Friday, December 18, 2009

Perverse Incentives

Now that the GOP and conserva-dems have killed the public option, let's think about the consequences that are likely to result.

Firstly, a few notes on how insurance companies operate.  A typical company pulls in about $50 billion in premiums, out of which around 80% are returned to the customers in medical care, or about $40 billion dollars (40/50 = 0.8 or 80%, which is the "medical loss ratio" reported in the insurance company books).  The company chews up $10 billion in profit and overhead on the $50 billion premiums.  Note that only about $2 billion is profit (4%) but it takes them about $8 billion (16%) to process the claims (and pay for corporate jets etc.).  So if you go to the doctor and the doc needs $200 to cover his/her time, you will need to pay $240 to the insurer.

With reform, the insurance companies will get a bunch of new "mandated" customers, let's say that this results in a 20% increase in income from premiums (I don't have any real numbers here, so I'm just guessing).  Based on the old formulation, the company above would expect about have $60 billion in premiums with $2.4 billion in profit and $9.6 billion in overhead for a total of $12 billion while it pays out $48 billion.  But it appears that the reform bill will have a mandated "medical loss ratio", which required the insurance companies to pay out 90% of their premium income in medical claims. Thus, the company would have to pay out $54 billion in claims and would have only $6 billion for profit and overhead.

It seems to me that a company taking in $12 billion in overhead and profit is unlikely to want to see that cut in half.  But that is OK, because mathematically there is another option: $12 billion is 10% of $120 billion, so if the insurance companies can arrange for medical care to cost more, then they can reap the same amount of profit and overhead on the same number of customers!

Perverse incentives: we are going to have a system that provides incentives for the insurance companies to encourage medical costs to rise, so that they can raise insurance rates and maintain the style of living to which they are accustomed.  They won't need to become more efficient, just arrange their books to justify larger rate increases.

What's the solution?  free market competition.  Of course,  the now-dead public option was the only part of the bill that really forced competition on the insurance companies - they are too big and too well connected to actually want to compete.  Keep in mind that free markets are actually antithetical to capitalism.  Most capitalists don't want free markets - they want a monopoly or oligopoly and will work both legally and illegally to get it (which is why Intel recently paid $1.25 billion to AMD to settle lawsuits).

Prepare yourself for insurance rates to rise.  The fault will lie with those who killed competition by killing the public option.

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