Map of life expectancy at birth from Global Education Project.

Monday, December 28, 2009

The (very) visible hand

Okay, back on track. Let's say you run an insurance company. Most people today are covered by for-profit insurance companies. Most of the Blue Cross/Blue Shield companies have been converted to for-profits. The largest health insurance company in the U.S., WellPoint, owns the Blue Cross/Blue Shield brand in 16 states. It’s a publicly traded corporation and they put the stock price on the front page of their web site, right next to a tab leading to investor info. So obviously your mission is to make money for the owners and executives, just like any other corporation.

Your revenue is premiums, and you have expenses for administration, marketing, and paying for health care, which you call “medical losses.” (Really.) So you want to keep those medical losses as low as possible. Marketing costs money but if it can more than pay for itself in additional premiums from people who will produce low medical losses, you’ll spend that money. A good part of the expense of administration is devoted to reducing claims, as I’ll explain momentarily, so once again, you don’t mind spending that money if it more than pays for itself. I you have competition (and you might not) you'll compete on price to the extent that any customers you can draw from the competition will still cost you less than the premiums they pay. You might think (as Republicans claim) that the last point means that competition among insurance companies is good for consumers. But let’s see how that actually works.

Let’s try a thought experiment. Imagine the little town of Wagawaga out there on the prairie, where happy corn-fed people bake pies all day. Everybody has health insurance, that pays for what they need, and everybody pays the same price. There’s even competition. Let’s call the companies, oh, I don’t know, BluePoint and WellCross.

The executive at BluePoint has a brilliant idea: raise the price for people over 50. Sure, BluePoint will lose business, but it all happens to be customers who tend to cost more in medical losses. Driving those people away allows BluePoint to lower the price for people under 50, and still increase its profits, so WellCross suddenly has a big problem: They have more of the expensive customers and fewer of the inexpensive ones. Their medical losses go way up in relation to their revenues, so they are forced to adopt the same pricing policy as BluePoint and while we’re at it, let’s get rid of some other higher cost customers. Maybe we can charge more to people with high cholesterol, or a family history of cancer . . . So Bluepoint retaliates by dumping people whose medical losses exceed a certain amount in the pat year. And so it goes, back and forth until . . .

This is called the Death Spiral. Every person who tries to buy insurance gets a comprehensive assessment of exactly how much their health care is likely to cost in the coming year, and they are charged exactly that much plus enough for profit, administration, and marketing. That might seem fair to somebody, somewhere, but the fact is, under those circumstances, there is essentially no reason for anybody to buy insurance – certainly not anybody who really needs it, because they already have a chronic illness or are at high risk. They know insurance will just cost them more than not having any.

So unregulated competition among insurance companies doesn’t produce consumer choice, lower costs, or anything else that’s good. Sorry Milton Friedman. Competition among insurance companies is bad. It harms consumers. Medical underwriting means charging people according to indicators of risk, whether it be age, obesity, smoking, blood lipids, etc.; denying coverage for conditions you already have, an idea which can be stretched as far as you like; and canceling insurance when people actually get sick. In other words, you didn’t have insurance after all, you just paid the company money.

They can limit claims in other ways. I’ll talk about the issue of co-pays a bit later, for now I’ll just say that they are generally justified as making consumers aware of the costs of medical services and turning us into careful shoppers. We’ll see about that.

Well, the death spiral hasn’t really happened. All of that nasty stuff does go on, it's a bumpy ride, and lots of people have been thrown out of the plane, but it hasn't crashed into the ground. The insurance industry still exists and it has customers. I'll explain why that is next time.


C. Corax said...

From an article in the Guardian about Vic Chesnutt:

Chesnutt struggled with depression, but also with the cold hard fact of his medical bills. In 1996, Madonna, Smashing Pumpkins, Garbage and many more recorded a Chesnutt tribute album, to benefit a fund for musicians' health costs. More than a decade later, the singer-songwriter was allegedly being pursued for $30,000 (£18,799) in hospital fees. "There's nowhere else in the world that I'd be facing the situation I'm in right now," he said in an interview earlier this year. "[Outside of the USA,] they cannot understand what kind of society would inflict that on their population."

Cervantes said...

Just one more crime perpetrated by our broken political system. This one just happens to be publicly visible.

Anonymous said...

Hi. I'm a state insurance regulator (property-casualty). I've seen this thought experiment before, but our conclusion has never been that competition hurts the consumer. Competition drives more accurate pricing and also possibly reduced expenses. When a risk characteristic is supported by an increased risk of losses, we consider the increased rates "fairly discriminatory".

Why are more accurate rates beneficial? Because with these risk characteristics, the pool of insureds sharing these risk characteristics support their own extra costs. Should young adults have to support the extra costs of 50+ adults, or should 50+ adults pay 30% more in insurance to cover the extra costs of this age group? There is reasoning behind both sides, but in general 50+ adults have much more wealth and incur much greater costs on the system and therefore it would seem reasonable to charge them more.

Should slim people be charged extra to support the increased costs on the medical system imposed by overweight people? Should the costs of careless drivers be supported by careful drivers?

With few risk characteristics, insurance encourages moral (and particularly morale) hazard.

A health insurance system which is highly tailored to specific characteristics is not necessarily a death spiral. It could encourage healthier habits. Currently I think most states don't allow many risk characteristics in healthcare insurance.

If you don't like the idea of charging more for old people, an age lock-in could be developed. I've seen these in pet insurance where age doesn't affect the price. In effect the insured pays extra when the pet is young in order to keep the same price when the pet is old. Considering that people have trouble saving, this might be best.

I do agree that a universal health insurance system is likely better, but it is not accurate to say that competition is bad. The US doesn't have enough competition.

Obviously, health insurance doesn't work for chronically ill people. There is no question that a separate government program is necessary for them. However, in the meantime we shouldn't be encouraging obesity (which contributes to most chronic conditions such as diabetes, - these people should pay extra, somehow.

Ben Creasy

Anonymous said...

There's a movement to radically change California government, by getting rid of career politicians and chopping their salaries in half. A group known as Citizens for California Reform wants to make the California legislature a part time time job, just like it was until 1966.

Anonymous said...