As a principled pragmatic, I often reject the ‘Right vs. Left’ or ‘Tyranny vs. Freedom’ debates that political parties and moneyed interests frame for us. I find that our best solutions are usually arrived at when we as a country focus and build upon those common-ground areas where we agree. So you’d think I’d be delighted with the current monomania both parties are giving to the idea of increased competition among health insurance carriers as a way to reduce health insurance costs.
The President and the White House staff often cite the need for increased competition. So does Mitt Romney, as he looks to unseat them. As do Senate Republicans, House Republicans, and pundits alike. In fact, when I googled either “Health Insurance Competition Editorial” or “Health Insurance Competition News” I did not find any real dissent to this common sense Truth that increasing the number of health insurers will drive down the cost of premiums, and therefore healthcare costs. You’d think that this meeting of the minds across the aisles would have me skipping down the street, happily whistling a dubstep Kumbaya/It’s A Small World medley. But instead I just find that my jaw is sore from the teeth grinding all this talk is making me do. Seriously, it drives me fishing nuts – it makes me want to pull out the very tiny amount or hair that I still have right out of my skull. Because while everyone on both sides of the aisle might agree, there’s the slight problem that everyone on both sides of the aisle is absolutely, positively, totally, incredibly, 100% wrong.
Increasing the number of health insurers in a market doesn’t decrease premiums. It increases premiums – a lot. Any public policy that looks to encourage more insurers competing in the same markets are going to backfire and make our annual premium increases far worse than they already are.
There are two reasons for this:
1. You’re Relationship With Your Insurer Isn’t What You Think It Is.
The phrase that I have heard a lot in my job over the years is that health insurance “acts in a way that is counter-intuitive to free market principles.” But over time I am more and more thinking that this isn’t quite right. I have started to think instead that it is more accurate to say that health insurance does do what we would intuitively expect it to do in a free market, but that by and large people don’t understand a health insurer’s relationship to themselves. In essence, your health insurer’s relationship to you is not that of a vendor or a retailer, as your auto insurer’s is; it also acts as your financial advocate.
Your health insurer actually has three main functions. The first two are obvious: One is to administrate claims, another is to pool risk. But it also negotiates the costs that providers can charge you for any given task well in advance of your visiting your doctor. Your provider network wishes to maximize its profits (even non-profit providers), and because of this they want to charge you more than they currently do. Your health insurer acts as a large buying group, and as such negotiates on your behalf for lower charges. In addition, your carrier will negotiate against your provider selling you services that are unnecessary, overly expensive, or even harmful. They will demand generic prescriptions are made available to you when those generic prescriptions are as effective at a fraction of the cost as those new hybrids that are designed by pharmaceutical companies for the sole purpose of charging you more money with a unique chemical compound.
The view that many people have (and liberal pundits foster) of a health insurance company sitting on piles of money – trying to find ways not to pay claims so they can keep it all for themselves – is a fiction. Like workers compensation, health insurance is a pass through system; insurer contracts are set up so that the insurer makes a couple of points of the top. In fact, the more claims an insurer pays the more premiums go up, and the more profitable the insurer becomes. When you hear about an insurer refusing to cover pre-existing conditions, it isn’t actually the carrier’s money they are trying to protect – it’s the money and future premiums of the other group members. They don’t absorb those costs, their clients do. (It is still self-serving, though; an insurer can absorb so many costs as to make its clients decide they don’t want to do business with them any longer.)
So, why does this mean that more insurers lead to higher rates? Understand that providers themselves bind themselves together to negotiate as large groups. In fact, the days of having many small providers are disappearing, as large provider conglomerates continue to absorb one another. So when your insurer negotiates with “all the providers” in your state, they are really only negotiating with a few separate, giant entities or negotiating groups. The number of actual clients (potential patients) is fairly static, so the more insurers there are the smaller piece of the pie they represent. The smaller a piece of pie you represent, the less power you have in negotiations. Imagine: If there are two providers in your state and yours represents 50% of all the potential clients, most providers find that they are willing to come to the table and sacrifice a lot of margin in order to secure the rights to those clients. But if there are 30 insurers and each represents 3% of all the potential clients, there is no reason for a provider to meet any demands for cost cutting – the insurer needs that provider to survive, but the provider can easily live without the insurers clients.
The fact of the matter is that the fewer health insurance carriers there are in any given state, the lower the premiums will be. The surest way to increase premiums is to flood a state with dozens of carriers and make each toothless when negotiating with provider groups.
2. The Law of Large Numbers Does Better With Larger Numbers
Unlike the relationship-to-the-client angle, the law of large numbers issue carries through to all lines on insurance. Put simply, the law is this: the greater the sample of data, the greater the chances of predicting the outcome.
If you own a roofing company with ten employees, for example, my underwriters can’t begin to predict with any degree of accuracy how many of those ten employees will be injured on the job over the course of the next year, or how much it might cost to treat them. But if you join together so many roofing companies that you collectively have one million employees, my underwriters’ prediction of how many will be injured and what it will cost will be so damn close it will seriously creep you out.
As stated above, as the number of insurers in a set population increases that same population’s client-to-insurer ratio decreases. This means that the more carriers there are in a state, the harder it is for any one to predict outcomes accurately. It should surprise no one that when faced with a model that predicts with less accuracy, an insurance company is not inclined to say “Well, we’ll just cover the loss if we guess wrong.” Instead, they charge more than their model predicts, to make sure that they are not left holding the bag if their predictions fall short. Should expenses be less, they’ll keep holding onto that cash in IBNR accounts, because the next year might not be so kind.
Your auto or home insurer can often get away reducing premiums with this unpredictability. Because those lines do not act as a pass through, they can risk their shareholders’ reserves in the hope of getting more market share. But for pass through lines like workers compensation or health insurance, doing so can too easily lead to insolvency. The only pass through system carriers I have ever seen do this successfully are state accident funds, since the people that run those funds know they have their state’s general fund pie to dip into if need be. But even that leads to disaster sooner or later. (I’m lookin’ at you, California!)
In fact, if there is a concern I have about government being involved with dictating healthcare insurance policy it is a fear that the law of large numbers will be ignored in favor of political expediency. A lot of the people we work with are high-mucky-muck enough that they actually have a seat at the wonk tables in Washington (for now anyway). The concern I get from them is that politicians’ self-serving desire to deliver only good news makes them ill suited to give the deference needed to the necessary statistical tables. This is worth noting. Democrats are saying there is nothing to worry about the plan as is. Republicans are saying we absolutely should worry, because the numbers they see look too big; they say it costs too much as is. But every insurance professional I know that is reviewing PPACA agrees that the plan doesn’t cost enough. They don’t worry that the costs shown are too outrageously high – they worry that it won’t be sufficiently funded.
Normally with these types of wonky expert-driven policy decisions, I have faith that the people behind closed doors will avoid doing fabulously stupid things just to appease the people that don’t know how things actually work. I expect politicians to say fabulously ignorant things, like the heavier a vehicle is the less likely you are to be injured in it at high speeds. And I expect that all the people that didn’t pay attention in physics class the day they taught momentum will nod along and tsk-tsk those know-it-all engineers who don’t rely on common sense. But eventually the Senate and House subcommittees adjourn, the circus leaves town, and the government engineers can talk to the auto manufacturer engineers about actual engineering. But I’m starting to get a little nervous about this whole “we need more competition with health insurers” thing, because I don’t see any dissenting voice from either party.
I’m starting to worry that legislation that artificially expands the number of health insurers in any given market might actually pick up sufficient traction in an election year. I hope I’m wrong.