its own set of challenges and requires a different strategic toolkit. Success in one area does not guarantee success in the other; in fact, they can sometimes be at odds.
Front One: The SG&A Reduction
Reducing the SG&A ratio from a typical 19% to a target of 16% is a test of pure operational discipline. For an insurer, these costs encompass everything from marketing spend and broker commissions to technology infrastructure and corporate administration. A 300-basis-point reduction over three years is ambitious but achievable, primarily through technology-led transformation rather than crude cost-cutting. Levers include automating claims processing and customer service functions, shifting member acquisition to lower-cost digital channels, and rationalising legacy IT systems onto more efficient, scalable platforms. The goal is to remove structural costs, not just trim discretionary spending, to create a durable competitive advantage.
Front Two: The Medical Loss Ratio Tightrope
Lowering the medical loss ratio—the percentage of premium revenue spent on medical claims—is a far more delicate and contentious exercise. The target of 80% is particularly sharp. Under the US Affordable Care Act (ACA), insurers in the individual and small group markets must spend at least 80% of premiums on healthcare claims and quality improvement, or issue rebates to customers. An 80% target leaves no margin for error and invites intense regulatory scrutiny.1
Controlling this ratio requires more than just tough negotiations with hospital networks. It involves a sophisticated approach to care management, such as promoting preventative care, steering members towards high-value providers, and managing the spiralling cost of specialty drugs. The recent surge in popularity of GLP-1 agonists for weight loss, for example, represents a significant headwind for MLR management that was not a major factor a few years ago.2 Successfully managing MLR without compromising care quality is the true mark of an advanced insurer.
Benchmarking the Path to Superior Margins
To understand the scale of this ambition, it is useful to compare the targets against current industry performance. While individual company figures vary, industry-wide data provides a clear benchmark for what constitutes an outlier performance.
| Metric | Illustrative Current State | Stated Target (2027) | Typical Industry Range (2023-2024)3 |
|---|---|---|---|
| SG&A as % of Revenue | 19.0% | 16.0% | 17% – 21% |
| Medical Loss Ratio (MLR) | 84.0% | 80.0% | 82% – 87% |
| Gross Margin (100% – MLR) | 16.0% | 20.0% | 13% – 18% |
| Implied Operating Margin | Negative to Low Single Digits | ~4.0% – 5.0% | 2% – 4% |
Note: Operating Margin is illustrative and derived from Gross Margin less SG&A, excluding other income/expenses. The industry range is broad, reflecting different business mixes (e.g., government vs. commercial).
As the table demonstrates, achieving both targets would place an insurer at the top of the industry in terms of profitability. A 400-basis-point improvement in the gross margin combined with a 300-basis-point reduction in SG&A is what transforms a low-margin business into a highly profitable one.
Second-Order Effects and Unseen Risks
Pursuing such aggressive targets is not without peril. A singular focus on driving down the MLR can lead to practices that alienate both members and providers. Narrowing networks, increasing prior authorisation requirements, or being overly aggressive in claims adjudication can damage a brand’s reputation and lead to higher member churn, ultimately eroding long-term value. Service quality is a crucial, albeit difficult to quantify, asset in this sector.
Furthermore, the regulatory risk is substantial. Falling even slightly below the 80% or 85% MLR floor triggers mandatory rebates. This is not just a financial penalty but a public admission that the insurer collected excess premiums, a situation that regulators and the media tend to view unfavourably.4
A Forward-Looking Hypothesis
For investors and strategists, the key is to look beyond headline targets. The crucial question is not whether a company can hit a specific number in a given year, but whether it is building a sustainably efficient operating model. This means monitoring not just SG&A and MLR, but also member retention rates, provider satisfaction scores, and investment in technology that drives structural, rather than temporary, cost reductions.
As a speculative hypothesis, the next market cycle is likely to create a significant divergence in the health insurance sector. We will see the emergence of ‘platform insurers’—those who master the use of data and technology to optimise both administrative and medical costs simultaneously. These firms will command premium valuations. Conversely, insurers reliant on scale alone, without underlying operational agility, will struggle with margin compression as healthcare costs continue to outpace inflation. The ultimate winner will not be the company that simply cuts the deepest, but the one that builds the smartest, most efficient, and most durable platform for managing health and cost.
References
1. PwC. (n.d.). Behind the numbers: Your guide to health care finance and investment trends. PwC. Retrieved from https://www.pwc.com/us/en/industries/health-industries/library/behind-the-numbers.html
2. Oliver Wyman. (2024, September). Health Insurer Financial Insights: Q2 2024. Retrieved from https://www.oliverwyman.com/our-expertise/insights/2024/sep/health-insurer-financial-insights-q2-2024.html
3. Oliver Wyman. (2024, January). Health Insurer Financial Insights, Volume 12. Retrieved from https://www.oliverwyman.com/our-expertise/insights/2024/jan/health-insurer-financial-insights-volume-12.html
4. KFF. (2024). Hospital Margins Rebounded in 2023, But Rural Hospitals and Those with High Medicaid Shares Were Struggling More Than Others. Retrieved from https://www.kff.org/health-costs/issue-brief/hospital-margins-rebounded-in-2023-but-rural-hospitals-and-those-with-high-medicaid-shares-were-struggling-more-than-others/
@thexcapitalist. (2024, October 23). [Post discussing a company’s targets for SG&A reduction to 16% and MLR to 80% to achieve over 5% operating margin]. Retrieved from https://x.com/thexcapitalist/status/1871265819361218726
