Tag Archives: Health Insurance

Ex Ante Agreements, Ex Post Gripes

23 Tuesday May 2017

Posted by in Health Insurance, Profit Motive

≈ Leave a comment

Tags

, , , , , , , ,

Anyone signing a contract better know the terms to which it binds them. They sign voluntarily and do so because they believe it has value. They are presumed to understand what they are obligated to pay and when; what they are entitled to receive, when, and under what circumstances; what actions (and non-actions) are required of them to “perform” under the contract; and what recourse they have should the counter-party fail to perform. The value they perceive upon signing is always based on an expectation. Sometimes, that expectation summarizes risks they are paying to avoid, even as a counter-party is more than willing to carry the risk. The contract is signed and everyone is happy… enough.

Health insurance is an example to which I’ve dedicated ample space over the past couple of weeks (see the links in the left margin). Obviously, one buys health insurance before knowing an entire series of outcomes. The contract specifies what kinds of expenses the insurer is obligated to pay. Insurance is a highly complex product, and so an insurance policy or contract must be relatively complex, as the cartoon above suggests. In a well-functioning market, however, the insured pays a premium no higher than they consider worthwhile. Everyone would like to pay less, but absent a government mandate (heh!), no one is obligated to buy.

The ink is dry and life goes on. The premium is paid, health needs arise, costs are incurred, and sometimes those costs exceed a limit (the deductible) above which the insurer is obligated to pay at least a portion.

A calamitous health event typically brings heavy costs, and this possibility is exactly why people buy coverage, and it is exactly why insurers demand sufficiently stiff premia. These things happen to a fairly predictable percentage of an insurer’s  customers, but with enough variance to make the cash flows risky. As a backstop, insurance contracts sometimes include limitations on total lifetime benefits or on payments for certain kinds of treatments. Pre-existing conditions are a prominent example of limiting the risks that enter the risk pool, but there are other possible limitations on treatments and other aspects of care. While these are known upfront, disastrous health outcomes and their financial consequences are not.

An increasingly common refrain is that no one should profit from an individual’s acute health care needs, and that health insurers do just that. For logical consistency, this same complaint should be leveled against doctors, nurses, paramedics, hospitals, medical equipment manufacturers, and pharmaceutical companies. They all earn income by providing for health care needs, whether medical or financial, and income is income, after all. Whether that income is a wage or a profit is irrelevant. They are both forms of compensation for the use of resources. The major difference between insurers and the other income-earners is that insurers handle the financial risk of potential health care needs and pay when those needs arise, within and up to policy limits.

The crux of the complaint, however, is that insurers can deny claims, thus protecting their profits. Certainly there are claims denied for which the rationale can be disputed. Just as certainly, a financially prudent insurance company must impose some limits on the benefits offered by their policies. These limitations might preserve profitability, but they also protect the contingent benefits of other insureds as well as the solvency of the carrier. Those objectives are not independent.

The insurance buyer reveals the value of the contract ex ante, but sour grapes are easily conjured ex post if a claim is denied, no matter the agreed-to provisions of the insurance contract. The insurer is under no greater obligation to pay costs in excess of policy limits than the doctor, the nurse, or the man in the street. Yet insurers take special blame when inadequate coverage is an issue, whatever the reason.

Hospitals and physician practices sometimes provide uncompensated care. There are also a number of support organizations for severely-ill but inadequately insured patients. So, private charity is one answer to the dilemma of extreme health-cost outcomes. Public aid is another, and the appropriate breadth of the state’s role in cases of pre-existing conditions and extreme individual health care costs is a legitimate question.

In the end, private health insurers provide a valuable service by pooling and carrying the financial risk of health care events faced by individuals. Health insurance profits as a share of owner’s equity have fallen well short of market-wide averages in recent years (see my last post), though I regularly hear outrageous claims about excessive profits in the industry.

It’s not unusual for a buyer to feel remorse after signing a deal, but in cases of health coverage shortfalls, one could say that the insured bet too little or qualified for too little, or one could say that society doesn’t set aside enough resources to adequately care for the sick. However, one cannot say that the resources dedicated to arranging private coverage deserve no reward, or that the business should be pillaged on account of certain policy limitations, or that the future claims of other policyholders should be hijacked. Those who proclaim such nonsense are guilty of severe ethical misjudgment.

