Health care oxen

Many years ago I had a chance to do some work on health care policy and turned it down because it looked too hard.  I’ve never regretted the decision, but never acquired any special expertise.

Watching the current debate, I’m a little mystified that most of the discussion of insurance companies has focused on underwriting, especially avoiding people likely to get sick, and efforts to not pay claims on existing policies.  I’ve never been impressed with the industry’s underwriting smarts, especially when I learned that about a third of residential fires are caused by cigarettes and never saw a non-smoker discount offered in a homeowner’s policy, but trying to sell policies at average loss ratio prices to people who will have less-than-average losses certainly makes sense (for them) and so does stiffing existing customers.

What we don’t seem to talk about, to understand the incentives of the parties to this issue, is the centrality of our gross consumption of care to the size of the industry as a whole.  In the long run, with competition, any given loss ratio, and reasonable underwriting, the profits of the health insurance industry are their premiums times (1 – loss ratio), and investment interest on their reserves, which is directly proportional to those reserves and in turn to their claims payments.  In the long run,then,  the size of the insurance business is the size of the medical business.  Your fire insurance company wants you not to have a fire and will help you avoid one, but their lights and their competitors’ would be out forever if we stopped having fires. There used to be a business insuring against mule kick injuries; now not so much.

Reducing the cost of the health care system is an arrow aimed at the heart of the health insurance industry, not just the health care providers; really bending the curve is pouring red ink all over their financials.

Author: Michael O'Hare

Professor of Public Policy at the Goldman School of Public Policy, University of California, Berkeley, Michael O'Hare was raised in New York City and trained at Harvard as an architect and structural engineer. Diverted from an honest career designing buildings by the offer of a job in which he could think about anything he wanted to and spend his time with very smart and curious young people, he fell among economists and such like, and continues to benefit from their generosity with on-the-job social science training. He has followed the process and principles of design into "nonphysical environments" such as production processes in organizations, regulation, and information management and published a variety of research in environmental policy, government policy towards the arts, and management, with special interests in energy, facility siting, information and perceptions in public choice and work environments, and policy design. His current research is focused on transportation biofuels and their effects on global land use, food security, and international trade; regulatory policy in the face of scientific uncertainty; and, after a three-decade hiatus, on NIMBY conflicts afflicting high speed rail right-of-way and nuclear waste disposal sites. He is also a regular writer on pedagogy, especially teaching in professional education, and co-edited the "Curriculum and Case Notes" section of the Journal of Policy Analysis and Management. Between faculty appointments at the MIT Department of Urban Studies and Planning and the John F. Kennedy School of Government at Harvard, he was director of policy analysis at the Massachusetts Executive Office of Environmental Affairs. He has had visiting appointments at Università Bocconi in Milan and the National University of Singapore and teaches regularly in the Goldman School's executive (mid-career) programs. At GSPP, O'Hare has taught a studio course in Program and Policy Design, Arts and Cultural Policy, Public Management, the pedagogy course for graduate student instructors, Quantitative Methods, Environmental Policy, and the introduction to public policy for its undergraduate minor, which he supervises. Generally, he considers himself the school's resident expert in any subject in which there is no such thing as real expertise (a recent project concerned the governance and design of California county fairs), but is secure in the distinction of being the only faculty member with a metal lathe in his basement and a 4×5 Ebony view camera. At the moment, he would rather be making something with his hands than writing this blurb.

8 thoughts on “Health care oxen”

  1. As long as the cost of care for any serious medical condition is high enough to force the average family into bankrupcy the health insurance industry will be in business.

    As to profits: the insurance parasites have shown that they will tack on as much markup as they can get away with. The only limit in sight is regulation and a real public option available to anyone who wants it. Obviously the public option part is not going to be there so we must hope and pray that the regulation part will be of some use. I am not optimistic for the near future. Once again the Democrats are poised to snatch defeat from the jaws of victory.

  2. Michael, can you think of any policy success stories in this vein–large industries that were successfully downsized through regulation, rather than through obsolesence or competition or something? Were there once private toll road owners, private fire departments, private libraries, etc., lobbying against the provision of these public goods?

  3. Stockbrokers and negotiated commissions? Airline and trucking deregulation? Lawyers and advertising? Interesting that these are cases where industries were forced into a competitive environment where they couldn't protect themselves by regulation and actually grew instead of shrank. I think publishers and booksellers were originally opposed to public libraries…interesting question.

  4. Ben M, Yes, there were once private toll road owners, private fire departments, and private libraries.

    The private fire departments are an interesting case. Once upon a time there were no public fire departments, and people contracted with private fire departments. When a building caught fire, the private fire departments that had NOT been contracted by the building owner, would get in the way of the fire department that did have the contract. Brawling was a valuable part of every fireman's skill set because rival fire departments had to fight over the fire before anyone could start putting it out.

  5. "Profits of the health insurance industry" must also take into account federal income taxes and state premium taxes, as well as underwriting and administrative costs and expenses. Moreover, I am not sure what useful comparison can be drawn from the property (fire) insurance industry. Fire policies are normally purchased by owners of property, not the owner's employers and the policies themselves are "true insurance" in the sense that they compensate for unplanned and unexpected losses. In contrast, health insurance policies are more often than not purchased by the insured's employers and normally cover the routine and expected such as doctor visits and medicine. While employers may have an interest in reducing health insurance costs, I do not think they are adequate substitutes for the self-interested buyer in a competitive market interested in purchasing the best product for the lowest price. Competition is further limited because insurance policies and premiums are subject to the review and approval of state departments of insurance, which have the power to limit a company's ability to sell lines of insurance within the state.

  6. Yes, if you hold profits steady, then the industry is the size of the business. And yet when people present business plans with that kind of assumption, investors don't take them seriously.

  7. It seems to me that the analogy between fire/etc insurance and health insurance is a lot closer than we think, but with many of the similarities obscured by accounting differences. The fire insurance people (in a business setting, at least) will work with the insured on loss prevention. Health insurance companies will cover routine care that (in theory at least) reduces the likelihood of extreme payouts, or of excessive payouts for things that could have been handled at lower costs. The loss-prevention costs aren't listed as payouts for fire/theft/etc insurance, but they are for health insurance, even though to a first approximation they're similar sorts of things.

  8. Private insurance became a mechanism for paying for health care because of a superficial resemblance to financing catastrophe losses in the property/casualty area, we all know that other countries chose different paths. But, I think the closer analogy is education; all members of a society need to some minimum level of literacy, but that minimum has risen over time as society and technology have become more complex. You can question whether people will make better use of resources if they face out of pocket costs (premiums & cost-sharing, or tuition & student loans) or whether society would be better off with no price barriers to consumption of services (universal free public education, or universal insurance). But such choices are orthogonal to how we allocate, finance, and subsidize the flow of resources to the system as a whole, via broad-based progressive taxation, quasi-regressive property and sales taxes, or user fees.

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