Ideoblog

State competition for health insurance

Last week the Wall Street Journal suggested state competition as a possible alternative to the public option for reducing health care costs. The Journal quoted a recent exchange between the AARP's John Rother and Fox's Chris Wallace.

Mr. Wallace: "If you really want competition why not remove the restriction which now says that if I live in Washington, D.C. I've got to buy a D.C. health plan, and instead create a national market for health insurance, so that if there's a cheaper plan in Pennsylvania, I could buy in Pennsylvania?"

Mr. Rother: "There are states and localities where health care is much less expensive than others, and if we allow people to buy all their insurance from those places, it will raise the rates there. And it's called risk selection. It's a real problem, given the fact that health care costs can vary substantially from one place to another. So I think while the idea sounds appealing, the consequence would be it would make health care more expensive for those people who live in those low-cost areas."

The Journal responded to Rother that the high price of NJ insurance comes from NJ regulation. State competition would mitigate these regulatory costs and let consumers decide what they want to pay for. Arizona Rep. Shadegg, who initially proposed this idea in 2005, would protect high risk insureds with government funded risk pools. Rother's "risk selection" problem would be addressed by eliminating mandates that cause healthy people to opt out of health insurance.

The article concluded:

Interstate competition made the U.S. one of the world's most efficient, consumer driven markets. But health insurance is a glaring exception. When the competition caucus in Team Obama has to look for Plan B, this is it.

A letter to the WSJ published today responds:

That solution is unworkable. It would require enacting legislation repealing or modifying the McCarran-Ferguson Act, which allows states to regulate the "business of insurance"—a daunting task that would depend on overcoming the objections of those who champion states' rights, among others.

Yes, that's true – the solution would require dealing with McCarran-Ferguson. But that doesn't lead inexorably to federal regulation. Henry Butler and I have proposed in a working paper and shorter version in last winter's Regulation how to reform insurance regulation so as to get to state competition for insurance. Here's the abstract for the longer paper:

State regulation of insurance companies has been criticized for many years because of the burden imposed on insurers by having to comply with the laws of many jurisdictions. These higher costs are passed on to consumers. The problems with the current regulatory structure are prompting calls for increased federal regulation of insurance. However, all proposals to federalize insurance regulation create opportunities for abuse at the hands of the federal government and fail to utilize the benefits of a federal system. This article shows how many of the problems of the current system can be addressed without resorting to a large scale intrusion of federal regulators into insurance markets. The proposed solution calls for minimal federal intervention to provide for jurisdictional competition between states that would be allowed to charter insurers that could operate nationally with only the single license granted by the charter. This single-license approach addresses the most salient concerns of proponents of federal optional chartering. It also has the potential for triggering competition and innovation in insurance products and rates while preserving a meaningful role for state regulation.

Note that we don't propose to eliminate individual states' power to regulate the sale of insurance in their states, but rather to set ground rules on how states regulate. The goal is to balance states' power to regulate against the significant benefits of creating state competition and a national market.

Although our proposal does not deal with health insurance, its underlying reasoning applies in this context. It would be necessary to decide what states should be able to mandate in their states – in other words, to set federal maximum standards for state regulation. And even if states do retain some regulatory power, our proposal would emphasize competition and tend to erode inefficient regulation over time.

The issues are not simple. But our proposal provides a template for thinking through them that is more promising than any other approach out there.

Rise of the Uncorporation: Chapter 1

Chapter 1 of my book, Rise of the Uncorporation, is now available on SSRN. The book is expected out from Oxford University Press in about two months. Here's the abstract:

The analysis of business associations largely has been limited to corporations. Yet unincorporated firms, including general and limited partnerships and limited liability companies, comprise about a third of the firms in the US, and even larger percentages elsewhere in the world. The Rise of the Uncorporation covers the history, law, and finance of unincorporated firms. These "uncorporations" are now the dominant business form for non-publicly-traded firms. Moreover, through private equity, hedge funds, and publicly traded partnerships, uncorporations have emerged as a significant force in the governance of a wide range of large firms. The Rise of the Uncorporation is the first general theoretical and practical overview of the alternatives to incorporation. The book seeks to bring uncorporations into popular and academic debates that have previously focused only on corporations. This book also covers the ancillary concepts connected with the evolution of these uncorporations, and analyzes likely future trends in business organization.

