As an investor you want to be sure you enter a growth market and exit a shrinking market. While I cannot say that investing in insurance companies is either a good idea or a bad idea, what I will say is that the entire field of insurance has been greatly affected by Obamacare. Many health insurers incurred deep losses because they effectively were forced to support an untested marketplace. They had to underwrite those losses through profits they made in other areas of insurance. In effect, Obamacare may have raised the cost of non-health insurance in some places, although I am not aware of any studies testing this hypothesis.
Health insurance is very different from property insurance. With property insurance if your house is destroyed you can take the insurance money and start a new life elsewhere, or use the money to repair or rebuild your house. You can hire any contractor to build you a new house, or buy a house from whomever you please. The money is yours (minus whatever is used to pay off loans against the old property). With health insurance you must choose your care providers from restricted “in-network lists” or pay higher out-of-pocket costs for “out-of-network” lists; and you are not replacing any damaged lives or limbs but simply paying expenses for ongoing services.
In other words, property insurance replaces losses and health insurance pays ongoing expenses. We depend on life insurance to compensate our survivors for our deaths. Basic term life insurance is very similar to property insurance in many ways. Health insurance is more of an accounting mechanism to regulate the cash flow required to keep a group of people in generally good health and to treat their injuries and illnesses as they occur. The insurance company adds to the cost of health care through the profit it takes to cover its administrative costs and to ensure investors receive a profit (although mutual insurance company investors are, in fact, their customers).
Health insurance also creates a strange relationship between the middle man (the insurer) and both health care providers and insurance customers. If an insurer is the only company operating in a county or state, it is said to be a monopsony, effectively the only customer (that matters economically) to the health care providers. If the monopsonist refuses to do business with a given provider the provider will struggle to find patients. If the insurer is the only company providing coverage to consumers in a county or state, it is said to be a monopoly, the sole provider of the service being sold. There are regions in the USA where some insurance companies are both monopsonists and monopolists. So guess who has all the power in those areas?
The Affordable Care Act (aka “Obamacare”) changed the way the health insurance industry works by requiring insurers to accept everyone who applies for health insurance regardless of their gender or existing medical conditions. The law is predicated on the belief that if enough young (generally healthy) people are compelled to buy insurance (or pay tax penalties that underwrite state-controlled high risk pools) then insurance premium costs will be reduced for older, less healthy people.
Before the law about 45 million Americans lacked health insurance. After enactment of the law the number of uninsured Americans has dropped to somewhere between 15 million and 20 million (estimates vary).
The law forced insurance companies to compete for consumers in many markets. After a few years some insurance companies began pulling out of unprofitable markets (counties), and economists and health care experts have expressed alarm at the growing number of counties that have only one active health insurance company (although state high risk pools exist in some of these counties).
Competition Is Supposed to Lower Costs, But Does It?
When you have two or more providers in a market their need to attract new customers will force them to lower prices (unless they engage in price fixing, which can still happen). The more competitors that enter a market the greater the pressure is to lower prices to consumers. This works in many industries and to some extent it also works in health insurance, especially as a result of the ACA.
However, competition among insurers increases costs of health care services. Why does that happen? Because each insurer represents fewer potential patients and therefore they have less bargaining power with hospitals and doctors’ networks. This is just the way basic economics works. So while you can say that consumers benefit from competition in the health insurance marketplace, that very competition leads to higher costs among actual health care services.
Conversely, research shows that the fewer insurers that cover a county the better leverage the remaining insurers have in negotiations with health care providers. In fact, health care costs as measured in wages and employment numbers decline proportionately to the decline in competing health insurance providers. While this probably means that the quality of health care may also decline, it does mean that the health insurance companies become more profitable. Hence, they should (in theory) be able to pass on those cost savings to their customers.
In practice the exact opposite happens: the insurers keep the additional profit. You could dismiss this as a sign of corporate greed but remember that insurers may be profitable in one county and lose money in another county, so there is a broader economic issue at play here. They are spreading their losses across all of their revenue streams (as much as the law permits them to).
If Competition Raises Consumer Costs, Will Obamacare Fail?
The goal behind the Affordable Care Act’s mandate (which was modeled on a Republican plan enacted in a state) is to increase the inflow of premiums to the health insurance companies so that their profits come from covering healthy people. In other words, instead of charging higher premiums to ill people (or denying them coverage) the insurers are expected to subsidize their losses by selling coverage to people who really don’t yet need it.
This is, technically, how all insurance is supposed to work: the majority of customers experience no losses or expenses and their premiums are used to subsidize the claims (losses or expenses) of the minority. Ironically, some Republican law makers (such as House Speaker Paul Ryan) believe that it is unfair to compel healthy people to pay the health care costs of ill people.
Like it or not, the mandate keeps consumer costs per subscriber low by compelling more people to become subscribers before they need health insurance. All that can be done with insurance is to shift the costs around. Someone has to pay the bill. In an ideal situation everyone pays a small part of the bill with the full knowledge that if anything bad happens to them the insurance will bail them out.
What Does This Mean for Investors?
As insurance companies pull out of unprofitable local markets, their overall profits should increase. The more profitable an insurance company becomes the more desirable it becomes as an investment vehicle.
However, rewarding insurance company stocks with new investment capital because they have abandoned difficult insurance markets is a short term strategy. In the long run we are all better off if we find innovative solutions to managing the health care costs.
Insurers that negotiate well with pharmaceutical companies and hospital networks can reduce drug and medical costs. But we need a few changes in the law to ensure that consumers benefit from these situations as well as investors.
- Insurance companies should be able to offer national plans
- Insurance companies should be required to split profits from cost savings with customers
- Insurance companies should be offered incentives to remain in expensive markets
If the first two options are enacted there will be less need for the third option but even in the best of conditions some insurers will be reluctant to provide coverage in the poorest counties. Instead of compelling them to offer such coverage it would be in everyone’s best interests to find ways to make those poor counties more attractive to several insurers.
One way to do this would be for states to tax insurance premiums (like a sales tax) and to use that money to subsidize insurance in poor counties. If the insurers don’t have to worry about customers’ ability to pay, and if they can spread costs across national plans, then insurance premiums should come down for many high expense areas and should only increase modestly for most other parts of the country.
Investors should support companies that look at the long term picture with their investment capital. Supporting companies that make good long-term choices equates to supporting the best strategies for managing risk, and that is really what insurance is all about.
