Tuesday, July 3, 2012

Insurance, Negotiation, and Obamacare

In Forbes, Avik Roy claims that Obamacare's medical loss ratio rule will result in private insurance monopolies, and that premiums will therefore go through the roof:
As I mentioned above, smaller plans will get squeezed, because they won’t be able to take advantage of economies of scale, nor of a more “favorable” mix of enrollees. Larger plans will be just fine. Carl McDonald of Citigroup, an HMO analyst who has done the most detailed work on medical loss ratios, estimates that Obamacare’s mandated rebates will cost the six biggest insurers about 1.4 percent of premiums collected. [...] 
Obamacare’s MLR mandates will make health care more expensive, and harm those who are most in need of health coverage. Those who think that this is a good thing have revealed something about themselves.
Let's assume Roy's basic premise here: if Obamacare requires insurers to spend 80% of their revenues on medical care, reserving only 20% for administrative costs and profit, small insurers will go out of business, driving down competition. However, even assuming that administrative costs axiomatically cannot be reduced to levels similar to Medicare, there is an embedded economic conclusion: that competition decreases insurance prices across the market.

And it turns out that's simply not true. Competition in health insurance markets isn't correlated with plan quality or service prices -- which seems unusual, until you look at what health insurers actually do.

Health insurance companies aren't 'insurance companies' in the normal sense. They don't 'insure' against unexpected events. Most of us can expect to visit doctors, some of us can expect to get pregnant, and all of us can expect to die. In practice, health insurers operate more like buyers' cartels, setting prices for a wide variety of services ahead-of-time, so that consumers don't have to negotiate for critical care while under threat of imminent death.

Because of this negotiating function, the market for health insurance is double-ended: they sell policies to consumers on one end, and negotiate for health services on the other. To raise its profits, an individual insurer can either negotiate with providers for lower prices, which is generally in the interests of buyers, or raise prices on consumers, which obviously isn't. Whether a health insurer will behave antisocially (and raise prices on consumers) is essentially a function of its incentives. Those incentives are essentially a function of market structure.

Competitive, highly contested insurance markets fragment the negotiating power of individual insurers, narrowing margins and increasing the cost of medical care. On the other hand, uncontested monopolies allow insurers to dictate prices both to consumers and to providers, allowing them to take a larger share of profits. As a consequence, in most cases, the ideal shape of a health care market is a contested duopoly, which concentrates negotiating power while providing an active 'fringe' of small insurers. 

In other words, if Obamacare's medical loss ratio rule reduces the amount of competition in the insurance market, we may start to see some of the advantages of oligopsony in formerly highly contested markets. Except, perhaps, for small insurers, that will be a good thing for everyone.
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