Chapter 11: The Private Health
Insurance Industry
Health Economics
Outline
Industry structure.
 Industry conduct.
 Industry performance.

Health Insurance Industry
Structure
The Competitors
 Market exhibits perfect competition - large # of
health insurance companies of different types.
 Commercial (for-profit)
 BCBS
 HMO’s
 Self-insured companies
Health Insurance Industry
Structure
Types of Private Health Insurers and Number of
Enrollees (million)
Total private insurance
Insurance companies
Group policies
1994
182.2
75.8
1995
185.3
76.6
82.4
83.3
Fully insured
ASO
MPP
Individual/family policies
Blue Cross/Blue Shield
Self-insured
HMO
Blue Cross /Blue Shield
Insurance Companies
Independent
37.1
39.9
6.3
7.0
7.0
65.2
112.9
65.6
61.0
59.1
8.8
8.5
41.8
Health Insurance Industry
Structure
Persons with Private Health Insurance Coverage,
Selected Years, 1950-1995
Year
Number (millions)
1950
1960
1970
1980
1990
1995
76.6
122.5
158.8
187.4
181.7
185.3
% of Population
50.3%
67.8
77.4
82.3
72.7
70.5
Source : Source Book of Health Insurance Data 1997-1998,
Washington DC : Health Insurance Association of
America, Table 2.5
Health Insurance Industry
Structure
1. Commercial Health Insurers
 > 500 in operation, most national or regional in scope
1996
Total accident & health premium
1. Prudential
2. Metropolitan
3. CIGNA
4. Aetna
5. The Principal Fin. Group
6. John Hancock
7. AFLAC, Inc.
8 Guardian
9. Mutual of Omaha
10. Anthem
$9b
• 1992 4-firm concentration
ratio : 22% premium
• < 40%, which defines mild
oligopoly
Health Insurance Industry
Structure
2. Blue Cross Blue Shield
 52 in 1998, organized regionally as not-for-profits.
 tend not to compete with each other.
 Often exempt from state property taxes, have
lower premium taxes.
 Can pass on savings to consumers.
 Higher demand from lower prices also
 market share, so can negotiate discounts with
providers.
 Blue Cross - hospital insurance
 Blue Shield - Physician insurance
Health Insurance Industry
Structure
3. “Other” Insurance Plans
 1970 : 8.1 m members
1994 : 112.9 members
A. Self-insured plans (large employers)
 Exempt from premium taxes (as high as 2%)
 Under 1974 Employment Retirement Income Security
Act, exempt from state mandate benefits.
Type of Self-insured Plan
1) Administrative Services Only (ASO)
 Employer establishes self-funded health plan, pays an
insurance carrier to process claims.
2) Minimum Premium Payment (MPP)
 Employer self-funds, but purchases stop-loss insurance for
excessive claims.
Health Insurance Industry
Structure
3. “Other” Insurance Plans (cont.)
B. HMOs : 593 in the US, 48m enrollees (c.a. 20%
of population in 1995)
Penetration varies widely by region (lowest in South,
highest in the coasts).
HMO providers, 1995
1) 51% National managed care firms
2) 13% Blue Cross/Blue Shield
3) 36% Independent ownership/sponsorship
Health Insurance Industry
Structure
Are there economies of scale to insurance provision?
1) Evidence from cost regressions (cross section)
(Blair et. al. 1975)
OPCOST = .464 - . 0000002P - .0003GI/T + other factors.
(34.32)
(3.152)
(19.693)
R2 = .589, N = 307 insurance companies
OPCOST = average administrative costs
= total operating cost/health premiums written
P = premiums written
GI/T = group insurance premiums/premium written
•Coefficient on P
: economies of scale
•Coefficient on GI/T : lower admin. cost for group policies
Health Insurance Industry
Structure
Who is the Consumer?
Majority of commercial insurance purchased by
groups. (e.g. employers or union representatives).
Why?
1) Monopsony buying power
2) Group expert makes informed choices
3) In large group, health status uncorrelated with
employment status
Commercial group insurance premiums unregulated,
unlike benefit/premium ratios of individuals.
Health Insurance Industry
Conduct
Price Components
Premium = E(Benefit) + Admin + Tax +
Profit
Loading Fee
 Ex ante, insurance comp. does not know exact
amount of benefits any individual will receive.
 E(Benefit) = Ben + e
 Common measure of price : Premium-to-benefit
ratio.
Premium
Admin + tax + profit + e
= 1 +
Ben
Ben
Health Insurance Industry
Conduct (cont.)
 Price competition in 2 forms drives down loading
fee.
1) Normal price comp. competes away profits.
2) Managed care contains health care costs

