Health Insurance and Reputation
By Bryan Caplan
Here’s an argument even I’ve found seductively appealing:
The problem with free-market health insurance is that if a customer develops a truly serious health problem, his insurance company will try very hard to weasel out of the contract. At best they’ll deliberately give poor service to the people who need it most, because they know that none of their competitors want to poach customers with serious pre-existing conditions. At worst, they’ll claim that you broke the contract somehow, and hope you die before your lawsuit gets to a jury.
It seems plausible, no? If your condition is truly catastrophic, won’t profit-maximizing health insurers struggle to “contain their costs” at your expense?
The problem with this argument is that it proves far too much. The same argument applies to life insurance and home insurance. You dutifully pay your premiums for years. Then you suddenly die, or your house burns down. What’s a profit-maximizing insurer to do? Say you died or the house burned down because you were smoking in bed, of course! Can you prove otherwise?
Yet in practice, people almost never complain about disingenuous disputes with life or home insurers. Why not? The obvious explanation is that life or home insurance companies that shirk their responsibilities hurt their reputation. It might seem profitable to reject expensive claims, but in the long-run, an insurance company that mistreats its expensive customers is going to have trouble attracting any customers at all. After all, what’s the point of buying insurance from a company that won’t pay when you need it most?
So why would the reputational argument be any less convincing for health insurance? I wouldn’t choose an insurer that was known to abuse or abandon its sickest customers. Would you? And why would word of mouth, advertising, and other conduits of reputation be less potent here than in other lines of insurance?
I agree that there is a popular perception that health insurance is an unusually crooked industry. My main explanation is that customers of health insurance companies have more latitude for unreasonable demands. If your dad dies, the life insurance company owes you $X. If customers ask for $X+1, the firm refuses, and no one sees this as proof that the free market can’t be trusted with life insurance. If you get sick, in contrast, it’s hard for an insurance company to decisively prove that they’ve lived up to their agreement. You can always insist on another expensive test, even if the insurer knows it’s useless.
Insurance companies want a good reputation for taking reasonable care of their customers. However, they can live without a reputation for paying for everything, no matter what. Some companies might want to be known as “generous,” and charge their customers correspondingly higher premiums. But most insurers prefer a reputation for decent but cost-conscious care. If that means affordable premiums, customers will happily buy cheap – then complain if their budget insurer makes them wait or tells them no.
Am I saying that health insurance companies never play dirty tricks on their customers? Of course not. It’s a big world, lots of bad stuff happens. What I’m saying, rather, is that reputation works well even in industries where firms have big, lumpy liabilities. There are plenty of examples. What reason is there to think that health insurance isn’t one of them?