The second coming of Hank Greenberg

More than four years ago Eliot Spitzer was responsible for Hank Greenberg's departure from AIG. As I said In August 2005, reporting on the decline in AIG's stock price since then, "history will probably demonstrate that AIG was better off with him in charge, or trusting to corporate governance processes to replace him, than with Spitzer's political maneuvering."

I followed up here, and more recently suggested that Spitzer's improvident action may have helped trigger AIG's collapse, which figured prominently in the crash.

Today we learn via Dealbook:

Shares of the troubled insurance giant American International Group soared Thursday following a report that its new chief executive, Robert H. Benmosche, had sought a reconciliation with his estranged longtime predecessor, Maurice R. Greenberg. * * *Bill Bergman, a senior analyst at Morningstar, attributed Thursday's gains in the stock to "the notion that there's a reconciliation under way between Greenberg and the company." Mr. Bergman told Reuters that Mr. Greenberg could help attract new private capital investment to the company.

The rough beast of proxy access slouches toward Washington

Unfortunately, its hour seems to be come at last. Its opponents lack conviction (or at least votes), while its supporters (e.g., labor unions) are full of passionate intensity.

According to today's WSJ, "the measure [Rule 14a-11] looks like it will be passed by the Securities and Exchange Commission in November." It will allow mere 1% stockholders to put director candidates into corporate proxy materials, at the company's expense. SEC Chair Schapiro, who evidently holds the deciding vote with the Democrats and Republicans split 2-2, thinks this will bring more accountability, in the wake of the financial crisis.

John Carney once again disagrees:

Far from increasing the power of ordinary investors the move would have left them vulnerable to exploitation by special interests, especially union dominated pension funds. Shareholders don't really have an interest in companies being more democratic. * * * Proxy access dresses itself in the name of shareholder rights but it is really inimical to shareholder interests

I would add, as I said a couple of years ago:

the reason why the SEC should keep its hands-off here has more to do with the appropriate limits of SEC power than with the substance of the proposal. This is a matter of internal corporate governance which should be for the states. There is no justification for making this a federal matter unless you buy in to the shareholder democracy myth.

But there's hope. We saw when listings fled to London and elsewhere to escape SOX that even the federal government faces competition.

Moreover, these rules necessarily apply most directly to corporations. How do you regulate proxy access in uncorporations that don't have boards and don't have proxies? At some point tinkering with corporate governance will get so expensive that competitive capital markets and creative lawyers will find and exploit contractual alternative. The great thing is that these moves to the uncorporation could increase rather than decrease accountability. All this is laid out in The Rise of the Uncorporation, my book forthcoming from Oxford U Press in a couple of months.

So the headlong move to mess with corporate governance could have some positive effects. Things will fall apart, the center not hold, and anarchy will be loosed upon the world. I hope.

The death of hourly billing

The WSJ has an interesting article on the state of the billable hour. It confirms what most people suspect – it's declining – but has some notable details.

The article notes that clients spent $13.1 billion this year on alternative billing, vs. $8.6 billion last year, with a reported average cost savings of 15%.

The article suggests it's the current economy. The chairman of the Association of Corporate Counsel says "[l]aw firms are more receptive to change because they are in the business of needing legal work." Saul Ewing's managing partner says "[j]ust like the tech and housing bubbles, there was a legal-profession bubble, and now we are experiencing a correction."

But the decline of the billable hour is not just about the recession. After all, if demand goes down you cut your prices, meaning in this case hourly rates. But clients are demanding a change in the pricing method, away from the billable hour.

The billable hour has worked well for law firms. They just count lawyer hours and slap a profit on them. Historically, clients haven't been in a position to question that profit, because they haven't had a better way to control costs. But now with beefed up in house counsel offices, increased sophistication about what lawyers do, and competition from outsourcers, among others, clients are in that position, and there's no reason to think they'll revert to old practices when the economy improves.

