Health care reform need not break America's fiscal budget

By Sahil Gujral     2/26/09 6:00pm

Now that the President has been elected and the stimulus package passed, Washington is once more at war over American health care. The range of policy proposals made by Democratic and Republican lawmakers has been predictable. More government spending. Insurance mandates. Tax credits. Tort reform. Information technology updates. Prevention and education programs. And, of course, more government spending.Certain key problems with these ideas are already well understood. They would raise America's fiscal burden during a time of growing macroeconomic uncertainty. They could erode monetary incentives for top-flight doctors and researchers to practice in the US. They might outspend or "crowd out" private sector competitors, even if actually less efficient. And, they may foment rationing. Alas, amid these common critiques, the most obvious issue is lost.

We need more competition in American health care insurance, not less. The current round of political proposals is unlikely to get us there. More competitors means more affordable policies for more Americans, just as it does in other industries. Such competition doesn't cost the taxpayer a dime, preserves incentives for doctors, gives patients more options, and might make an entrepreneur very rich. So why haven't we seen it already?

The historical record gives us a clue. Between Dec. 31 of 2001 and Dec. 31 of 2007, the stock price of WellPoint, which operates as Blue Cross Blue Shield in many states, outperformed the S&P 500 by more than 210 percent. The company's free cash flow grew nearly 400 percent. In a scandal that would rock any lesser business due to other concerns it would raise about management's integrity, WellPoint's CFO resigned in 2007 under allegations that he slept with employees while filing for divorce. The shareholders didn't seem particularly fazed. The story is much the same with companies like UnitedHealth or Humana.

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An 2004 paper in Health Affairs by James Robinson found that in 47 of the 50 major U.S. health insurance markets, the top three providers controlled more than 50 percent of the market. A recent NBER paper by Leemore Dafny finds convincing evidence of price discrimination by the big health insurers, a classic hallmark of monopolies.

This isn't the behavior of typical insurance, an industry where competitive advantage usually stems from being the low-cost leader of conservative risk pricing over time. In auto insurance, GEICO isn't just a profitable business for its owners. It's quite cheap for policy holders as well. But, in health insurance, the rub is that insurers not only price risks but can mitigate them after the fact. They have enormous bargaining power. In economic lingo, these derive from informational asymmetries in claim negotiation, the inelasticity of the supply and demand for health goods, a lack of price transparency, and network externalities.

The information gaps are powerful. Imagine if most American car mechanics were employed by GEICO. Would they recommend you get as many repairs? Many HMO and PPO services in America perform an analogous, "rationing" function. Most cynically, your HMO primary provider is a private investigator paid to determine what is not wrong your health. Similarly, the legal mandate for auto insurance in the U.S. means most accident settlements are negotiated between professional auto insurers. However, most health claim disputes are between non-medical consumers or small businesses and specialist companies like WellPoint.

Regarding elasticity, the rigors of medical licensing and communal trust issues means that the physician supply in most U.S. regions is not nearly as sensitive to demand as that of car mechanics. To an extent, you can learn car repairs on the job. Try that as a doctor. Similarly, most people who are seriously ill do not forgo health care simply because the cost has increased.

On price discovery, medical information is rapidly evolving and requires a high degree of specialized knowledge to intelligently consume. There is a reasonable sense of what you are covered for in a typical GEICO policy. Things are rarely as clear in health insurance. Even veteran doctors frequently find themselves shocked at the things insurers refuse to cover.

Finally, network externalities apply. Neither providers not patients can afford an infinite number of insurers. So patients tend to pick those that offer the most doctors. Doctors tend to pick those that offer the most patients. It is hard to be a new player in such a system.

So, how to encourage more competition? The answer is not antitrust suits or government subsidies. I propose a new class of unleveraged securities, modeled after catastrophe reinsurance bonds. To review, in catastrophe reinsurance bonds, investors receive regular coupons in exchange for accepting insurable risks. Part or all of the principal that the investor paid for the bond is deducted when an insured event transpires. Here, customers seeking insurance would pay most of their "premiums" as coupons to investors who have assumed certain of their health risks.

The remaining part of the stream would fund independent claim administration companies. They would parse claims and handle payments. The prospectus and filings of each bond issue would contain aggregate information on the insureds' age, obesity, race, illnesses and smoking preferences - the sorts of information we already provide our health insurers. The pay-out and claim characteristics of different issues would be regularly disclosed. The bonds could trade publicly.

These would allow competition in the underwriting of health care risk without necessitating entry into the health delivery business. Given the current market turmoil, billions of investable dollars might enjoy the opportunity to invest in a new, uncorrelated asset class. Investment banks might find a new line of business to tide them through the shriveling of the securities markets. And the opportunity to compete on risk pricing is real. As WellPoint states on page 28 of the 10-K portion of their Annual Report for 2008, "our health care products that involve greater potential risk tend to be more profitable than administrative service products and those health care products where employers assume the underwriting [insurance] risks." Straight from the horse's mouth: There is plenty of room for new competitors to drive down the prices of health care policies.

I admit that this idea may have been "pie in the sky" a few decades past. But, computer technology and financial markets have evolved to the point where it is now eminently doable. Market transparency revolutionized the economic landscape of the 20th century. It may now allow Americans to live healthier lives as well.

Sahil Gujral is a Martel College senior.

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