Market functionality in insurance types

Yesterday, Gin & Tonic rightly called me out for a big assumption:

is extremely attractive assuming deep and well functioning individual markets

Quite an assumption there.

 

I think that I have an understated assumption that the health insurance markets are far less functional of a market compared to most other insurance product markets unless there is a massive regulatory thumb on the scale. I think and believe that the big differentiator of health insurance compared to home, auto, fire and life insurance is the combination of politically and economically strong counter-parties and very localized monopolies with significant barriers to entry.

Next week, my wife and I are closing on a new house. We’ve spent most of this week chasing down all the final threads of paperwork. My wife had to take care of the homeowner’s insurance policy. She was able to look at several national carriers that operate in North Carolina. They all offer functionally similar coverage. The big differentiator is customer service and bundling discounts. She chose to go with Allstate because we get our auto insurance through them so the bundled discount is significant and the friction cost of setting up another bill and keeping track of it is not worth any marginal savings.

If a triggering event occurs for the home owner’s policy, they will send an adjuster and then write a big check. After the check is deposited into our account, we then get to go argue with local general contractors to fix whatever the problem was. The same basic story applies for an auto insurance policy. The local auto repair market and the local home repair markets are fairly fragmented, price-taking markets with modest information asymmetry. Almost all general contractors and mechanics will take a personal check and all of them will take cash. The counter-party/doer barrier to entry for new insurers to enter a region is reasonably small for home and auto insurance. It is very small for life insurance as a check is written and accepted for deposit in any US bank.

Health insurance is more complex. There is massive informational uncertainty and asymmetry. I can evaluate reasonably well if my roof has been repaired but I am guessing for a while if my knee will be right after an intervention. I, as a patient, have a harder time evaluating quality as well. I can assess whether or not the check cleared the bank. I can assess whether or not Joe’s Autobody did a good job of replacing my right front fender. I have a harder time determining if a hospital/doctor/pharmaceutical intervention fixed the underlying problem, masked the symptoms or alleviated the worst of the situation without making things go back to the status quo pre-event.

Health insurers build a network of preferred contracted providers. When something goes wrong that triggers a health insurance claim, that claim comes through the contracted network. I think this is a significant barrier to entry when there are locally concentrated medical markets. An insurer can only get a good price on services with either massive government shoulder throwing as in Medicaid, Medicare and Medicare Advantage, or by being able to steer large populations to preferred rate providers and away from not-preferred entities. Building a network is a chicken and an egg problem. An insurer gets good pricing with a big membership base. They get a big membership base because they have good pricing on a good network. It is a natural neck deep moat for dominant local insurers against new entries. New entries, as we saw with co-ops in the ACA, have a hard time getting competitive pricing on their provider networks until they can build up the membership base. This means selling loss leaders for several years and lighting a lot of money on fire.

This is true for the individual market.  This is true for large group markets.  It is not as true for Medicare Advantage as price setting regulations in Medicare sets a ceiling of roughly 110% of Medicare Fee for Service as a pragmatic anchor point in pricing.  Medicare Advantage has other start-up  challenges in risk adjustment but building a non-exorbitantly priced network while having a low membership base is not one of those challenges.

I think that I assume that local/regional health insurance markets that don’t have significant price regulations are not the most functional markets.  They reward size and incumbency so new entries need to be able to climb over some very large hurdles.  I think this is less true in the individual market as the decision making agent is an individual with only family needs in mind and more true in large group where the decision making agent is someone in HR with a strong budget and a moderately strong scream constraint to work against.