The article suggests some implications for the lawyer market:

• Orrick "is employing some college graduates who can perform routine tasks at a lower cost."
• Orrick is "focusing less exclusively on hiring graduates from elite law schools, who can command starting pay of $160,000."
• A Sidley Austin partner told the reporters that Pfizer's switch from hourly to fixed fees meant they could assign more efficient senior associates rather than having to use juniors because Pfizer restricted hourly rates to no higher than those of second-year associates.

Doesn't sound too good for the entry level lawyer market.

How far will this go? According to the article, "[a]ttorneys say it is doubtful flat fees could ever supplant hourly billing for the most complicated and high-stakes matters, such as an antitrust fight with the government or a particularly tricky corporate merger, where it's too hard to estimate how much effort it will consume." But we're in early days for alternative billing. Certainly aspects of even the most complex litigation can be charged on a fixed basis, perhaps with bonuses.

The implications for Big Law are substantial. Fixed fee and other alternative billing make legal work more like a commodity and less like a specialized one-on-one service.

Even more importantly, hourly billing has been Big Law's profit engine for decades. If it ends, Big Law will have to adapt or give way to new kinds of firms.

What kinds of firms? I'm working on a paper tentatively titled "The Death of Big Law." Watch this space.

Time for a federal snow commission?

Snow resorts lie about snow, according to Zinman and Zitzewitz, Snowed: Deceptive Advertising by Ski Resorts. Here's the abstract:

Casual empiricism suggests that deceptive advertising is prevalent, and several classes of theories explore its causes and consequences. We provide some unusually sharp empirical evidence on the extent, mechanics, and dynamics of deceptive advertising. Ski resorts self-report 23 percent more snowfall on weekends; there is no such weekend effect in government precipitation data. Resorts that plausibly reap greater benefits from exaggerating do it more. We find little evidence that competition restrains or encourages exaggeration. Near the end of our sample period, we observe a shock to the information environment: a new iPhone application feature makes it easier for skiers to comment on resort ski conditions in real time. Exaggeration falls sharply, especially at resorts where iPhones can get reception.

The authors suggest that this is just one example of how "deceptive advertising can prevail when consumer search or switching costs are high."

Fortunately these conditions don't prevail in liquid securities markets, where many devices serve the purpose of the iPhone app in reporting on ski conditions. So maybe the SEC's efforts can be redirected.

Elois and Morlocks

The juxtaposition here is great.

Yesterday the WSJ Law Blog asked What Can Law Firms Do To Make Everyone Happy? A: Read This. What ensued was a discussion of Larry Cunningham's suggestion on Concurring Opinions that law firms offer partner sabbaticals. Cunningham says:

Firms adopting such policies would instantly win the affection of the many younger associates now concerned, by associate-targeted firm policies, about their own job prospects and security. * * * Instead of running a firm like a business, riveted only on bottom line and promoting cut-throat cultures, the practice of law could return to its erstwhile professionalism, characterized by thoughtful advice to clients, service to the public weal, collegial support among firm members, and cultivation and training of the next generation's legal professionals.

At around the same time, Above the Law had a post about contract attorneys, with quotes from Big Debts Small Law about a piece of the real world of modern law practice. I've been discussing the bigger picture in my Lawyers archive.

I wonder whether Cunningham's suggestion doesn't fit at all in the real future of Big Law, or whether the future will be H.G. Wells's bifurcated world.

Methodist ministers are paid like CEOs

So says David Yermack in Is a Higher Calling Enough? Incentive Compensation in the Church. Here's the abstract:

We study the compensation and productivity of more than 2,000 Methodist ministers in a 43-year panel data set. The church appears to use pay-for-performance incentives for its clergy, as their compensation follows a sharing rule by which pastors receive approximately 3 percent of the incremental revenue from membership increases. The elasticity between ministers pay and parish size is similar to the firm size elasticity of compensation for public company CEOs. Among a range of possible performance measures, those with the greatest informativeness about pastoral effort are linked most closely to compensation.

Studies on backdating and "say on pay" to follow.

