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The Problem of (Some) Profits

Yale law professor Stephen Carter has a puzzling op-ed this morning defending the general concept of...profits. Of people making money. You might wonder whether anyone has actually gone so old school as to actually question whether it is good when Safeway posts a healthy margin or a laundromat stays open for another year or General Electric can repay its shareholders. Sadly, Carter's op-ed doesn't have any examples of such a generalized distaste for the basic mechanics of capitalism. Instead, his op-ed is a generalized response -- and thus not much of a response at all -- to those who question the specific business models of certain industries.

Carter responds to unrest over massive insurance industry profits, for instance, by offering the sort of cutting rejoinder I once associated with Introduction to Economics classes. "The only way a firm can make money is to sell people what they want at a price they are willing to pay," he explains. "If a firm makes lots of money, lots of people are getting what they want."

Maybe. Or maybe not. This is a bit like saying that people walk outside in freezing cold temperatures and thus lots of people want to take walks in the freezing cold. Health insurance isn't something that people decide they "want" so much as something people feel they "need." As such, they're pretty much stuck with the rules of whatever insurance market they happen to be able to participate in.

But one way that insurers amp up profits is by developing clever models and methods to discriminate against the sick and the ill. Is that what people "want?" If insurance margins go up because insurers have managed to separate the sick from the well and only offer coverage to the latter group, is that evidence that "people are getting what they want?" If an insurance firm sees its stock price rise because it managed to make its "medical-loss ratio" -- the percent of every premium dollar they spend on health care -- fall, is that what people "want?" I sort of doubt it. People "want" insurers to cover their medical costs. Insurers that are very good at not covering their medical costs, however, often post the biggest profits.

Or to use another example, is the fact that financial firms managed to post incredible profits during the early years of this century evidence that people "wanted" concentration of tail risk and a land mine placed at the center of the economy? Strange thing for them to want. Or is it evidence that firms often make money by focusing on the short-term to the exclusion of the long-term?

These are hard issues. The profit-incentive can be a wonderful thing, but it can also be a terrible one. And if you want to see the ways in which it can be terrible, you can look at the uninsured, or the rise in health-care costs, or the state of AIG. And pretending these downsides don't exist -- pretending that the profit incentive is perfectly aligned with the public interest -- is exactly the sort of blinkered thinking that got us here.

By Ezra Klein  |  July 30, 2009; 10:06 AM ET
Categories:  Economic Policy  
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There's a lot of that kind of thinking in libertarian circles: whatever happens between people happens because both/all parties wanted it that way, otherwise one of them would be a) dead or b) back in a time machine changing the past to prevent whatever it was from happening. Reminds me of Voltaire's Candide with his "all for the best in this best of all possible worlds".

Posted by: csdiego | July 30, 2009 10:52 AM | Report abuse

Take utilities. We want utilities to make a profit to reinvest in technology and infrastructure. But we regulate the rates. Demand for natural gas in Minnesota in the winter is pretty heavy. How much would you pay to heat your house when it's 20 below zero if you had to buy it at auction? How many people would live in Phoenix if they had to buy electricity or water in the summer on the spot market?

As a society we have decided that it is in everyones interest to have heat in the winter and air conditioning in the summer, and that regulating the rates enables economic growth and stability. If your employees don't come in because they froze to death, this impacts your ability to grow and profit yourself. You can look at health care the same way. Or not. But it is not unprecedented that we make decisions to put some limits on some things that have been determined to be in the public interest. Is health care one of those things? Many people think so.

Posted by: luko | July 30, 2009 10:59 AM | Report abuse

Carter is right if he is talking about a truly discretionary purchase. The problem is that many purchases--utilities (as mentioned above), auto insurance and health insurance, for example, are not discretionary. This is why we have regulation.

Posted by: scott1959 | July 30, 2009 11:06 AM | Report abuse

I am also all for making profits but most arguments against the public option seems to be very shortsighted.

