The Truth Behind America's Health Insurance Companies - It Hurts

The following post is in the form of a letter written to the editor of The New York Times on 16th August 2009 in response to an op-ed penned by the President, Barack Obama calling for reform of the health care system in the U.S. I have chosen to retain the original letter exactly as it was penned and reproduced here for providing you a sense of how going after the profits of insurance companies is at best, a case of missing the woods for the trees, and at worst, a willful attempt at manipulating and distorting public opinion.

Dear Editor,

This is with reference to the op-ed, Why We Need Health Care Reform by our President, Barack Obama. One of the main culprits in his story are the health insurance companies which he rallies against with one argument after the other. He is either promising that “by making Medicare more efficient, we’ll be able to ensure that more tax dollars go directly to caring for seniors instead of enriching insurance companies” or is proposing more consumer protection which will “finally hold insurance companies accountable enriching insurance companies.” (read more trial lawyers and more million-dollar compensation and damages for “pain and anguish”) For all his grievances about insurance companies, let me spill the inconvenient truth on that. And unfortunately I am not a paid hack of the insurance companies. I am a graduate student in Economics, appalled at how many of the President’s policies have relied on economic calculations that would not pass muster with most serious professional apolitical economists and how he has tried to camouflage his utopian, socialist ideals in the language of professional economics.

As far as health insurance companies are concerned, many of the for-profit ones are publicly listed on one of America’s many stock exchanges. You can look at the websites of any of these insurance companies and check their financial figures for yourself to see whether what the President is saying holds any water or not. But for now, let me do that heavy lifting.

On the question of profitability, one of the standard ways of measuring it for any company or industry is to look at something known as Return on Sales. Return on Sales is basically this - if I sell $100 worth of stuff, and make a total of $4 after I take out all of my expenses, then my Return on Sales is 4%. It’s simple and it’s an easy way of understanding how profitable an industry is. Not surprisingly, this measure varies tremendously from industry to industry. In some industries, such as discount retailing, margins are usually wafer-thin and in the range of around 3%. For example, Wal-Mart, arguably the best run discount retailing operator in the world reported a net profit of $13.4 billion on total sales of $406 billion - that is a profit margin of 3.3%.
(http://walmartstores.com/sites/AnnualReport/2009/docs/fr_statement_income.pdf)

And then on the other end of the spectrum you have some technology companies like Microsoft, Google or Apple which have significantly higher profit margins. For example, take the most innovative of these companies, Apple. In 2008, they made $ 4.8 billion of profits on a revenue of $ 32.5 billion – thus their Return on Sales stood at approximately 15%. So in a very crude sense, what you have above is a range of profitability of industries, varying between approximately 3% on one hand (ignoring car companies & airlines for now, whose profitability is even lower) to around 15 - 20% for some tech companies.

Where do health insurance companies fall on that spectrum? Closer to the 3% range than to the 15-20% range. I take the three largest for-profit publicly listed health insurance companies, United Health Care, Well Point and Aetna, which are also among the better-run ones. United, in particular, has a reputation of being among the most well-managed companies out there not just in the health care space but even more generally. So let us look first at what United Health Care, the largest insurer in the U.S made in (obscene) profits (Do I hear someone sayings windfall profit tax?). For 2008, United made a total profit of around $2.9 billion on a revenue of $82 billion - that is a measly profit margin of 3.6%. (http://www.unitedhealthgroup.com/invest/2008/UNH_2008_AR_FINAL.pdf)

Let’s look next at Aetna. In 2008, Aetna made a total of $1.4 billion in profits on a total revenue base of $31 billion - a profit margin of 4.5%. (http://www.aetna.com/2008annualreport/financial.html)

And finally I look at WellPoint, another very large insurer, which claims to cover 1 out of every 9 Americans with their plans. In 2008, WellPoint made a total of less than $2.5 billion in profits on a total revenue base of $61.3 billion, a profit margin of 4.1% - right in between the profit margins of Aetna and United Health Care.
(http://library.corporate-ir.net/library/13/130/130104/items/330165/E86BF009-7E78-41AE-A12A-02C69ED8E3B6_Wellpoint_08_Summary_AR.pdf)

So that’s where we stand in terms of profitability; the best-run and largest health insurers in the United States made less than $5 in profits for every $100 of revenues that they get, hardly staggering with respect to any reasonable yardstick of comparison.

