Profits and Premiums

Why a healthcare system dominated by large insurance companies could lead to less competitive markets.
MANY IN THE UNITED STATES object to a government-driven healthcare system, because they believe it isn’t as efficient or competitive as one driven by the private sector. But a recent study finds that a private healthcare system might be less competitive than many think. The study’s authors include Francesco Bova, assistant professor of accounting at the University of Toronto’s Rotman School of Management; Yiwei Dou, assistant professor of accounting at New York University’s Stern School of Business; and Ole-Kristian Hope, Rotman’s Deloitte Professor of Accounting.

The group examined federal disclosure data on benefit plans from a sample of fully-insured U.S. firms between 1999 and 2011. They found that in the free market, U.S. companies report lower profits when dealing with large health insurance companies with strong bargaining power. And for good reason: When companies show rising profits, insurance providers hit them with higher premiums.

That is no small consequence, say the authors, given that the firms in this study paid a mean 29 percent of their net income on premiums. When large healthcare providers can exert such control over prices, the healthcare market is not “perfectly competitive.”

Firms using large insurance providers were more likely to use discretionary practices such as “write-downs,” subjective estimates that can undervalue assets. When health insurers merged, companies were especially likely to report lower earnings.

The study points to the example of the 1999 merger between Prudential and Aetna, which was followed by downward earnings reporting among corporate customers in six U.S. states. The exception was Texas, where state government forced Aetna to give up some of its business to competitors as part of the merger.

The study also found that lower reporting can negatively impact areas such as stock price, accounting quality, and the cost of capital. “Additional costs to society may accrue following employers’ attempts to reduce inefficiencies in the health-care market,” the authors write. “Employers (and their shareholders) may also be worse off than if health insurance markets were perfectly competitive.”

“Health-Insurer Bargaining Power and Firms’ Incentives to Manage Earnings” can be downloaded at ssrn.com/abstract=2438716.