What Healthcare Policymakers Can Learn from Other Industries

New study finds valuable lessons from the energy sector.

May 01, 2017

Elizabeth Austin

When federal policymakers sit down to draft health care regulations, it’s useful to have an energy economist in the room – because electric utilities and health insurance companies are more alike than most consumers (and elected officials) might imagine, says University of Chicago economist Steve Cicala.

In a new working paper published by the National Bureau of Economic Research, Cicala, an assistant professor at the University of Chicago Harris School of Public Policy, found that a provision of the Affordable Care Act (also known as Obamacare) resembles a type of regulation that sometimes has been used to set prices for utilities, usually resulting in increased rates. Although this provision of the health care law was aimed at making private health insurance more affordable, it had the similar unintended consequence of raising health care costs.

In the study, Cicala and his co-authors, Ethan M.J. Lieber, an assistant professor at University of Notre Dame, and Victoria Marone, a Ph.D. candidate in economics at Northwestern University, looked at the politically popular “80/20” rule of the Affordable Care Act (ACA). Under the ACA, every health insurance company must meet a minimum Medical Loss Ratio (MLR), defined as the percentage of premiums that is actually spent on consumers’ health care. If an insurer pays less than 80 cents of every premium dollar to health care providers, the ACA requires that insurer to rebate the difference back to consumers. These rebates have provided an annual opportunity to praise the rule’s success, with President Obama remarking in 2013: “Already millions of families have actually received rebates from insurance companies that didn’t spend enough on their health care. So this law means more choice, more competition, lower costs for millions of Americans.”

Limiting insurance companies’ profit margins may sound like a good deal for the insured, Cicala said. But in reality, the regulation created a strong incentive for health insurance companies to overspend; when regulations cap only the percentage of each dollar that companies can keep without managing total expenditure, the companies can simply spend more to protect their profit margins.

Cicala, whose work focuses on the economics of regulation in the energy sector, noticed this problem when he was reading about health care reform. In looking at the MLR limitation, Cicala said, “I recognized it as being very similar to the cost-of-service style regulation I had worked on in the electricity sector.” These types of percentage limits create incentives for “gold-plating” – purposely over-spending on unnecessary or even wasteful capital improvements. “The bigger the capital base that utilities have, the more money they make,” Cicala says.

“The important question lies not so much in more regulation vs. less regulation in health care, but in how firms as well as consumers respond to regulation. I think it’s valuable to apply lessons that we’ve learned in regulating other sectors, so that we avoid repeating mistakes we’ve made in regulating those sectors.”

- Asst. Prof. Steve Cicala, Harris Public Policy

State regulators have systems in place to block this profit-boosting ploy by utilities. “There is a long (if checkered) history of experience of regulators trying to make sure that utilities are working in their customers’ best interests to keep costs down,” said Cicala, whose prior work has evaluated how politics and uncertainty can distort costs for electric utilities under this type of regulation. “Typically, the utility will come to the state utility commissioner and have a rate hearing, which is basically an audit of the utility – looking at expenses, how much they are paying for fuel, what plants they need to build.” The utility commissioner then decides which expenses were prudently incurred and should be passed on to the ratepayers in the form of a rate increase.

“In the electricity sector, at least there is someone to say no,” Cicala said. “The regulator can say, ‘This is an expenditure that is not in the customers’ best interests.’ But in the health insurance industry under the ACA, they get to mark up over every single dollar they spend, whether it makes sense to spend that dollar or not, and insurers get a cut out of that dollar.”

In looking at the experience of MLR regulation under the ACA, Cicala and his coauthors found that in the first year, 2011, health insurance companies that failed to meet the minimum wound up paying their customers more than $1 billion in rebates. Over the next four years, however, the annual rebate amounts dropped dramatically – but not because premiums were reduced to save customers money. Instead, the insurance companies simply increased the amount they paid to hospitals and medical providers until they hit the ACA-mandated minimum.

“To keep health care costs at all reasonable, you have to rely on some adversarial relationship between providers and insurers,” Cicala said. “Effectively, the insurer serves as the middle man, negotiating on customers’ behalf to keep costs low. When you implement this kind of regulation, it weakens the insurer’s incentive to reduce costs.”

While the authors find significant cost increases among those insurers affected by the regulation, Cicala stressed that their study is unable to estimate what would happen if MLR regulations were lifted altogether. “It’s not entirely clear to me that removing this regulation would necessarily make things much better. Health care is complicated,” he said.

The larger issue, he says, is that the MLR miscue demonstrates the value of thinking about regulatory design across divergent sectors of the economy. “The important question lies not so much in more regulation vs. less regulation in health care, but in how firms as well as consumers respond to regulation,” Cicala said. “I think it’s valuable to apply lessons that we’ve learned in regulating other sectors, so that we avoid repeating mistakes we’ve made in regulating those sectors.”