Fun and games with health care accounting

Megan McArdle looks at some of the unintended consequences of trying to limit an insurance company's profits.

Igor Volsky at WonkRoom has just discovered that when you arbitrarily set restrictions on what sorts of expenses companies can take, they will arbitrarily reclassify those expenses as something else.  Specifically, government officials think it would be nicer if insurance companies spent a higher percentage of their revenues on medical care rather than administrative overhead.  Without particularly investigating whether this was sound, or even possible, they enacted a rule dictating that the "medical loss ratio" had to be a fairly high percentage of revenues.  Predictably, companies are reclassifying administrative expenses as medical in order to make their numbers.

Now, maybe this is an example of evil companies struggling to hold onto their profits.  But you certainly couldn't prove it by Volsky's post.  He seems to confuse administrative overhead with profits, and further seems unaware that overhead (apart from profits) is usually higher when dealing with a lot of small clients rather than a few big ones.  He refers to the MLR rules as "one of the few ways to prevent insurers from earning outrageous profits before most of reform's provisions kick in", even though the health insurance industry isn't particularly profitable.

It is true, of course, that profits are part of the overhead targeted by the medical loss ratio rules.  But it does not therefore follow, as night to day, that if you raise the percentage of money that you spend on treatment, you lower profits.  It certainly doesn't follow that you lower profits the way you want to--by taking money from greedy executives and giving it to nice folks seeking treatment--rather than, say, by forcing companies with high overhead out of the market entirely. 

He seems blind to the other obvious way to meet your MLR requirements:  stop searching for fraud on either the customer or provider end, and let costs balloon.  If you stop paying attention to controlling costs, your overhead goes down, especially relatively to your costs.  Normally, this is a recipe for bankruptcy, as your competitors undercut you.  But when your competitors are all subject to the same rule requiring them to let this happen....

I do think that the most dangerous weakness on the pro-reform side is a broad ignorance of how companies actually work.  There seem to be a lot of assumptions that are intuitively satisfying, but blatantly silly to anyone who has ever managed a company (or spent much time talking to those who do).  The assumption that lower overhead is invariably better is one of these, but not the only one.  Others include a fairly persistent confusion about how companies make investment decisions, and how capital markets work; the belief that price rationing and government rationing are somehow economically equivalent because they both contain the word "rationing"; and the belief that having more the one product in a market is obviously wasteful "me-too" competition which is bad for consumers.

Elsewhere, Jonah Goldberg cites William Buckley's favorite quote: 'The trouble with socialism is socialism. The trouble with capitalism is capitalists.'

One might just as easily say that the problem with socialism is capitalists, too.

If by "capitalist" you mean someone who cares more about his own profit than yours; if you mean someone who cares more about providing for his family than providing for yours; if you mean someone who trusts that he is a better caretaker of his own interests and desires than a bureaucrat he's never met, often in a city he's never been to: then we are all capitalists. Because, by that standard, capitalism isn't some far-off theory about the allocation of capital; it is a commonsense description of what motivates pretty much all human beings everywhere.

And that was one of the reasons why the hard socialism of the Soviet Union failed, and it is why the soft socialism of Western Europe is so anemic. At the end of the day it is entirely natural for humans to work the system -- any system -- for their own betterment, whatever kind of system that may be.

And likewise, it's perfectly natural for corporations, including insurance companies, to so arrange their affairs so as to minimize the impact of government regulations on their business.