Good Profits and Bad Profits

18 Thursday May 2017

Posted by in Health Care, Profit Motive

≈ Leave a comment

Tags

, , , , , , , , , , , , ,

Toles-on-Regulatory-Capture

There are two faces of profit. It’s always the fashion on the left to denigrate profits and the profit motive generally, as if it serves no positive social function. This stems partly from a failure to examine the circumstances under which profits are earned: is it through competitive performance, innovation, hard-won customer loyalty, and the skill or even luck to spot an underpriced asset? Such a “good” profit might even exceed what economists call a “normal profit”, or one that just covers the opportunity cost of the owners’ capital. On the other hand, profit can be derived from what economists call “rent seeking”. That’s the dark side, but the unrecognized spirit of rent seeking seems to lurk within many discussions, as if the word profit was exclusively descriptive of evil. The “rent” in rent seeking derives from “economic rent”, which traditionally meant profit in excess of opportunity cost, or a “supra-normal” profit. But it’s impossible to know exactly how much of any given profit is extracted by rent seeking; a high profit in and of itself is not prima facie evidence of rent seeking, even though we might argue the social merits of a firm’s dominant market position.

Rent seeking takes many forms. Collusion between ostensible competitors is one, as is any predatory attempt to monopolize a market, but the term is most often associated with cronyism in government. For example, lobbying efforts might involve favors to individuals in hopes of swaying votes on regulatory matters or lucrative government contracts. Sometimes, a rent seeker wants lighter regulation. At others, a rent seeker might work the political system for more regulation in the knowledge that smaller competitors will be incapable of surviving the heavy compliance costs. Government administrators also have the authority to change fortunes with their rulings, and they are subject to the same temptations as elected officials. In fact, in the aggregate, administrative rule-making and even enforcement might outweigh prospective legislation as attractors of intense rent-seeking.

Rent seeking is big-time and it is small-time. It takes place at all levels of government, from attempts to influence zoning decisions, traffic patterns, contract awards, and even protection from law enforcement. When it’s big time, rent seeking is the very essence of what some call corporatism and more generally fascism: the enlistment of coercive government power for private gain. A pretty reliable rule is that where there’s government, there is rent-seeking behavior.

Otherwise, the profit motive serves a valuable and massive social function: resources are attracted to profitable uses because they signal the desires of potential buyers. In this way, profits assure that resources are drawn into the most-valued uses. The market interactions between new competitors, drawn by the prospect of profits, and willing buyers leads to a self-correction: supra-normal profits get competed away over time. In this way, the spontaneous actions of voluntary market participants lead to a great achievement: all mutually beneficial trades are exhausted. Profit makes this possible in the short-run and it assures that trades evolve optimally with changes in tastes, technology and resource availability. By comparison, government fares poorly when it attempts to plan outcomes in the short- or the long-run. Rent seeking is an attempt to influence and even encourage such planning, and the profits it enables impose costs on society.

Good and Bad Profits In Health Insurance

I’ve written a few posts about health insurance reform recently (see the left margin). Health care is scarce. If relying on government is the preferred alternative to private insurance, don’t count on better access to care: you won’t get it unless you’re connected. Profits earned by health insurance carriers are roundly condemned by the left. It is as if private capital utilized in arranging coverage and carrying the risk on pools of customers deserves zero compensation, that only public capital raised by coercive taxation is morally acceptable for this purpose. But aside from this obvious hogwash, is there a reason to question the insurers’ route to profitability based upon rent seeking?

The health insurers played a role in shaping the Affordable Care Act (ACA, i.e., Obamacare) and certainly had hoped to benefit from several of its provisions, even while sacrificing autonomy over product, price, coverage decisions, and payout ratios. The individual and employer mandates would force low-risk individuals to purchase extensive coverage, and essential benefits requirements would earn incremental margins. Sounds like a nice deal, but those policies were regarded by the ACA’s proponents as necessary for universal coverage, stabilizing risk, and promoting adequate coverage levels. There were other provisions, however, designed to safeguard the profitability of insurers. These included an industry risk adjustment mechanism, temporary reinsurance to help defray the cost of  covering high-risk patients, and so-called risk corridors (also temporary).

As it turned out, the ACA was not a great bet for insurers, as their risk pools deteriorated more than many expected. With the expiration of the temporary protections in Obamacare, it became evident that offering policies on the exchanges would not be profitable without large premium hikes. A number of carriers have stopped offering policies on the exchanges.

It should be no surprise that health insurance profitability has been anything but impressive over the past three years. The average industry return on equity was just 5.6% during that time frame, and it was a slightly better 6.2% in 2016, about 60% of the market-wide average. It’s difficult to conclude that insurers benefitted greatly from rent seeking activity with regard to the ACA’s passage, but perhaps that activity had a sufficient influence on policy to stabilize what otherwise might have been disastrous performance.

The critics of insurance profits are primarily interested in scapegoating as a means to promote a single-payer health care system. While some are aware of the favors granted to the industry in the design of the ACA, most are oblivious to the actual results. Even worse, they wish to throw-out the good with the bad.

