Saturday, October 17, 2009

Insurance as a Natural Monopoly

In a comment, RD brought forth an extremely odd notion. He apparently learned in school that Health Care is a natural monopoly.

When I was working in insurance (before the managed care industry) the sentiment was the exact opposite. The belief then was it was entirely too easy for people to start ibnsurance firms.

Insurance is not like other industries. In most industries one invests capital to create a product then sell the product. In insurance one collects money for future expenses. So, you get the money upfront then spend it later.

Young insurance companies tend to be flush with cash and very irresponsible. They would collapse when the expenses hit.

Regulators spend a great deal of effort throwing up road blocks to stop the formation of new unprincipled insurance companies.

Since the money comes in before the expenses, it takes surprisingly little capital to start an insurance pool. The problem is in calculating future liabilities.

Since insurance does not involve the upfront capital of businesses like the railroad, the buyer's co-operative is actually a better model for an insurance compan than the standard corporate model.

The early insurance market was dominated by small unprincipled upstarts. The fact that insurance today is dominated by monopolies is really a sign of regulation run amok.

In other words, the regulatory agencies in state governments have been captured by the industry. The monopolies are a direct result of the captured regulators.

If the 2009 Health Care debate was about breaking the corrupt regulatory agencies, we would have a completely different beast. However, it is simply about adding another layer of corrupt captured regulators sitting between patients and their doctors.

Insurance is not a natural monopoly. It is the captured regulatory regime that creates the monopolistic tendencies.

The Medical Savings and Loan and Regulation

I guess I should add an end note. Unprincipled young insurance companies fail to retain adequate reserves for expenses and fail. This creates the need for regulation. The regulatory system is routinely captured and creates insurance monopolies.

The Medical Savings and Loan does not hold funds in a liability pool. It simply aids individuals in saving. The reserves for the loans are owned by the savings accounts. As this structure is not dependent on a pool, it does not have the temptation to burn through liability reserve. This reduces (if not eliminates) the need for regulation ... breaking the need for regulation and the monopoly resulting from regulation.

Like insurance of old, the Medical Savings and Loan is better suited for the co-oop business model than the corporate model.


RD said...

your ignoring the fact that insurance company's ether own their hospitals or are in bed with large chains of hospitals. These hospitals will charge much lower rates to these partners then anyone else effectively preventing small startups from being able complete on price with the big company.

Second Their is a pretty good chunk of capital required to negotiate the provider network that requires a good number of customers to spend out the cost enough.

Thirdly Big Insurance company's have their own fund managers providing them much much better rates of return on the premiums investment pool then a smaller company can maintain by outsourcing this function.

Fourthly Underwriting can be expensive, but bigger is cheaper.

Fifthly Insurance company's are exempted from anti-trust laws so they can get away with all kinds of things that would be naughty anywhere else. The Big 5 DO collude to set prices.

y-intercept said...

The post did not ignore managed care. I was careful to note that I made these observations before the regulatory regime based on managed care.

Just as motorcycles and trains are different things in the transportation industry. "Managed Care" and "Insurance" are different things in the health care industry.

NOTE, a person can zip around corners on a motorcycle, but have difficult time hauling twenty tons of iceburg lettuce to market.

Insurance companies do not naturally own hospitals.

As you note, the ownership of hospitals came from regulations.

Managed care was a new idea when I was working in insurance.

Managed care was brought into existence by a health care reform movement similar to the one we see today. The goal of the reform was to reign in all the little insurance companies that irked the political elite.

The 2009 Health Care Reform movement is not about breaking the monopolies of the last health care reform movement. The goal of the current movement is to find new ways to progress health care into socialized medicine.

Obama used threats of breaking the monopoly status of health management companies to help keep them in check during the debate, but reversing the harms of the last reforms is not part of the equation.

I've been opposed to the 2009 Health Care reform effort because the effort is taking great pains to avoid any fundamental debate about the nature of health, the nature of insurance, nor the nature of managed care. They are simply pushing a set of definitions that have been carefully framed to present a choice between fascism and socialism.

Using the term "insurance" as a synonym for HMO is just such a trick.

BTW, if health savings accounts were to gain critical mass, one would see the corrupt HMOs fall like bricks under their own weight.

The only things keeping these horrible things alive is the captured regulatory regime that was created in past health care reform efforts.

RD said...

