The Tragedy of Health Insurance

How the insurance industry has haplessly abetted the rise of a government-run health care system


Tragedy "resides in the solemnity of the remorseless working of things," declared philosopher Alfred North Whitehead in Science and the Modern World (1925). And few things are more tragic in the policy world than the current spectacle of private health insurers destroying their industry, and along with it, hope for a future of dynamic and innovative medical care. In just a few short days, shortsighted actions by the health insurance industry and its lobbyists have resurrected congressional proposals for a government-run health insurance scheme, the so-called public option.

On Saturday, a front page article in the New York Times reported that small businesses are seeing their health insurance premiums go up an average of about 15 percent for the coming year—double the rate of previous year's increases. Apparently, insurers are trying to revive their stock prices and top up their coffers before health care reform legislation passes later this fall. Opponents of private health insurance quickly seized on these reported price increases. "This underlines the urgent need for health insurance reform, including a public option," said Speaker of the House Nancy Pelosi (D-Calif.).

Congressional Democrats provided the health insurers with another opportunity for public self-immolation by proposing to repeal the health insurance industry's antitrust exemption under the McCarran-Ferguson Act. That Act also allows states to regulate the business of insurance without federal government interference. Congress passed the McCarran-Ferguson Act in 1945 in response to a Supreme Court ruling that insurance could be regulated by the federal government as interstate commerce under the Commerce Clause of the U.S. Constitution.

By conferring a regulatory monopoly on each state, the McCarran-Ferguson Act ends up protecting insurance companies from interstate competition—residents may not buy policies from insurers located outside their state. Because health insurers are insulated against out-of-state competition, state insurance commissions and legislatures feel free to impose coverage mandates that significantly drive up policy premiums.

The proliferation of hundreds of state health insurance mandates and regulations also serves as effective barriers to entry for potential competitors. An insurance company trying to enter a new market would have to meet all of a state's mandates. At the same time, the company would have less negotiating clout with doctors and hospitals, which means it would have to pay providers more for their services. In addition, a new entrant trying to attract policyholders would have to charge lower premiums than the incumbent companies to gain a foothold. So a would-be competitor must pay more to health care providers while earning less from policyholders.

Given these mandated barriers, insurance companies have found that the easiest way to enter to a new state is to buy another company that is already operating in the market. It is this dynamic that is driving the trend toward consolidation in health insurance markets.

The American Medical Association (AMA) sponsored an analysis in 2007 that looked at the concentration of health insurance companies [PDF] in 313 metropolitan areas. To gauge the level of competition among insurers in the health insurance industry in each area, the AMA study used a Justice Department antitrust benchmark, the Herfindahl-Hirschman Index. A score above 1,000 shows "moderate" concentration. Those scoring above 1,800 yield a "high" concentration, suggesting that there is very little competition in the area. The analysis showed that 96 percent of the 313 HMO/PPO (health maintenance organizations/preferred provider organizations) metropolitan markets studied were above the 1,800 threshold.

The AMA is not exactly a disinterested party when it comes to health insurers, however. The medical credentialing board has a complicated relationship and a long history of conflict with health insurers. But others have found that fewer health insurance competitors in a market mean higher policy prices as well. A 2008 study by Kellogg School of Management professor Leemore Dafny found that local markets with fewer than six insurance carriers charged higher group health premiums. Dafny's study also found that "markets with 6 or fewer carriers increased dramatically over time, from 7 percent in 1998 to 23 percent in 2005." She added, "Concentration has only increased since." 

In 38 states, the largest insurance company controlled one-third or more of the market and in 16 states the largest firm controlled more than half the market, according to a 2004 study by University of California-Berkeley health care economist James Robinson. Robinson also noted that during this period of increasing consolidation from 2000 through 2003 saw double digit growth in insurance company premiums, earnings, and equity share prices. Insurance premium prices annually grew 1.5 to 2 percent faster than their costs.

Last week, the House Judiciary Committee voted to narrow the McCarran-Ferguson antitrust exemption. However, many analysts think that action will have, at most, a minor effect on improving competition among insurers. In fact, National Underwriters newsletter reported that the Moody's rating service does "not believe it would fundamentally change the way health insurers operate or lessen the barriers to entry and change the competitive landscape."

Changing the competitive landscape, University of Illinois law professor David Hyman argues, requires amending the McCarran-Ferguson Act to allow for jurisdictional competition in health insurance regulation. Insurance companies would pick the state under which they want their policies to be regulated and then would be allowed to sell their policies in all other states. "The goal is to identify the 'Delaware' of health insurance regulation," Hyman says. That is, to allow the market to find the state whose health insurance regulations are the most reasonable balance between protecting the interests of both shareholders and policyholders. This proposal would create a national market in health insurance coverage and help keep premiums low. Neither Congress nor the health insurance lobby favors such proposals. 

Which brings us back to the remorseless working of things. If the Democratic proposal to change the McCarran-Ferguson Act is just an empty populist gesture and would not really increase competition among health insurers nor reduce their profits, wouldn't this be a good time for health insurance lobbyists to maintain decorous silence? That didn't happen. The chief health insurance lobbying group, America's Health Insurance Plans, opposes even this half-hearted repeal of the antitrust exemption. By kicking up a fuss, they have handed the Democratic leadership another occasion to demonize hapless health insurers for being anti-competitive and giving proponents of government run health insurance additional rhetorical ammunition for justifying the creation of a public option.

The truth is that companies don't want competition; they want government guaranteed profits. Mesmerized by the prospect that an individual insurance mandate would provide them with tens of millions of new government-subsidized customers, private health insurers have allowed themselves to be maneuvered into an inexorable process that will lead to their destruction. In 2004, Berkeley economist Robinson warned that double digit growth in premiums and profits was unsustainable. "In the long term, health insurance will be either revitalized by the private sector, through product innovation and competitive entry," wrote Robinson, "or disciplined by the public sector, through purchasing power and regulatory requirements."

Five years later, health insurers are about to experience public sector discipline with a vengeance. Make no mistake about it: The government-run public insurance option will eventually out-compete private health insurers by means of the simple expedient of Medicare-style price controls on physicians and hospitals. Under the guise of advocating choice and competition, the Obama administration and congressional Democrats are, in reality, pushing the country inevitably toward a single payer government health insurance scheme. The result will be rationed patient care and drastically slowed medical innovation. Now that's remorselessly tragic.

Ronald Bailey is Reason magazine's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books.