So finally let us push this thought exercise a step further. Let's set the profits of the insurance companies (assuming that is what President Obama wants) to zero. Add the profits of UHC, WellPoint & Aetna. Those add up to $ 6.8 billion. Estimates of their market shares vary (depending on which population group you are talking of) but let’s put it at 30% of the private health insurance market between these three, a number which is almost certainly downward biased. So if these three companies with say, 30% of the market between them earn a total profit of $6.8 billion, then as a rough first order approximation, if you were to take away ALL the profits of EVERY SINGLE for-profit insurer in the United States against which the President likes to rally against, we would get around $6.8/ 0.3 or $22 billion of savings annually. Now I don't know why anyone would choose to stay in business if you set their profit margin to zero (unless, of course, you forced them at the point of a gun) but even if you did you would get no more than $25 billion of savings annually. And now compare these very modest numbers to the cost numbers that are being bandied around for the legislation (which needless to say runs into several hundreds of billions of dollars) and you will see why the President’s numbers don’t add up. He probably knows all of this or at the very least, his illustrious economic team of Larry Summers and Christina Romer do, yet I am appalled that the administration continues to talk about health insurance profits, as if they were the culprit behind all of America’s health care problems. I just wish that they (and you, yes you, the liberal editorial board of The New York Times) would stop deluding the American public and tell us about the hard and painful choices that have to be made to slow the rising costs of health care.

I have tried to keep my own personal opinions out of all of this and adopted an attitude of just the facts, ma'am no politics here. And you can choose to do so as well and look up the sites of these insurance companies yourself and check every single number that I have provided. But I am afraid if you do so, you will realize how off the President’s numbers are. But wait, you are The New York Times. You already know that, it is just that you don’t want to share that with your audience and are happy to have them worked up about “obscene profits of insurance companies.”

Sincerely,
A disillusioned economist and a disgruntled reader of The New York Times,
Sutirtha Bagchi
(Websites: http://sitemaker.umich.edu/sbagchi/home & http://alonelycapitalist.blogspot.com/)

Drawing the right lessons from the massacre at Virginia Tech

One of the many advantages to being a graduate student in economics is that in many cases, you can explain what you are working on to a lay person and not lose his interest completely. Give me five minutes worth of your time and I will guarantee you that you will be able to appreciate the broad contours of the research topics I have been working on this past year, something few of my friends working on Quantum Physics or let’s say “Automatic Circuit Sizing in the Presence of Environmental and Manufacturing Variations” could claim. This advantage however is not an unmitigated blessing. While the lay person may feel ill at ease commenting on either Quantum Physics or the most optimal way to configure a circuit, he is unlikely to restrain himself when it might come to many of the topics we as economists work on. Today’s discussion is on one such topic – Gun control, a topic on which you, the reader, are likely to have strong feelings one way or the other.

Before I get into a discussion of why I am in favor of gun control or opposed to restrictions on the same, let me at least walk you through the legal framework regarding this issue. My comments generally pertain to the situation as it exists in the U.S., even though some of the arguments that I offer later on in the discussion would apply equally well to countries other than the U.S. But in any case, coming back to the U.S. legal context, this is what the constitution has to say on the rights of gun owners and the ability of the state to impose restrictions on the same. “A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed.” [1] Hugely illuminating, I am sure! In any case, for a long period of time since 1939, no case had come up before the Supreme Court that dealt with interpretations of the Second Amendment unlike other amendments such as the First Amendment right to free speech which had been litigated endlessly. This was until last year when a Washington D.C. resident, Dick Anthony Heller challenged that the ban on owning hand guns for all D.C. residents violated his constitutional rights guaranteed by the Second Amendment. Given the limited judicial precedent surrounding the Second Amendment, this case winded its way through the judicial system and finally made its appearance on the docket of the Supreme Court. In a narrow and closely contested 5-4 verdict, the Court agreed with Dick Heller and sided against the local government of Washington D.C. which had enacted such a ban in the first place. I cite from the original ruling delivered by Associate Justice Antonin Scalia because, at the very least, it makes for great reading: "We are aware of the problem of handgun violence in this country, and we take seriously the concerns raised by the many amici who believe that prohibition of handgun ownership is a solution. The Constitution leaves the District of Columbia a variety of tools for combating that problem, including some measures regulating handguns. ... But the enshrinement of constitutional rights necessarily takes certain policy choices off the table." [2] Translated to plain English, it essentially means that – “Yes, we don’t want madmen and psychopaths running around with guns. But in order to prevent that from happening, governments cannot enact a blanket ban which prevents all citizens from owning them because doing so would be in violation of the Constitution.” Which is NOT GOOD!

