Does Competition Benefit Health Insurance Subscribers?

From: New York Times


Uwe E. Reinhardt is an economics professor at Princeton. He has some financial interests in the health care field.

How does competition work in the health insurance market? Do more competitors in a market area — say, a state — invariably mean a better deal for the insured?

These questions are germane as regulators are busy implementing the Affordable Care Act, which imposes a series of stringent new regulations on the market for health insurance, particularly the market for small-group or individually purchased insurance.

After months of hard work, for example, the National Association of Insurance Commissioners on Oct. 21 submitted to Kathleen Sebelius, the secretary of health and human services, its recommendations for defining the minimum loss ratio that health insurers must meet as of Jan. 1.

As I noted in two earlier posts on the ratio, it expresses what portion of the premiums collected by insurers must be paid out in the form of “medical benefits.” For insurance sold in the small-group or individual insurance market, the portion must be at least 80 percent. For insurance sold in the large-group market it must be at least 85 percent.

One can debate whether, with properly conducted health insurance exchanges, this regulation of the minimum-loss ratio was actually necessary. I think not, because if both the benefits and the premium for them are clearly stated, I can comparison-shop. It’s not important for me to know how insurers allocate the premium.

But if it were to be imposed, it should have been phased in gradually, over, say, four years or so, as was done with the Medicare prospective payment system for hospitals introduced under the Reagan administration in the mid-1980s and the Medicare physician-fee schedule introduced by the George H.W. Bush administration in the early 1990s.

If major changes in the health system are imposed rapidly, they tend to generate untoward and sometimes unanticipated side effects that must then be addressed with ad hoc waivers or other adjustments, such as the esoteric “credibility adjustment” of the minimum-loss ratio, whose details most readers of this blog probably wish to be spared.

Now that the regulation is on the books, one wonders what impact it will have on the number of insurers competing in the market and what effect their numbers will have on the insured.

In a letter submitted to the insurance commissioners in May, the Council for Affordable Health Insurance reminded the commissioners that these states’ traditional “standards for individual-market loss ratios vary between 55 to 65 percent, depending on the type of plan.” The council, as well as the American Health Insurance Plans, argues that the effect of the regulation will be to drive many small insurers from the market and thus to reduce competition for health insurance.

I have no doubt that this prediction is on the mark.

The question is whether a reduction in the number of insurers in a given market area invariably is to the disadvantage of the insured. On this point one’s memories of Econ 101 can be quite misleading.

The narrative in Econ 101 centers on a producer of the legendary “widgets,” a standard, mass-produced, imaginary product whose characteristics satisfy all the conditions required for perfectly competitive product markets. Students are then shown convincingly that if only one producer offers widgets in the market — a monopoly — the price of widgets will be far above what it would be in a perfectly competitive market and the volume sold much below the competitive benchmark.

Things are a bit better for the buy side when there are a few producers-sellers — what we call an oligopoly — but widget prices will still be above the competitive benchmark and volume below it, especially when the oligopolistic sellers cooperative formally or informally.

Buyers will find the lowest conceivable widget price and can buy the largest number of them under perfect competition, in which many sellers and buyers interact and arbitrate, and market entry, as well as exit, is easy and cheap for the sellers.

One can see why, when this narrative is grafted onto the market for health insurance, the conclusion emerges that the more sellers in the insurance market, the cheaper health insurance and health care must be for the insured.

Evidently, President Obama and his Congressional allies profess to believe the narrative, as they advocate the public-insurance option or at least new nonprofit insurance cooperatives. Representatives of the insurance industry profess to believe the narrative as well. Perhaps most people actually do. In an editorial on Tuesday, The Wall Street Journal appears to deplore the likely shrinking of the number of insurers doing business in the United States (roughly 1,200), even though, as noted above, many small insurers pay out only 55 to 65 cents of every premium dollar they collect in medical benefits.

But is the facile Econ 101 narrative actually apt for the health insurance market of the real world?

That market does not trade in widgets. It trades in immensely complicated financial contracts that bundle into one deal a number of distinct product lines. Ideally, these product lines include:

1. A transfer of much or all of the financial risk of ill health from the insured to the insurer, facilitated by the statistical miracle of risk pooling;

2. Claims processing.

3. Management consulting services to help patients manage their health, including disease management.

4. Purchasing of health care on behalf of the insured, including:

a. bargaining on behalf of patients over the prices of health-care products and services
b. monitoring the quality of care delivered
c. monitoring the appropriateness of care delivered.

Some widget that is! The premium paid by the insured can be thought of as a bundled payment for all of these distinct services.

So the question is whether production costs of each of these distinct product lines, and the prices that consumers are charged for them, will necessarily fall as the number of health insurers in a market rises. Do they?

I will explore this question in the next post.

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