First it was banks. But too big to fail is coming soon to health care.
This month, UnitedHealth Group Inc. announced it is buying a controlling interest in Amil Participacoes SA, Brazils largest health insurer and hospital operator. UnitedHealth is spending nearly $5 billion to become a large international business at a time when its U.S. operations are coming under more and more regulation.
The events of, and the government response to, the 2008 global financial crisis are giving rise to this business strategy: Grow really big at all costs.
The financial crisis led regulators to start identifying financial institutions that were very important to the whole system and thereby in need of government guarantees when markets freeze up. The dramatic recession that followed the financial crisis led to a similar determination on the part of the government that the auto industry was too important.
Now its time for health insurers to get big. As the Patient Affordable Care Act comes into full force over the next two years, health insurance companies will seek to grow bigger and achieve economies of scale.
There are a number of trends driving U.S. executives to enlarge and diversify their firms. First, regulation such as Sarbanes Oxley discourages smaller firms from growing. Large firms can bear the reporting and compliance requirements more easily. Financial institutions of all sizes face similarly strong compliance costs under the Dodd-Frank Act of 2010, and thus must get bigger.
Government isnt responsible for all forces driving firms to get big. Many of the most promising growth areas for business need large capital investments, such as biotechnology and energy resources. It is expected that only large, geographically diversified firms will be able to raise the needed capital.
However, whenever policy makers see economic-growth opportunities and the resulting new jobs, they like to get in the game. Regulators in New York are doing just that as part of shale oil development in that state. The government thus has an incentive to support the efforts of big businesses over those of smaller businesses.
Economic history and theory predict that in the long run, a get big strategy serves neither the firm nor consumers. The too-big-to-fail problem only gets worse.
Consider first the international diversification strategy like that of UnitedHealth. Economic theory shows that diversification is a good personal investment strategy but a poor business strategy.
It is much easier for shareholders to diversify their investments than for business managers to find good, diversified assets. Managers should only seek investments outside their core competencies if the assets complement existing assets for greater cost efficiencies or better customer service. UnitedHealth has been successful selling insurance plans in Idaho and around the country, but there is no way to know if these skills can be easily transferred elsewhere.
Second, the growth at all cost strategy hurts the consumer, because industries become oligopolistic. An oligopoly is a market structure where only a few sellers offer similar or identical products.
Oligopolists maximize profits by forming cartels and acting like monopolists. You may say that cartels are illegal and this cannot happen. But firms, particularly large businesses, can implicitly act as cartels by not undercutting each others businesses, thereby protecting their turf from further competition.
Like Dodd-Frank for finance, the Patient Affordable Care Act is creating a barrier to entry in the health insurance industry. Only large firms that can handle the many compliance issues will be able to compete, and these same firms will control pricing and be beholden to government regulators.
We are simply creating too many too-big-to-fail businesses.