Somehow I can’t reconcile how some people that are all for small business & are against the public option. Do these people know how much money small business owners spend annually on providing health ins to their employees? Does anyone understand that the public option opens up more job opportunities/growth due to the savings by these businesses?

If a small company has 30 employees, pays 30% of each employees health ins cost and a standard american family of 4 pays 15,609/yr in health ins

That’s 30 X ( (15,609 X 30) /100 = $140,481/yr

This company can hire 4GM workers who lost their jobs and train them for that much --- as long as there is a public option.

So when these people say they support business, they really mean that they support conglomerates (mostly health insurance)

Ok, even if that was the case:
GE has 300,000 full time employees

That’s 300000 X ( (15,609 X 30) /100 = $351,202,500/yr

Imagine the kind of boost the economy would have just from people spending on everyday things from the saving they would have.

There are of course a number of outliers that I have to consider in this model (taxes, incedentals, singles, smaller families and such) – but I have to get back to work here cause I really don’t want to lose my health ins.

Although the public option would be the best way to go right now, it will take another 20yrs or so for it to be actually implemented – when a smarter generation can call the shots & when we realize the long term value of it.

If we look at the data from the French system, we would already know the value of this(monetary or otherwise)& put the public option through today. Even if we were to take a strictly monetory stand point… What is the $$ value of a healthy employee??

Not sure if you read these Ezra--LOVE FROM UNI HIGH -CLASS OF ‘02!

Posted by: Priyancashyam | July 30, 2009 11:06 AM | Report abuse

Ezra - I think you suffer under a few misconceptions regarding the insurance market. People may be "stuck with the rules of whatever insurance market" they can participate in. But you know who sets the rules: state and federal government.

Second it seems that you believe insurers can refuse coverage of anyone they so desire. This is wrong in a couple ways. First they have greater ability to refuse coverage in SOME states in the individual market. Many states (as Krugman wrote about recently) have rules that require insurers to take all comers or charge everyone the same rate. We can debate whether these rules are good or bad, but they exist and they prevent insurers from refusing coverage.

Also the individual market is small, representing less than 10% of the total population (about 25 million people -my estimate based on US Census data of 26.6 million in 2007). The employer market makes up about 60% of the population and in this market insurers can't pick and choose who they cover. They must take or leave the entire group. So your comments apply only partially to a very small piece of the population (a subset of the 10%), whereas you seem to imply that the entire insurance market is like this.

Second, if insurers were able to (or wanted to) separate the sick from the well, then the population that is uninsured should be less healthy than the population that is insured. Yet this is not the case. The health status of the uninsured is very similar to that of the insured. (see bottom of page 1 here:

Really, health insurers would love to serve more of the uninsured because many are young and healthy and consume very little healthcare, but they just don't want to buy insurance (justifiably so).

Posted by: mbp3 | July 30, 2009 11:07 AM | Report abuse

Are you going to retract your quotation of the bogus 428% profit increase? I assume that someone of your high moral and ethical standards would admit their own mistake.

If private insurers are so evil then why does their real profit margin only average to about 3%? If they were really being as unethical as you suggest they would have much higher profit margins.

Did you really just blame the financial crisis on the profit-motive? How did you miss the Government's role in that mess?

So your not opposed to the basic principles of capitalism? That's news to me and most of your leftist readers. You're pretty old school dude.

Posted by: fallsmeadjc | July 30, 2009 11:48 AM | Report abuse

Most health insurers are employed by employers. They cover everyone the employer employs regardless of health status considerations.

The inability to charge risk adjusted individualized premiums to people under these employer contracts inflates the premium prices of people who buy insurance individually. A logical solution would be to pass reforms that separate insurance from employment. The current reform doesn't do that.

Instead it creates a public option that will destroy private insurance and reduce the choices available to consumers. Any real reform would separate health insurance from employment and increase choices for consumers.

We all know you've never taken an intro econ class.

