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.