Monday, January 13, 2014

Strong parallels between individual health insurance and Internet service markets

Telecommunications providers, consumers and policymakers should be aware of the strong parallels between wireline residential Internet service and the individual health insurance marketplace as it existed prior to the market reforms of the Patient Protection and Affordable Care Act.
Both residential Internet providers – and formerly individual health insurers -- shared a business model whose success is ironically predicated on not selling to all potential customers in their market areas. The underlying principle is risk aversion: vendors believe they cannot adequately manage the risk of loss associated with an expanded market. A smaller, more certainly profitable customer base is better than a larger one notwithstanding the potential for greater revenues.

Before the Affordable Care Act outlawed the practice starting this month, individual health insurers employed underwriters charged with selecting relatively healthy individuals less likely to incur high medical costs, refusing to offer coverage those who didn’t meet specified underwriting standards. Similarly, wireline residential Internet service providers offer service to one address while declining to serve another nearby – even as close as quarter of a mile away or less. As individual health insurers did, these providers reject the latter residences (as well as some small business sites) as more costly to serve and thus less potentially profitable. Their infrastructures are engineered and built to accommodate preferred addresses and redline the rest.

The problem with this business model for individual health insurers is that medical underwriting limited the size of the pool of individuals and families who could pay premiums to cover claims costs. Consequently, the pool and the number of healthy people staying in it shrank to the point it was on the verge of collapse when the Affordable Care Act was enacted in 2010. The federal law intervened to head off market failure by requiring health plan issuers to sell to anyone applying for coverage regardless of medical history or health condition.

The restrictive marketing practices of Internet service providers bring about a similar problem. Just as insurance pools are more viable with more people in them, telecommunications networks are more valuable when more people are on them or able to get on – both for providers and subscribers. This principle is known as Metcalfe’s Law. Those who argue for broader deployment of fiber to the premise (FTTP) Internet infrastructure carry over the Metcalfe principle to economic activity and education. Greater numbers of premises with modern Internet access can lead to more online commerce and business formation. Increased access to information and educational curricula, similarly, lead to a more informed and better educated society.

As time goes on and these broader benefits – and conversely costs of not having affordable premises Internet access – become more evident, it could lead to large scale market reforms such as are now reshaping the individual health insurance market.

1 comment:

InfoStack said...

Metcalfe's law implies that value at the core of the network grows geometrically and scale economies likewise increase at a geometric rate so that profitability is enormous. We saw this in long-distance in the days of old and we see this in the internet with Google, Amazon, FB, twitter, etc...

The edge of the network sees a linear progression in value and costs. While value increases and scale economies are achieved driving incremental costs down (note Google's fiberhoods) the economics are much different than in the core. Today's communications networks--balkanized into siloed, vertically integrated carriers--do not efficiently translate value from the core to the edge. Nor are costs efficiently shared and scaled. The result is high average costs and a lot of potential demand left unserved; reducing the overall network effect.

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