Posted by: fallsmeadjc | July 30, 2009 12:09 PM | Report abuse

fallsmeadjc can you define "real" profit margin? Is that net income after "expenses" (like multimillion payouts to execs, settling claims for cheating policy holders, etc.) And is an average of all insurance companies really a good measure. How about the top 7 or 10 insurance companies that control over 70% of the market? What are their profits? How about the profits for the companies that have over 50% market share in a region? What are their profits?

"Did you really just blame the financial crisis on the profit-motive? How did you miss the Government's role in that mess?"

The government had a huge role in not creating and/or applying regulations on businesses. However, the real point here is that businesses through the creation of super leveraged derivatives created huge amounts of short term paper profits without retaining sufficient capital to pay up when the value of the securities they were in effect insuring lost value. Does there need to be a regulator over every banker's shoulder telling them not to over leverage or should professional bankers know not to do that? It was the pursuit of short term profits without taking into consideration what the long term consequences their actions might cause (ie cascading bank failures, narrowly averted by shoveling hundreds of billions in capital to banks) that triggered the financial crisis. Bankers should know better and should have lost their fortunes and jobs when everything went south. Unfortunately as usual the short term profits were privatized through obscene bonuses and the losses were socialized to the taxpayer.

Posted by: srw3 | July 30, 2009 12:22 PM | Report abuse

fallsmeadjc, Separating insurance from employment would be great. Employer provided insurance was a way to get around wage and price controls during and after WWII. Unfortunately this vestigial system is what we have now and it is hard to wean people off that system to an new more rational, single payer system. Economically and logically it makes sense to get rid of employer based health care. Politically it is a non-starter, because it takes away what people know and replaces it with something they don't know.

Your solution "to charge risk adjusted individualized premiums" is totally bassackwards. The goal is to have the largest risk pools possible so that any individual's premium is low regardless of that individual's health status. Your solution would encourage insurers to make insurance unaffordable to AIDS, cancer, diabetic, and/or disabled persons. It is the essence of cherry picking healthy people to insure and leaving those less healthy on the curb.

Posted by: srw3 | July 30, 2009 12:32 PM | Report abuse

To answer the question posed above: The average profit margin for the 4 largest publicly traded health insurers (aetna, cigna, Wellpoint and UnitedHealth) was 5% after-tax in 2008. The margins for the large non-profit insurers are similar, but a little lower.

It's not a great business. They are certainly not able to produce "windfall" or "excess" profits. Five cents on the dollar is about the same as grocery chains.

Posted by: mbp3 | July 30, 2009 12:42 PM | Report abuse

You've brought out the fact that maximizing profits may have negative consequences for the customers, the employees, the community, and the environment. But there's another hidden aspect to the "profits are wonderful" theme.

Carter says "And profits accrue to the benefit of those who own stocks: overwhelmingly, pension funds and mutual funds." Yes, but if we look at the distribution of wealth in the USA, especially financial (non home ownership) wealth, we get a different perspective. The top 5% of households own 69% of the country's financial wealth. Chances are that when an employee puts in an extra effort so as to "maximize shareholder value", the wealthy will capture the vast majority of the benefit.

Given the very uneven distribution of wealth, corporate profits are not an unalloyed "good thing", even if no gouging of customers or polluting the environment
was involved.

Posted by: mej1 | July 30, 2009 2:29 PM | Report abuse

If healthy people payed lower premiums to health insurance companies they would not be more profitable and cherry picking would be irrelevent. Premiums should reflect risk. Making that consideration illegal inflates the costs of premiums for healthy people.

I don't have a problem with subsidizing the cost of premiums for unhealthy people and poor people via some sort of voucher system or tax credit. That would be infinitely more efficient than creating another waste and fraud prone Government bureaucracy.

Private Health insurance companies still have better approval ratings than Congress.

Posted by: fallsmeadjc | July 30, 2009 4:18 PM | Report abuse

Sadly, we live in a time when the middle-class, which has been experiencing stagnant incomes for many years - the reverse of profit - is becoming unable to support the high cost of profits in certain industries - like oil and health insurance.

Posted by: anne3 | July 30, 2009 4:38 PM | Report abuse

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