Actually their has been a lot of talk about repealing the insurance company anti-trust exemption, A bill has been introduced and attempts to amend the house health bill's to include it will happen later this month.

Managed care is not a regulatory mandate, its the evolution of the health insurance industry. Managed care is a result of the so called "freemarket".

HSA's are not a 1 to 1 cost shift. Due to the Massive return rate difference between the investments that a pooled insurance company can make and the invest options available to an individual. Insurance company's can easily obtain 12-20% return rates on the investment of premiums where as the individual can only obtain 0.5-2.0% return rates from savings accounts. The difference is truly astronomical.

HSA's also have the disadvantage of requiring time to build up, And would be woefully insufficient against major problems. Risk management is an important part of health care and CDHP(consumer driven health plans), MS&L, High deductibles+HSA, and Very High deductibles+HSA provide very poor risk management options.

I won't say your idea is completely without merit, reconnecting consumer price pressure and giving more options to the individual are excellent goals to strive towards. I mainly question the practicality of many of the approach's offered at present.

y-intercept said...

I realize that what I am doing is confusing. I am essentially trying to use definitions and economic undstandings that evolved from Aristotle through Adam Smith, Benjamin Franklin, Thomas Jefferson, et. al.

The mainstream uses terms as framed by Marx, Russell, Chomsky, et al.

The market we have right now is about as close to a free market as I am close to being a brain surgeon. I no where the brain is and which end of the scapel is sharp.

Your notion that insurance companies can get sustained interest of 20% on investments seems a bit off. The assessment that money owned by an insurance company will outperform money owned by others doesn't mesh either.

Quite frankly, there are many reasons to believe that the hedging tools created by insurance have been at the root of the devasting economic crises which have dominated the markets in recent decades.

e.g. Credit default swaps were an ill fated attempt to self-insure loans. CDSs ended up creating systemic risk for the world economy. They wiped out several companies that were too big to fail.

The system I describe is sustainable. The monstrosity created by the insurance giants are a systemically flawed mess that could reduce our nation to abject poverty.

RD said...

I meant 12% to 20% on average. I am currently invested in a mutual fund that has averaged a 14.4% rate of return sense 1979 when it was created.

At 12% an account can double in size purely from interest every 4 years.

none of the major health insurance company's as far as I know have gone bankrupt or have been at risk of bankruptcy.

I will agree however the financial instruments used by the market have gotten rather crazy. The derivatives market has gone from a modest system of hedging bets through options contracts to a batcrap crazy system bound to implode.

y-intercept said...

Last century, there actually was a really big problem with insurance companies bellying up because they underestimated their exposure.

It is a terrible experience for the people involved when the company they depend on for health care suddenly becomes insolvent.

For insurance, it is better to have a company with outrageous profits in low claim years and modest profits in high claims years to one that has modest profits in low claims year and bellies up in high claims years.

A big problem with the insurance model is that companies have to price their product well above anticipated peaks to stay solvent.

A better model is one where the policy holders actually own the risk ... which is what I was trying to do with the medical savings and loan.

In this program, the policy holders would own a loan reserve pool. This pool would hold the risk ... the MS&L would then simply have predictible operating expenses and would and would not have the need for the outrageous profits.

charmcoach said...

Y--You claim RD called the health care a "natural monopoly" and went on to refute his argument without refuting the natural monopoly concept. Yes, you argue that "Insurance is not a natural monopoly. It is the captured regulatory regime that creates the monopolistic tendencies." That creates a monopoly, but not a natural monopoly. A natural monopoly occurs when a single firm is more efficient (lower average costs) at producing a product or service than multiple the garbage company in your home town. I'd be intersted in hearing your argument against that.

James Morgan - Puritan Financial Advisor said...

Insurance is not like other industries. In most industries one invests capital to create a product then sell the product. In insurance one collects money for future expenses. So, you get the money upfront then spend it later.

y-intercept said...

charmcoach, one could restructure any apparent natural monopoly so that there's multiple companies and competition. If we spent time analyzing our waste stream, we'd actually find it goes to different places.

This would be an intersting thread, but I want to answer Mr. Morgan's observation.

y-intercept said...

Mr. Morgan,

Your observation about insurance companies collecting money upfront is spot on.

The primary risk with new insurance companies is that they blow the cash before the liabilities roll in. They then fail to deliver the coverage they promised.

The fact that one gets money before the expenses means that it would be possible for a company to start a medical savings and loan with less upfront capital than other businesses.

Terry said...