Obamacare and the importance of customer selection

Obamacare and the importance of customer selectionAetna announced on Tuesday that it will withdraw its Obamacare offering from 11 of 15 states. One problem that insurance companies have with Obamacare is the customer pool:

Insurers have been saying Obamacare customers are, overall, less healthy than the companies need them to be so that the medical costs covered by the plans don’t exceed the premiums the customers pay in each month.

The unique challenge of health insurance

Why? Why might we expect Obamacare customers to be less healthy than other customers?

Obamacare is designed for people who didn’t have health insurance before the Affordable Care Act was passed in 2010. What kind of people didn’t have health insurance before 2010? People with pre-existing health conditions. People without full-time employment. People with full-time employment whose employers didn’t offer health insurance as a benefit.

People with pre-existing health conditions are, by definition, less healthy than people without such conditions. It’s easy to believe that people that are unemployed, or underemployed, are also less healthy than average. For some fraction of this group, health concerns may be part of the cause of their employment struggles.

Obamacare’s challenges are a demonstration of one of the idiosyncrasies of health insurance: the people who need the most insurance are the ones (generally speaking) least capable of paying for it.

Think about car insurance. Who requires the most coverage? Accident-prone drivers, and drivers with very expensive automobiles. Accident-prone may or may not be able to afford higher premiums. People with expensive cars almost certainly can afford higher premiums.

Or think about home insurance. Who requires the most coverage? People with fancy homes, who can presumably pay higher premiums.

That’s not how it works with health insurance. The people that require the most care, i.e. the greatest “service intensity”, and who don’t already have insurance, are the people who are probably least able to pay the necessary premiums.

The importance of defining and targeting market segments

Quickly we get to the reason that Obamacare is a political matter. The market’s resolution is to not supply health insurance to this segment of the market. If, as a community, we decide we want everyone to have health insurance, then we have to reconfigure market dynamics to make that happen.

Still, there is a market-based lesson here. Know what segment of the market you’re targeting. Any viable product or service has a market. Almost all markets can be segmented in some way. For example, look at the automobile market:

  • You have a mainstream segment, with Ford, Honda, Toyota, et cetera.
  • You have a luxury segment, with Cadillac, Infiniti, BMW, et cetera.
  • You have a premium segment, with Bentley, Rolls-Royce, Lamborghini, et cetera.

(If you were really segmenting the automobile market, you’d dive deeper than this. You’d probably pick a class, say four door sedans, and do a thorough price/feature comparison. Different segments would emerge. As a manufacturer, you want to clearly target a certain segment or segments.)

Different businesses will find different segments more or less compelling. If your advantage is built around your low costs, then targeting the low-end, mass market can be lucrative. If your advantage is built around design and technology, then targeting the high-end, niche market can be lucrative.

Once you have a segment in mind, you craft your offer accordingly. You do the best you can to expand that segment, while protecting your competitive advantage or advantages. Then, you find a new segment to target, and start the process over again.

Existence of customers doesn’t guarantee a viable business

With health care, we have a structural problem. The cost of care required by the highest-demand segment (the sick) is greater than the price that segment can pay. In a free market, that segment would not get served. That’s why we’ll likely see some change in, or dismantling of, the Obamacare infrastructure, depending on who has political power.

Even though Obamacare is largely a political issue, it exposes customer selection challenges that all businesses face. One recent example is the failure of food delivery startups. They targeted the customer segment that valued fresh food and insisted on the convenience of home delivery. Two problems emerged:

  1. That segment of customers was too small to support the fixed cost base necessary for a delivery service
  2. Competition drove prices down to the point where margins were no longer acceptable

It’s not a perfect analogy to Obamacare, but there is a connection. Just because there’s a market of people waiting to be served, and there’s an existing business model that fits, doesn’t mean the returns will be acceptable.

The Obamacare case shows that while markets may technically exist, you might not want to serve them. Know what kind of products and services each market segment demands. Know what resources are required to meet those demands. Decide whether employing those resources in that kind of market will yield an acceptable return.

If so, great, you have a growth opportunity. If not, sit it out. That kind of call requires great discipline.

I’ll close with a thought from Warren Buffett, the king of insurance. Here’s an excerpt from his 2015 letter to Berkshire Hathaway shareholders:

Many insurers…simply can’t turn their back on business that is being eagerly written by their competitors. That old line, “The other guy is doing it, so we must as well,” spells trouble in any business, but in none more so than insurance.

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