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Re: Health Insurance/HMO's (fwd)From: Robert J Woolley (wooll005@tc.umn.edu)Tue Dec 30 09:47:32 1997
I took the liberty of forwarding Linda's post to one of my best friends, Reed Olsen, who is a professor of economics and specifically teaches health economics at Southwest Missouri State Univeristy. ---------- Forwarded message ---------- Date: Tue, 30 Dec 97 09:31:02 CST From: Reed Olsen <RNO174F@VMA.SMSU.EDU> To: "Robert J. Woolley" <wooll005@tc.umn.edu> Subject: Re: Health Insurance/HMO's (fwd) Feel free to forward my reply to the list. I'll assert that I'm an expert in the area and provide some statistics.
>I guess you think people are more altruistic than I do. Why would any The answer is quite simple. Profits = total revenue (TR) - total costs (TC). Hence, its quite straightforward to notice that there are two methods by which profits can increase...increase TR or decrease TC. So...to answer your question, an executive would voluntarily decrease costs in order to increase profits.
>Remember, on a CV, if you are a businessman, you are judged by how many people Somehow, one does imagine that the ability to generate profits might be an important method of judging a businessman's success. Just a thought. There is, btw, a long-known tension between *managers* (*not* businessmen, per se) and *owners* of companys. Managers do have an incentive to try to maximize things other than profit, while owners are primarily concerned about profit. To the extent that owners can properly monitor managers efforts, then managers will be profit maximizing. However, managers *never* have the option of ignoring profits, as long as owners are themselves interested in maximizing profit. The health care industry is different than most other industries because it has a number of non-profit institutions. There is an extensive literature on such institutions, including the major non-profit institutions in health care insurance, blue cross and blue shield. As one would expect, when no profit incentive exists, the institution is *less* likely to worry about costs. There exists a fairly extensive amount of evidence that (a) BC/BS behaved inefficiently (i.e., did not minimize costs of production) for a number of years (e.g., their use of community rating) and (b) increased competition in the insurance market has mostly done away with the ability of BC/BS to behave in this manner (e.g., they've abandoned their community rating scheme).
>If he/she were in the fight of a life and the company was going down If I understand you correctly, you're claiming that competition in the insurance industry is minimal, profits high, and, hence, firms don't need to reduce costs. I'll ignore the profit incentive that I discussed above and just mention your claim of lack of competition. I'll focus only on the health care insurance industry, as I assume that is the topic of conversation. One method of measuring competition is to look at benefit to premium ratios. The benefit measures the average size of the benefit paid out for paid claims, while the premium measures the average size of the premium. The question to address is what should the ratio be when the market is perfectly competitive. In a perfectly competitive market, competition has driven profits to zero and, in order to remain solvent, a firm must minimize it's costs of production as well. A B/P ratio of 1 would mean that average benefits = average premium, which would seem to imply that costs are minimized and profits zero. In other words, the insurance company is exactly paying out in benefits what it brings in in premiums. This might appear to be the case where TR = TC, but the company has additional costs not yet accounted for, the costs of administering the company (i.e., the cost of gathering up premiums and paying out benefits.) Hence, the B/P ratio cannot equal 1 even in a competitive market, but must be less than 1 (i.e., B < P). However, as the B/P ratio gets *closer* to 1, this is evidence that the market is more competitive. Here as some numbers for health insurance (source: Paul Feldstein, Health Care Economics, 4th edition, p159) In 1955, B/P ratio for *all* types of health insurance was .721, by 1989 this had risen to .859. For commerical insurance (i.e., profit maximizing, regular third party health insurance companies), the ratio was .725 in 1955 and .828 in 1989. For independent insurance (i.e., self-insurance plans and pre-paid plans like HMOs and PPOs), the B/P ratio was .912 in 1955 and .896 in 1989. Let me try to interpret the data for you and make some sense of it. In 1955 almost none of the health insurance industry was covered by independent plans. The level of pre-paid plans, like HMOs, was miniscule, almost unmeasurable, there were only 3 HMOs that I'm aware of in existence. The lack of HMOs and other types of pre-paid insurance was due to anti- competitive practices by medical organizations, such as the AMA and local physician organizations. Notice that the independent plans had a B/P ratio that was very close to 1. Yet, they had a miniscule impact on the market, even though they offered insurance at better rates. It wasn't until the 1970s, when many anti-competitive practices were found illegal under anti-trust laws, that the independent plans began to increase their market share. In 1950, for example independent plans covered 5.7 percent of the total insured population. This number did not begin rising significantly until the mid to late 1970s, after the anti-competitive practices had been declared illegal. By 1980, coverage by independent plans had risen to 18 percent, and has increased even more dramatically beyond that into the 1980s and 1990s (source: Feldstein, p. 150). So, we have a situation where a highly efficient type of insurance, with very high B/P ratios, begins to gain significant market share. This increased competition, in turn, forces profit maximizing third party plans, to also decrease costs and decrease premiums, increasing their B/P ratio as well. This is just a brief summary of only part of the evidence. However, the evidence is fairly convincing that (a) the health insurance industry was not competitive in the past and (b) the level of competition has increased dramatically in the past 20 years.
>Most of their profits are made on investments made with Well, part of it does, part doesn't. As I noted, profit maximizing firms always have an incentive to cut costs because it increases profits. The rest of it does make sense. As long as entry barriers exist which don't allow for competition, then prices will remain high. I'm not quite sure what you mean by "innovation", but if you mean doing things so as to cut costs, then you are wrong on this as well. However, the major problem with your premise is that, empirically, you're wrong about the health insurance industry. The major barriers to entry have been declared illegal and a large amount of competition currently exists in the industry.
>or do you still think a perfect market system is at work I doubt that any market system is "perfect", so I hope that my remarks won't be taken as supporting *that* assertion. I merely note that the level of competition in the health insurance industry has increased.
>I may be too pessimistic, but the insurance Sounds a lot like the new world order.
-- Reed Olsen
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