So this is where we stand in terms of the legal framework. However by no means, we should stop there because like other provisions of the Constitution, this too is not set in stone in the sense that the Constitution also provides a way to amend it. Sure it is problematic and messy but amendments to the Constitution should be. After all, if it were easy then picture a situation in which the nemesis of the liberals, George W. Bush enacts a constitutional amendment prohibiting free speech, a right protected by the First Amendment to the Constitution. Doesn’t sound good, right? So yes, while constitutional amendments are hard, they are doable. There have been dozens and dozens of amendments to the Constitution since its original adoption and there is no reason why we as a nation should not amend the Constitution and prohibit all forms of gun ownership should we feel that doing so would reduce crime. The more important question is that should we as a society ban guns? That is the question I pose before you today.

Now it may not come as a surprise to some of you that I am very strongly opposed to such a blanket ban that many, perhaps most of you, may choose to support. My intention in this particular post is to lay out my rationale for why I am opposed to stricter controls on gun ownership. If you are impatient and don’t want to wait to hear my idle ramblings, then the key rationale can be summarized in these few sentences – Bad guys will always have guns, no matter what the law says. Thus the only folks that a gun ban will prevent from having guns are the good guys making it easier for the bad guys to kill the good guys, presumably people like you and me. And that is precisely why having a ban on guns is such a fundamentally flawed idea. In the following paragraphs, I offer some supporting arguments but essentially all of them play off this simple logic.

Contrary to what some people might think, the relationship between guns and crime is not an obscure topic. A quick search on the Social Science Research Network, more commonly known as SSRN, with the key word “guns” in the abstract reveal a total of approximately 150 hits. While some of the papers which crop up are not germane to the issue of gun control and crime, most are. Several of them have illuminating titles such as Right-to-Carry Laws and Violent Crime Revisited: Clustering, Measurement Error, and State-by-State Break downs by John Lott Jr., Estimating the Causal Effect of Gun Prevalence on Homicide Rates: A Local Average Treatment Effect Approach by Tomislav Victor Kovandzic et al and Gun Prevalence, Homicide Rates and Causality: A GMM Approach to Endogeneity Bias by Gary Kleck et al. What does the literature say? Let us hear what the experts have to say on that.

After the most thorough analysis of all the existing literature, by no means, limited to just these above articles that I cite on SSRN, a panel of public policy experts appointed by President Bill Clinton came to this extraordinary conclusion: “The committee found that answers to some of the most pressing questions cannot be addressed with existing data and research methods, however well designed. For example, despite a large body of research, the committee found no credible evidence that the passage of right-to-carry laws decreases or increases violent crime, and there is almost no empirical evidence that the more than 80 prevention programs focused on gun-related violence have had any effect on children’s behavior, knowledge, attitudes, or beliefs about firearms. The committee found that the data available on these questions are too weak to support unambiguous conclusions or strong policy statements.” [3] Yes – first let me give you a bit of time to digest all that mumbo – jumbo. Now let me add that it wasn’t just that this fact-finding commission had been appointed by President Clinton, a Democrat (to state the obvious) and a strong advocate of severe and stringent gun control. It was also the case that of the members on the commission, it was known that most of the members had always been publicly in favor of gun control when they were appointed to the commission. And yet what did such a panel of public policy experts come up with after reviewing all of the evidence that had been accumulated till that point? Something that should warm the hearts of everyone who has ever been in a PhD program - More research is necessary before we can conclude.

