30115688_1_health-insurance-insurers-offer-small-businesses

PhillyInc: That queasy feeling over health care

September 05, 2011|By Mike Armstrong, Inquirer Columnist

Nothing exasperates small-business owners more than the cost and complexity of health insurance.

The mood of men and women who have built businesses can go from manic excitement about what they do to utter frustration when the conversation turns to the annual chore of trying to pick a health plan that won't bust the budget.

Many of them switch insurance providers every year, chasing lower cost. Or they trim plan benefits to try to hold down the level of the premium increases.

These are smart people who seek out and find the lowest prices for all sorts of goods and services. Why can't they successfully chip away at the cost of their health insurance plans?

A new paper by a Boston University management professor and several colleagues points the finger at an economics concept called "search frictions." In an interview, James Rebitzer said such frictions occur whenever consumers cannot easily compare the options available to them, and that's especially true of those who try to buy individual and small group health plans.

If search frictions sounds at all familiar, it may be because the 2010 Nobel Prize for economics went to three economists, including MIT's Peter A. Diamond, for their work on the concept in the 1970s and 1980s. Their research explored labor markets where there can be a large number of job openings at the same time a lot of people are unemployed.

A similar disconnect occurs with health insurance. Businesses have to buy it every year. There are dozens of health insurance plans to pick from, and at all sorts of prices. It's hard to compare one plan with another. So what does a businessperson do? Hire an insurance broker or consultant to make sense of it all and offer a recommendation.

Small businesses, in fact, are doing what they need to do to lower costs in a market-based system. According to Rebitzer's paper, published in the August 2011 issue of the American Economic Review, the trouble is the system doesn't work.

Search frictions increase the cost of health insurance in the small-group market 29 percent on average, concludes the paper.

While there is competition among insurers, the fog of uncertainty gives them great pricing power. So instead of being forced by competition to offer equivalent plans at low prices, insurers offer all sorts of plans at prices set above their marginal cost.

After a lot of math, Rebitzer and his colleagues concluded that search frictions are a factor in transferring about 13.2 percent of the "consumer surplus" from policyholders to insurers. That amounted to a transfer of about $34.4 billion in 1997, and much of it was spent on marketing by insurers of all those plans.

In fact, he described it as a "marketing arms race between insurers that leads to excessive spending."

Marketing includes fees and commissions to those insurance brokers and consultants that the small employers use to help them pick the plans.

What's a possible solution? Well, the proposed state-run health insurance exchanges that were part of the federal overhaul of health care might help because they should help consumers compare insurance plans and prices, Rebitzer said.

States must set up health insurance exchanges by January 2014. As long as they're clear and easy-to-use, the exchanges should help reduce that turnover rate and lower marketing expenses, Rebitzer said.

It just so happens that the Pennsylvania Insurance Department held three public hearings in August on how it should construct such an exchange. Patient advocates, insurers, and business groups offered their two cents at a daylong hearing at the Crowne Plaza Liberty Convention Center in King of Prussia on Aug. 11. (If you missed it, you can catch a very long video of it on the department's website.)

Among those testifying was Gerry McGlone, middle-market practice leader at Trion, an insurance broker and consultant with 320 employees in King of Prussia. He defended his industry's role, calling the services provided "an extension to the HR departments" of employers.

The fees and commissions paid are not "an unnecessary expense," he said. "I will say that I think we've come a long way as an industry as far as transparency on fees. And if we can't create value, we shouldn't get paid. But I'm very, very confident that we do create a lot of value in the process."

Brokers and consultants may indeed help employers and their employees navigate the health system, Rebitzer said. But his advice for businesses hiring brokers echoes Ronald Reagan: "Trust, but verify."

Contact Mike Armstrong

at 215-854-2980, marmstrong@phillynews.com, or @PhillyInc on Twitter. Read his blog, "PhillyInc," at www.phillyinc.biz