Mr. Potter's changed ways

I'm not afraid to admit when I might be wrong, and health care is one issue where I might be wrong.

This morning I read an op-ed about Wendell Potter, a former health insurance executive who is now testifying concerning the need for health care reform.

(I love that his name is Potter--it makes me think of the mean old man in It's a Wonderful Life.)

Stories like these about the health insurance industry should not go unnoticed:

Mr. Potter says he liked his colleagues and bosses in the insurance industry, and respected them. They are not evil. But he adds that they are removed from the consequences of their decisions, as he was, and are obsessed with sustaining the company’s stock price — which means paying fewer medical bills.

One way to do that is to deny requests for expensive procedures. A second is “rescission” — seizing upon a technicality to cancel the policy of someone who has been paying premiums and finally gets cancer or some other expensive disease. A Congressional investigation into rescission found that three insurers, including Blue Cross of California, used this technique to cancel more than 20,000 policies over five years, saving the companies $300 million in claims.

...

Mr. Potter notes that a third tactic is for insurers to raise premiums for a small business astronomically after an employee is found to have an illness that will be very expensive to treat. That forces the business to drop coverage for all its employees or go elsewhere.

All this is monstrous, and it negates the entire point of insurance, which is to spread risk.

The emphasis in the last paragraph is mine. For some reason that sentence triggered a suspicion in me that perhaps there are theoretical problems with the system as we have it.

Perfect competition in free markets depend on perfect information. Such a thing does not exist in the real world, so competition is never perfect, but the worse your information is, the worse your competition is.

In the case of health insurance, the information available is very bad for more reasons than I had realized. For one thing, insurance companies will look for any kind of loophole they can, and this creates huge uncertainties for a customer--you never know when you'll be dropped just when you actually need coverage.

I was already aware of this problem, and I do believe that it is the responsibility of government to do something about this. Laws are required to keep the market functioning, laws that make sure contracts between individuals are carried out faithfully.

But there's another problem, I realized, and it's a theoretical problem having to do with the nature of insurance. The problem is that insurance companies can defy some of the basic laws of competitive markets. Here's why I think so.

You don't need insurance now; you may or may not need it later, but you buy it just in case, to minimize risk. This means plenty of customers will probably go years without ever having a complaint about their insurance, because they never come into dire straits.

Now consider the 20,000 people in the story above who lost their insurance just when they needed it most. That's a lot of people who experienced a grave injustice--but relatively speaking, these cases don't happen that often to that many people.

That word relatively is critical. What it means is that insurance companies can save huge amounts of money by offering what is more or less an inferior product--except that they can count on a majority of their customers finding it acceptable a majority of the time.

So it's possible to see, in theory, why competition wouldn't solve this problem. Another company might come along and say to the customers who go screwed over, "Buy from us, and this will never happen to you." But there are two huge problems:

• one, the damage has already been done, in the sense that customers have already paid lots of money into a plan that they now no longer have, and
• two, because these unfortunate customers are relatively few (though not actually few--each of these lives matter) it's possible that it's not profitable for competing insurance companies to pick them up.

If you're a competing insurance company seeking to profit from another company's bad business, you have to win over a lot more customers than just the screwed-over customers, and that requires overcoming the problem of limited information.

It's probably just more efficient for all health insurance companies to adopt the same business practices as their competitors. But efficiency for health insurance companies is not what we really want; we want a system that's efficient for consumers.

I can't think of any great solutions. Having a public option seems like an inefficient allocation of resources, but what we have now is already enormously inefficient. I can't think of another feasible way to solve the problem.

My issues with the current proposed plan are much deeper than whether or not they violate market principles, so at this point I'm still not a fan. But who knows? Maybe some good will come out of this, after all.