The left is almost universally ignorant of the social function served by the profit motive. Profits stimulate supply, competition and innovation in virtually every area of economic life. To complain about profits in general is to wish for a primitive existence. Unfortunately, the potential for government to change the rules of the market makes it a ripe target for rent-seeking, and it creates a fog through which few discern the good from the bad.

Benefit Mandates Bar Interstate Competition

30 Thursday Mar 2017

Posted by in competition, Health Care

≈ 1 Comment

Tags

, , , , , , , , , , , , ,

The lack of interstate competition in health insurance does not benefit consumers, but promoting that kind of competition requires steps that are not widely appreciated. Most of those steps must take place at the state level. In fact, it is not well known that it is already legal for states to jointly create interstate “compacts” under Obamacare, though none have done so.

The chief problem is that states regulate insurance carriers and the policies they offer in a variety of ways. Coverage mandates vary from state to state, as do rules governing the coverage of pre-existing conditions, renewability, dependents, costs, and risk rating. John Seiler, writing at the Foundation for Economic Education, offers a great perspective on the fractured character of state regulations. Incumbent insurers within a state have natural advantages due to their existing relationships with local providers. Between the difficulty of forming a new network and the costs of customizing policies and obtaining approval in multiple states, there are significant barriers to entry at state lines.

Federalism is a principle I often support, but state benefit mandates and other regulations are perverse examples because they restrict the otherwise voluntary and victimless choices available to a state’s consumers. Well, victimless except perhaps for in-state monopolists and their cronyist protectors in state government. Many powers are reserved to states under the Constitution, while the powers of the federal government are strictly limited. That’s well and good unless state governments infringe on the rights of individuals protected by the Constitution. In particular, the Commerce Clause prohibits state governments from obstructing the flow of interstate commerce.

Here is a bit of history surrounding the evolution of state versus federal control over insurance markets, as told by Pennsylvania Insurance Commissioner Teresa Miller (as quoted by reporter Steve Esack):

“Since the 1800s, the U.S. Supreme Court held individual states, not Congress, had the power to regulate insurance companies. The high court overturned that precedent, however, in a 1944 ruling, United States v. South-Eastern Underwriters, that said insurance sales constituted interstate trade and Congress could regulate insurance under the U.S. Constitution’s Commerce Clause.

But states cried foul. In response, Congress passed and President Harry S. Truman in 1945 signed the McCarran-Ferguson Act to grant a limited anti-trust provision so states could keep regulating insurance carriers. The law does not preclude cross-border sales. It means insurance companies must abide by different sets of rules and regulations and laws in 50 states.“

Congress obviously recognized that state regulation of health insurance would create monopoly power and restrain trade, even if states place bridles on insurers and impose ostensible consumer protections. The solution was to exempt health insurers from broad federal regulation and anti-trust prosecution by the Department of Justice.

Last week, the House of Representatives passed a bill that would repeal McCarran-Ferguson for health insurers. However, that would do little to encourage cross-border competition as long as the tangle of state mandates and other regulations remain in place. The regulatory landscape would have to change under this kind of federal legislation, but how that would happen is an open question. Could court challenges be brought against state regulators and coverage mandates as anti-competitive? Would anti-trust actions be brought against incumbent carriers?

Robert Laszewski has strong objections to any new law that would allow interstate sales of health insurance as long as state benefit mandates remain in place for “local legacy” carriers. In particular, he believes it would encourage “cherry picking” of the best risks by market entrants who would be free of the mandates. Many of the healthiest individuals would jump at the chance to purchase stripped down, catastrophic coverage. That would leave the legacy carriers under the burden of mandates and deteriorating risk pools. Would states do this to their incumbent insurers without prodding by the courts? Would they simply drop the mandates? I doubt it.

No matter the end-state, there is likely to be a contentious transition. Promoting interstate competition in the health insurance market is a laudable goal, but it is not as simple as some health-care reformers would have us believe. Real competition requires action by states to eliminate or liberalize regulations on benefit mandates, risk-rating and pre-existing conditions. Ultimately, the cost of coverage for high-risk individuals might have to be subsidized, whether means-tested or not, through a combination of support from the states, the federal government, and private charities. And of course, interstate competition really does requires repeal of the health insurance provisions of McCarran-Ferguson.

Governments at any level can act against the well-being of consumers, despite the acknowledged benefits of decentralized governance over central control. Benefit mandates, whether imposed at the federal or state levels, are inimical to consumer choice, competition, efficient pricing, and often to the very concept of insurance. Those aren’t the sort of purposes federalism was intended to serve.