ben
 But managed care is costly; e.g. utilization review

admin. Costs
loading fee.
 Price competition forces insurer to balance
marginal cost saving vs. marginal admin. costs.
Health Insurance Industry
Conduct (cont.)
 Do managed care organizations (MCOs) actually
lower health insurance premiums?
MCOs, especially HMOs, lower medical costs 1520% through medical costs.
1993 average family monthly premium for
conventional insurance = $439, vs. $415 for HMO
insurance.
Health Insurance Industry
Conduct (cont.)
However, the higher monthly premiums for
conventional insurance may just reflect the decision of
sicker individuals to buy more generous insurance
policies.
Regression analyses that control for health status
differences find no significant difference in premiums
between conventional and HMO premium. Why??
1) Admin. costs may outweigh cost saving
2) HMO’s may “shadow price”.
3) Lack of consumer price consciousness.
Pricing Strategies
 Community rating - premium based on risk
characteristics of entire membership.
Rates for each individual do not vary according to
health history or health status.
Low risk individuals subsidize high-risk individuals.
Disadvantages :
1) low risk individuals discouraged from purchasing
insurance premium that are too high.
2) no incentive for individuals to adopt healthy lifestyle.
Pricing Strategies (cont.)
 Experience rating - premiums for individuals (or
groups of individuals) vary by risk status (e.g. age,
gender, industrial occupation, prior illness).
 Individuals or groups of individuals pay price closer to
expected medical costs.
Disadvantages :
1) “unfair” to make sickest pay more
- illness uncontrollable.
2) encourages “cherry picking”
Non-Price Business Strategies
 Cherry-picking and benefit denial.
 Once an insur. comp. sets health insurance
premiums, there is an incentive to keep low-risk
consumers and exclude high-risk consumers.
e.g. demand even higher premiums for patients w/
chronic health problems or high-risk conditions
(e.g. hypertension, diabetes)
or, exclude coverage for pre-existing conditions.
 More problem for individual vs. group policies.
Non-Price Business Strategies
(cont.)
 Limited enrollment period to deal w/ adverse
selection.
a) High risk consumers may know more about their
own health than insurers.
b) High risk consumers may get into cheaper plans
designed for lower risk persons.
c) High cost eventually drives up premiums, until
high-risk consumers switch to next cheaper plan.
d) Instability -- high adjustment costs for insurers.
Health Insurance Industry
Performance
Output (Quantity of Health Insurance)
 42.6 m = 15.5% of the population remains
uninsured.
young adults, unmarried adults, minorities, parttime & self-employed, poor less likely to be
insured.
Resulting inefficiencies.
a) uninsured eventually receive emergency care
 insured indirectly subsidize uninsured health care.
 inefficient vs. planned financing mechanism.
b) uninsured may “wait too long” for care, when earlier
treatment may have been cheaper.
Health Insurance Industry
Performance (cont.)

One measure of the health insurance “price”
is the amount of premiums the insurance
company receives, divided by the amount of
medical benefits paid out.

Using this measure, the relative “price” of
health insurance has declined over time.
 The
overall price hasn’t fallen, because medical
care expenditures are rising dramatically.
Health Insurance Industry
Performance
Price of Private Insurance in the United States,
Selected Years, 1950-1995
Insurance Companies
Year
1950
1960
1970
1980
1990
1995
.
Total Group Individual
$1.62 $1.44
$2.01
1.57
1.23
2.47
1.26
1.09
2.11
1.18
1.12
1.73
1.22
1.19
1.55
1.22
1.19
1.46
Self Insured Blue Cross &
and HMOs Blue Shield
--$1.17
--1.08
--1.04
$1.07
1.03
1.11
1.12
1.08
1.13
Source : Source Book of Health Insurance Data 1997-1998, Washington
DC : Health Insurance Association of America, Table 2.5
Health Insurance Industry
Performance (cont.)
 Job lock - Health insurance often tied to worker’s
job.
New job may require long waiting period for
enrollment, no coverage for pre-existing
conditions, less generous coverage.
Cooper & Monheit (1993) - Married men who
expect to lose health insurance 23% less likely to
change jobs.
Health Insurance Industry
Performance (cont.)
 Over-insurance/Moral Hazard.
Definition : Insured person no longer bears full cost of
her actions
may probability or magnitude of loss
covered by insurance.
analogy : restaurant bill splitting.
Health Insurance Industry
Performance (cont.)
 Over-insurance/Moral Hazard (cont.)
Causes and Implications :
1) Consumer pays coinsurance only
2) Less incentive to practice healthy lifestyle/preventive
medicine
3) Greater willingness to experiment w/ new, expensive
technologies
4) Less incentive to monitor providers
5) Less incentive to comparison shop
Practical Solution : increase copayment, w/ stop-loss
Cost Containment
 Industry has been slow to adopt cost containment.
 Tax exemption on employer-sponsored health
insurance reduced consumer’s demand for lower
premiums.
 Health insurance also used by employers as a
symbol of their generosity.
 Eliminating tax exemption may help to restrain cost
growth.
Conclusions
The health insurance industry is
structurally competitive.
 However, price and non-price strategies
still lead to disparities in access to
appropriately priced health insurance.
 The cost of health insurance continues
to rise.

 In
part due to rising costs of medical care.
 But also due to moral hazard problems.