Think for a second regarding the composition of the panel and ponder on the fairness of it. Consider a scenario in which President George W. Bush appoints a policy of four scientists to examine the question of climate change and suggest what measures should be taken, if any. Now if it turns out that three of those appointed have always been dismissive of climate change and that is public knowledge, one can be sure that the media would be up in arms against such a patently biased panel. And yet when President Clinton appointed such a panel, the best that they came up with is that “despite a large body of research, the committee found no credible evidence that the passage of right-to-carry laws decreases or increases violent crime” to which one of the panel members, James Q. Wilson issued a separate dissenting statement. In that statement Professor Wilson argues that “virtually every estimate shows a substantial and statistically significant negative effect of right-to-carry [gun] laws on murder.” [4] I could rest my case here but I have more arguments in store for you and so unfortunately will subject you to them should you decide to plod on.

Now if you think about it, it might be surprising to you that the incidence of violent crime does not go down once gun control legislation is put into place. Since guns are used in many such incidents, you may think that simply banning guns should lead to their disappearance. Well I wish it were so simple. As I alluded to at the very beginning, the main reason why bans have never worked and never will have to do with the frailties of human nature than with the social context we find ourselves in. The thugs and criminals will always get a way around it no matter what. So either a) let law-abiding citizens also have a legal option of getting a gun or b) only let the worst of society get their hands on one. This very sentiment is articulated well by Tom Palmer, a Washington D.C. resident who was once assaulted and wanted a gun in the house for self-defense and was one of the six plaintiffs in the case which was eventually decided by the Supreme Court. "The fact is that the criminals don't obey the law and they do have guns," he said. "It's the law-abiding citizens who are disarmed by this law." " [5]

If you don’t trust the above argument and absolutely insist that we do need to ban guns, you are in luck. That is exactly what Washington D.C. did in June 1976 when the D.C. Council voted 12 to 1 in favor of a bill restricting city residents from acquiring handguns while retaining exemptions for guards, police officers and owners who had registered their handguns before it took effect. Now this should have reduced the crime rate, right? Unfortunately for you, it did not. In one of his blogs on The New York Times web site, Steven D. Levitt, a Professor of Economics at the University of Chicago and a recipient of the Bates Clark award, given once in two years to the most promising economist under the age of 40, reviews the effects of the D.C. gun ban:

“Let’s start with the direct evidence. There have been a few academic papers that directly analyzed the D.C. gun ban and the papers came to opposite conclusions.
The fundamental difficulty is that you have one law change. So you can compare D.C. before and after. Or you can try to find a control group and compare D.C. before and after to that control group before and after (in what economists call a differences-in-differences analysis).
The problem here is that crime rates are volatile and it really matters what control group you pick. I would argue that the most sensible control groups are other large, crime-ridden cities like Baltimore or St. Louis. When you use those cities as controls, the gun ban doesn’t seem to work.” [6]

So if you wanted to argue that gun bans are a great idea, I hope that some of the above evidence may have dampened your enthusiasm a bit. But I understand that all of this may still have not satisfied you. You could still insist that all of my above arguments are bogus, the D.C. hand gun was not executed carefully or there wasn’t a gun ban in the neighboring states of Maryland and Virginia as a result of which it failed to have the desired effect and therefore the only way we will ever really get to find out what happens if we have a ban on guns for all private citizens (the police will hopefully carry guns even in your utopian scheme) is by actually implementing a gun ban and then seeing how it plays out. Well my immediate reactions to such a proposal would be two-fold: a) any such law would be unconstitutional and therefore would run into severe legal problems and so you might as well figure out a way to get rid of the Supreme Court or have the Constitution amended before such a proposal were to get hold. b) More importantly though to me it seems that such a proposition stems from the triumph of a woolly-headed fuzzy optimism over pragmatism. In social sciences, unlike the physical sciences, life does not give us the luxury of natural experiments, adding just a little bit extra of that reagent or that reagent and seeing whether the reaction takes place faster or not. We make conclusions and draw inferences on the basis of real-life data and use the best, most sophisticated econometric techniques out there to draw causal relationships. And in the case of gun control, as I have tried to point out above, economists and practitioners of public policy have literally ripped the data apart and have still not been able to conclude that having a gun ban helps.

