Insurance, Credit and Market Incentives

04/25/10

by John Eberhard

Democrats have now passed legislation requiring all Americans to have health insurance and fining them when they do not.

I want to talk for a bit about the overall nature of insurance and the effect this has on market forces and incentives.

My wife was at a gas station recently and some woman in a big pickup truck apparently wasn’t capable of seeing our car and bumped into it, making a tiny dent in the panel in front of the driver’s side door. It was a small dent, but we felt that it was someone else’s fault, so why should we have that dent in our car?

So we took the car in and got it fixed on that lady’s insurance dime. The final bill was over $1,000! To fix a dent that you could barely see. I was happy to have the car fixed, but I was beyond shocked at the amount.

I’m all in favor of everyone having auto insurance. But I want to point out that once no one has to pay that bill themselves, they are not overly concerned with how much it is. They won’t complain how much it costs, and they won’t shop around for the cheapest price.

So there is no market incentive for the owners of auto body shops to keep their prices low. So over time those prices go up and up and there is little to stop it.

When I was a kid when there was a dent in a car, the body shop hammered out the dent or maybe put that white paste stuff on, then repainted it. I don’t think they do that anymore. They just replace everything. Do you think they hammered out the dent in my car? No, likely they just replaced the whole panel. Does it cost more? Sure, but who cares? Insurance is paying for it.

I’ll give you another example. I went in for an eye exam recently, and afterwards they started showing me the glasses they sell there. The cheapest pair was over $500. That was not even looking at the designer frames. The last time I got a pair of glasses I worked for a company that had vision insurance. The glasses were over $400 then, but my co-pay was about $150 so I said OK. This time I am self employed with my own business, with no health insurance. That means I am paying cash for those glasses so I am shopping for a discount glasses place to get my glasses.

So without getting into a discussion about how maybe it is gauche for me to get my glasses at a discount place and object to the $500 price tag at the optometrist’s office, how did a pair of glasses get up to costing $500 for the cheapest pair?!

They got up to $500 a pair because of health insurance, and/or credit cards. If someone is not going to have to pay anything for the glasses, or if his co-pay is relatively small, or even if he just puts them on his credit card, that cost has a relatively minor impact on him. He’s not going to have any major objection to that.

But if every person walking in that office did what I did, saying that was too much money and they were going to shop elsewhere, it would have a major market incentive on that office to offer cheaper glasses. It would start to have a market incentive on the glasses manufacturers to find cheaper ways to manufacturer the glasses.

Some of you probably remember when the government broke up AT&T as a monopoly. Prior to that they were just that, one big monopoly. They owned all the lines, they owned your phone, they owned the long distance service. When they got broken up, it caused initial confusion because whenever you called one place about a problem they always said it was the other guy’s fault. Plus I really hated getting all those calls from Spring, MCI and AT&T all saying they had the best long distance service.

But look at the way it is now. After years of paying for expensive long distance service, we all have cell phones that have free long distance. And we now have free long distance for our land line through the cable company. Plus you can call overseas for free through Skype.

What brought all those costs down? It was market incentives. It was companies competing with each other, trying to find a way to win your business. It was competition and innovation driven by market incentives.

But insurance causes just the opposite effect. Most health care providers, unless they have a lot of cash business, have no incentive to find ways to keep costs low. The patients come in, and often don’t even know what the service costs. They don’t shop around, not for price anyway.

Can you imagine anyone not being concerned about the price they paid for their new car, for their new computer, for their appliances, for their furniture? So how come we aren’t very aware of and concerned about the price we’re paying each time we go to the doctor? Maybe you are and if so, bravo. But the insurance tends to insulate us from the costs, when someone else is paying for it. If we all had to pay cash, it would be a different deal.

So the new health care bill, it seems to me, is going to make this problem worse, not better.

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