My Cognitive Surplus

CEO Pay: Lessons from Parasitology

Executive pay comes up every year as topic of conversation as we marvel at how the top .1% lives.  One of the obvious points is that there is a disconnect between performance and compensation.  I'm sure this has gone on since the dawn of time, but as numbers get bigger it gets a little more obvious.

My initial reaction was that free markets ought to fix this problem.  And then I realized that I'm making the same mistake so many people make in analyzing evolutionary systems: they assume that the process tends towards some sort of improvement.  In fact, it does no such thing - or to the extent that it does, the improvement is very much in the eye of the beholder.  In the case of CEO pay, parasitology has something to teach us.

Parasites can influence the behavior of host organisms in ways that make them less fit.  The parasites, on the other hand do just fine.  Scientists have looked for evidence of relative fitness that parasites may confer on their hosts and they have come up dry.  In fact, parasites can destroy fitness up to and including killing their host.

Corporations in their modern form have existed for a little over a century, a time during which regulations on corporate governance have been eased fairly consistently.  Corporations can act anywhere, but their charters are regulated by states.  (If you want to understand the concern over the 'race to the bottom' in allowing health insurers to operate in multiple states, the world of corporate charters and regulation is an outstanding cautionary tale.)  The reason that Standard Oil was Standard Oil of New Jersey was not because of petroleum reserves in the Pine Barrens, but because New Jersey was the most open to allowing trusts.  Other innovations in corporate regulation have included staggered terms so that an entire board is not up for replacement at anyone time and a host of other rules which give management significant advantages in dealing with unruly shareholders. These tend to parallel the tools management uses to forestall unionization.

So the management of the company and the owners of the company have competing goals and the management wins. In his book, The Extended Phenotype, Dawkins talks about arms races and posits that the 13- and 17-year locust cycles may have come about to escape a now extinct parasite.  So if there's an arms race, how come the shareholders are losing?  The real issue is that for most shareholders, the impact isn't large enough to get excited enough to do anything about it.  If you're pissed, sell the stock.  For the CEO and his/her cronies, it's big bucks.

The solution?  Two choices, beef up the laws to encourage shareholder democracy or class action suits.  I know which one I'd pick.

How Many Health Insurers Do We Need?

Most industries have an efficient scale.  Based on commonly available technology, management processes and cost of raw materials, a competitive industry will shake out into firms of roughly comparable size.  For some industries, the efficient scale is a significant percentage of the market.  For example there are only so many car companies.  Health insurance companies tend to compete at a state level.  Some of this is driven by the structure of the Blues.

A competitive market of 'price-takers' will produce the most of a product and charge the least.  A monopoly, or price-setter, will produce less of a good and charge the most.  An oligopoly is somewhere in between.

In any event, you're really looking at 50 state sized oligopolies.  Which is probably worse than one national monopoly, certainly worse than a national oligopoly.  I'm guessing that with national competition you would see many fewer firms and a lot more insured people.  Which kind of sucks if you're an insurance executive.

Nobody Really Wants Employer Sponsored Health Insurance

Most employers have no special expertise in managing health care and no compelling reason to develop it as a competitive advantage.  According to the Kaiser Family Foundation, employers pay around 10% of payroll costs to fund health care for employees who get employer-sponsored insurance.  That's a lot of money for something that has nothing to do with your business objectives.

Losing that insurance because you change jobs or the firm elects to stop offering it is a major source of stress to most people.  When asked if they are satisfied with their insurance, 69% say 'yes', but there is an implied 'right now' in the answer.  The better question is "Are you happy getting the insurance you have from your employer, or would you prefer the same insurance at the same cost to you provided by the government?"   I'm guessing the latter would win.  And if you asked the employers if they would be just as happy to be out of the insurance buying business they would probably answer with a resounding 'hell, yeah.'

Private Health Insurace admin costs v. Medicare

Paul Krugman has a couple of good posts on administrative costs for private health care insurers vs. Medicare.

One of his commenters makes the excellent point that denying care from someone who has been paying premiums has an extremely high ROI - you get to bet after you play the hand.  It's not clear to me that that's an incentive you can easily manage out of the system.  Despite laws against discriminating against people once they make a claim, most of the recision abuse has been completely legal.

Also, someone made the point that all groups are underwritten pre-sale, I believe that's true of small groups, but large groups are underwritten after initial sale with some experience factored in going forward.  Large groups tend to benefit from the law of large numbers both prospectively when the insurer does initial pricing, and at renewal time when the averages tend to come through as expected.  Small groups taken together should as well (the idea behind community rating), but insurance companies take the win from healthy groups and claw back from groups in which there has been an illness by upping the rates (which doesn't really sound like insurance).  Overall this another case where the bulk of insurance companies bet is after the hand has been played.