In my final argument, I highlight the parallels of this debate on gun control with another issue that was equally controversial in its day, prohibition on the consumption of liquor. In a nutshell, the United States had a relatively long period between 1920 to 1933 when the sale, manufacture, and transportation of alcohol for consumption were banned nationally. That should have stopped the consumption of alcohol, right? Unfortunately yet again, things did not turn out quite exactly as planned. To quote from a letter, written in 1932 by wealthy industrialist John D. Rockefeller, Jr.: “When Prohibition was introduced, I hoped that it would be widely supported by public opinion and the day would soon come when the evil effects of alcohol would be recognized. I have slowly and reluctantly come to believe that this has not been the result. Instead, drinking has generally increased; the speakeasy has replaced the saloon; a vast army of lawbreakers has appeared; many of our best citizens have openly ignored Prohibition; respect for the law has been greatly lessened; and crime has increased to a level never seen before. [7]

Let me close off because this truly has been a long post by offering my arm-chair analysis of what causes otherwise perfectly normal, sane people to favor gun bans. I argue that it is the images of Columbine and Virginia Tech which lead people to do so. That is understandable. To have 32 people be killed in a matter of minutes is the stuff that is sure to move the coldest of hearts, (including mine by the way). And yet proposing a gun ban having been moved by those visually compelling images is missing the forest for the trees. The fallacy of judgment stems from paying attention to the obvious, the crimes which get highlighted by the media and actually occur and failing to consider those innumerable crimes which did not happen because of the existence of the right-to-carry gun laws – all of those burglaries or assaults which did not happen because of the fear that the other person might also be armed with a gun. Or failing to consider the many hundreds of thousands of cases of self defense which occur each year, several of which are compelling cases for why abolishing guns would be a completely wooly-headed idea. For example, as James Q. Wilson points out in an editorial on the pages of The Los Angeles Times: “In one Mississippi high school, an armed administrator apprehended a school shooter. In a Pennsylvania high school, an armed merchant prevented further deaths. Would an armed teacher have prevented some of the deaths at Virginia Tech? We cannot know, but it is not unlikely.” [8] And in a sense, the fact that guns also protect many of us from mindless violence is precisely what is being captured by the data that I have tried to draw your attention to and what is being reflected in the statement, “virtually every estimate shows a substantial and statistically significant negative effect of right-to-carry [gun] laws on murder.”[4]

Ultimately if you were to still be in favor of imposing a ban on guns after having read and reviewed all of the above arguments, then I think you should be honest in accepting that your proposal stems from a desire of promoting your own personal ideological goals and not from the desire of reducing crime or reducing the number of homicides. Because if you were truly interested in the latter goals, then you would be prepared to sidestep your ideological beliefs and trust the best known empirical evidence, even when the same conflicts with your own beliefs. And if you want to impose your own ideological view of the world on others, let me share my concern for all those drivers on the road. Given that a horrendously high 37,261 fatalities took place in the U.S. just on her highways, [9] the only way to prevent any of these fatalities from taking place is by eliminating driving altogether and turning into self-sufficient farmer-gatherers of yesteryears. If my suggestion of eliminating driving to prevent driving fatalities sounds unfair to you, then I am afraid so does your suggestion of banning guns to me and all those hill-billies who happen to enjoy owning a gun.

References:
1 http://en.wikipedia.org/wiki/Second_Amendment_to_the_United_States_Constitution
2 http://online.wsj.com/public/resources/documents/info-scotusdiary-071002.html
3 http://www.nap.edu/openbook.php?record_id=10881&page=2
4 http://www.nap.edu/openbook.php?record_id=10881&page=272
5 http://www.msnbc.msn.com/id/17538139/
6 http://freakonomics.blogs.nytimes.com/2008/07/07/no-more-dc-gun-ban-no-big-deal/?apage=3
7 Letter on Prohibition - see Daniel Okrent, Great Fortune: The Epic of Rockefeller Center, New York: Viking Press, 2003. (pp.246/7).