Tuesday, August 11, 2009

Private Health Insurers: Devils, Saints, or just Humans?

Congress is about to vote on one of the most consequential bills in American history, and proponents of the Obamacare bill refuse to present a real, fundamental analysis of the situation they're trying to address.

What are the problems, what are the goals, and what can we do to address the problems directly to achieve those goals? This kind of discussion is nowhere to be heard among Obamacare supporters. Even the President himself avoids it. Instead he simplistically states that there are 50 million uninsured in America, as if that were the problem. It's not - it's a symptom of the problem. Many problems, in fact. The correct questions to ask are: who are these 50-million uninsured, and why are they uninsured?

I've answered those questions previously. Suffice it to say that any plan that treats the symptom rather than the disease is doomed to failure. One of the big symptoms is that the costs of health care and insurance for that care are rising faster than the rate of inflation. The "diseases" causing this symptom can be divided into two overlapping categories: those concerning the insurance industry, and those concerning health-care providers (e.g. doctors, hospitals). In this post I address the former.

Private Health Insurers: Devils, Saints, or just Humans?

Democrats have suddenly re-branded their health bill "health insurance reform", rather than "health care reform". Nancy Pelosi has gone as far as to call insurance companies "villains". Liberals, Obama included, regularly lambaste the insurance industry for profiting from hard-working Americans' suffering - never mind the fact that insurance companies profit when their customers are healthy, and lose money when they get sick. So let's take a look at the insurance industry. Are their profits unreasonable? Are they milking their customers and benefiting from their suffering?

UnitedHealth Group, the country's biggest health insurance provider, has 70 million customers. In 2007, UnitedHealth made $4 billion in profit. That's a lot of money, but how much is that per customer? Or a better question: how much are consumers paying in their monthly premiums for UnitedHealth's big profits? The answer: ($4 billion) / (70 million * 12 months) = $5 per month.

That's right, Americans are paying $5 per month for their insurance companies' profits. Is a $5 monthly profit excessive, evil, and villainous? Let's say my individual insurance premium is $180 per month. If we completely wiped out all insurance company profits - i.e. transformed health insurance into a non-profit industry - my premium would only be lowered to $175 per month. And remember: that $5 provides all the incentive for these companies to exist and offer their services in the first place.

With this information any reasonable person can conclude that the "for-profit" insurance model is not one of our health care problems. But if only $5 of Americans' monthly premiums accounts for insurers' profits, how does the rest of the cost break down?

In the year 2000, administrative cost in the insurance industry was $256 per customer annually, or $21 per month. That number includes profits and other expenses that aren't really "administrative costs", such as taxes and health services provided directly by the company. So if my monthly premium was $180, removing all administrative costs - i.e. if the insurance company were to operate non-profit and at 100% efficiency - would lower it to $159. That $159 is essentially the per-person cost of the health care services used by all 200 million insured Americans. Health insurance reform can't touch that cost - unless they want to ration care.

Is $21 per month a reasonable amount to pay for the administration of an insurance policy? It's not wholly unreasonable, but I would prefer to pay less. The problem is, by 2005 that amount had ballooned to $38 - almost double! And that's still less than in government-run programs like Medicare, which had administrative costs of $32 per person in 2000 rising to $42 in 2005.

Why have administrative costs increased so rapidly, in both the public and private sector, and how do we fix it? High administrative costs are a sign of inefficiency. There is no uniform or sure-fire way to increase efficiency. Less paperwork, lower cost of doing business - including the cost of compliance with state regulations, higher worker productivity, better company organization - all these things could help, but the extent to which and the means of achieving these results will vary from company-to-company and institution-to-institution.

The interesting thing is, according to fundamental economics, a high degree of inefficiency should never manifest in an industry operating in a free market. Competition and the incentive to maximize profit should lead to improved efficiency over time. In light of this, one thing is clear: the insurance industry is not operating in a free market.

That the health industry is devoid of free market forces is widely-recognized, but ignored by Obamacare proponents. The lack of competition in health insurance, which is largely the fault of bad regulations at the state level, has caused that industry to bloat and swell with inefficiency. The rising cost of health insurance is not the fault of the insurance companies; it is human nature to become inefficient when the driving force for efficiency is removed. The same thing would, and does, happen to any company in any industry when competition is lacking.

The solution to this problem is not more state or federal control, as in Obamacare, because the monopoly of government also suffers from a lack of competitive forces. Rather, the solution requires a re-working of anti-competitive state regulations and a market-based approach to increase consumer choice and cost-based decision-making.

UPDATE: Health Insurance Industry Ranks 86th in Profit Margins