Reputation and rescission
Economist Bryan Caplan, a health-care reform skeptic, argued that health insurers’ concern for their reputation would prevent them from abusive practices like rescission, when coverage is revoked once patents need expensive care. Insurers are so concerned about reputation, he argues, that German insurers defied the Nazis and demanded the right to pay damages to Jews after Kristellnacht. Paul Krugman’s skepticism about the almighty power of reputation prompted Caplan to wish for a chart that would expose companies’ rescission rates (funny that didn’t turn up so easily) and later to elaborate on the wonderful powers of reputation in a competitive free market.
When we wanted a new house built, we gave 10% of the purchase price to the builder upfront. The builder gave us a contract almost devoid of legal remedies - practically everything was at the builder’s “sole and absolute discretion.” A few months later, we moved into our house. 99% of the details were exactly right, and they fixed the rest for free. Why would the builder treat us so well? Altruism? Ha. Legal remedies? Ha. Even repeat business is a stretch. What are the odds we’ll ever ask them to build a second house for us? The only answer that makes sense is reputation.
Caplan sneers at altruism, but is altruism so different from the professionalism we expect from doctors when we assume they are not keeping us sick to bleed more money out of us in office visits and so on? Altruism, human decency, professional dignity all matter in many of our exchanges, even though it is hard to find a place for them in a formula-driven rationalistic economic analysis of how capitalism functions. In fact (as the film The Corporation depicts) the firm may function to disperse that altruism and mitigate motives other than profit. Responsibility is spread throughout the corporation so no one has to feel particularly guilty about its cutthroat doings—as when sick patients have their coverage yanked from underneath them. Individuals within the firm can focus on their responsibilities to the hierarchy rather than to customers or society without feeling like unreasonable monsters. (Proprietors of small businesses have to face more of the brunt of the moral consequences of their practices, which makes it harder for them to fend of behemoths like Wal-Mart.) Damage to a brand’s reputation can be combated by the same forces that might publicize it, and a corporation is usually going to have more resources for this than those it has wronged.
Arnold Kling, Caplan’s co-blogger at EconLog, raises another problem with the reputation idea as it pertains to health care. “Reputation matters when exit matters. That is, if people will switch suppliers based on word of mouth, then reputation will be important.” But under the current system we don’t do that. And most people don’t have a problem with their insurers until they need to actually use the coverage, at which point it will be too late to switch.
UPDATE: Tyler Cowen makes another good point.
Reputation affects market practices, but possibly reputation is part of the problem. It’s relative reputation which matters. The operative reputational incentive is not always: provide a better product to get more customers. Sometimes the reputational incentive is: customers tolerate bad treatment, because established reputations suggest they will receive equally bad treatment elsewhere.
This seems to imply the cycle of relative reputation can push all competitors downward.
Comments
1. Caplan’s example is completely bogus and disingenuous. No matter what is in the contract, he has a huge legal remedy against the builder (if it fails to live up to its end of the bargain). First, if the contract was written that heavily against the consumer, a court would probably refuse to honor those previsions in the contract as unconscionable. Second, Caplan could sue his builder under consumer protection laws and recover huge statutory damages for its failures to do what it said it would. The builder knows all this, and not wanting to be sued, it makes the contractually required repairs. In individual cases, altruism might play a factor and so might reputation, but I would guess that the fear of a law suit always plays a factor. Caplan probably knows all this, but hates regulation and laws so much that he is willing to forget it to make a point.
2. The same or similar laws and equitable doctrines that protect Caplan from his builder also protect insureds from insurance companies, but even this rarely motivates them to behave well. Insurance companies are so wealthy and so experienced with litigation that they can and often do outspend and outlast any other litigant. For a good example of insurance company behavior take a look at the facts of this wrongly decided supreme court case: http://www.law.cornell.edu/supct/html/01-1289.ZS.html
3. Insurance is the only industry I know of that has succeeded in persuading congress to enact a law (McCarran Ferguson Act) that the federal government could not regulate it. How many times in our history has the federal government turned down regulatory power?
4. For a recent example of how powerful insurance companies are, just look at the bogus anti-stranger originated life insurance legislation that they pushed through in many state legislatures over the last two or three years in the guise of consumer protection. The real motive of insurance companies in pushing agressively for such legislation was not, as they claimed, to protect the elderly, but to allow them to rescind insurance policies without having to return premium payments and thereby reap windfall profits. As recently as 2005 insurance companies were encouraging insurance agents to take part in STOLI schemes. Now they are suing those same agents and insureds in an effort to have their cake (rescind the policy) and eat it too (retain the premiums) (note: normally when an insurance policy is rescinded the insurance company is required by law, usually state statute, to return the premium, but this is not the case under many STOLI statutes).
Comment by allie from Honduras — August 5, 2009 @ 7:12 pm
Not only is reputation irrelevant in a situation where people have no other health insurance choices, but the efficacy of reputation also relies on people openly discussing their medical histories, which few people are willing to do and even fewer people are are willing to hear about. More bluntly, is the fact that I couldn’t get my lady-parts infection treated going to cause the insurance company to lose customers?
Moreover, if reputation worked in keeping insurance companies in line, why are we in this mess?
Comment by TJ Bailey from washington, dc — August 6, 2009 @ 10:06 am