Michigan State Business Law and Narrative Conference

Here are details with complete links for this conference to be held September 10-11 at the MSU College of Law.

The lineup starts with my keynote address on September 10, now titled "How movies created the financial crisis." The next day are talks by, among many others, Geoff Miller, David Skeel, Frank Partnoy (lunch talk on his book, The Match King), Lyman Johnson, Don Langevoort, and my colleague, Christine Hurt, all organized by Mae Kuykendall.

More later!

Backdating prosecution bites the dust

It's ironic, as the WSJ Law Blog notes, that on a day that the WSJ chose to revisit backdating with a story implying that not enough is being done about it (see my earlier post), the key backdating prosecution of Greg Reyes, former Brocade CEO, the case that was the veritable criminal law poster child of backdating, the vindication of the WSJ's Pulitzer-hounding on this subject, has been reversed.

I've been covering this case, e.g. here and here, as part of my effort to highlight the ambiguities inherent in prosecuting backdating, and therefore why these cases are inappropriate for criminal treatment.

Although the case could have gone down on a number of grounds, e.g., materiality, the court chose to focus on the prosecutorial misconduct of "culpably" misrepresenting the state of the evidence during closing argument.

As the Ninth Circuit opinion emphasizes, this was no minor technicality:

At trial, an issue as to Reyes' criminal state of mind was whether Reyes knew the corporate records falsely stated the company's financial condition by under-reporting the company's expenses. Reyes' defense was that he thought the transactions were properly accounted for, in reliance on the Finance Department's expertise to comply with accounting principles and SEC regulations. The government, however, argued that the Finance Department was unaware of the backdating, and thus powerless to get the accounting right. A key question therefore became whether the Finance Department knew that the backdating scheme was taking place.

And this is a central problem with backdating cases generally: should the CEOs, unschooled in accounting technicalities, be held criminally responsible for the way compensation was set forth on the company's books? This is why, for example, it has been so difficult to distinguish Reyes from Steve Jobs, who unlike Reyes benefited from the Apple backdating. Why should the CEO be held criminally responsible for the way the company's experts were handling the accounting?

Well, there was lots of evidence that responsible people in the Brocade Finance Department did know. Yet, as the court said

the prosecutor asserted to the jury in closing that the entire Finance Department did not know about the backdating, and further that the government's theory of the case was that "finance did not know anything." "Our theory is that those people didn't know anything . . . . Elizabeth Moore says finance didn't know. Did you need everybody in the finance department to come and tell you that they didn't know?" The government even displayed for the jury a diagram explaining the prosecutor's position that the Finance Department did not know of the backdating. The prosecutor asked the jury to assume other employees of the Finance Department would testify that they did not know about Reyes' backdating procedure when the prosecutor knew they did. * * *

The record demonstrates that the prosecution argued to the jury material facts that the prosecution knew were false, or at the very least had strong reason to doubt.* *

Moreover, these facts were critical:

Although the government's case was relatively strong, the jury took seven days to deliberate, and the case was complex and technical. Moreover, the prosecutor's statements were particularly prejudicial given that Reyes' defense rested on his delegating his responsibilities to others and reliance on them. At the end there was considerable focus on the issue of what the Finance Department knew. The prosecutor's false statements went directly to this issue. Moreover, the statements were made during closing arguments, both orally and visually, and closing statements from the prosecution "matter a great deal." * * * Deliberate false statements by those privileged to represent the United States harm the trial process and the integrity of our prosecutorial system. We do not lightly tolerate a prosecutor asserting as a fact to the jury something known to be untrue or, at the very least, that the prosecution had very strong reason to doubt. * * *There is no reason to tolerate such misconduct here.

The court nevertheless refused to dismiss the indictment. Now the government has to decide whether to spend millions more to retry this case. Doing so would be incredibly irresponsible. How could the government justify a retrial of a case that, in the court's view, rested so fundamentally on the prosecutor's lie to the jury?

This case illustrates not only a central legal ambiguity in backdating cases, but the extent to which corporate crime cases have been marred by excessive prosecutorial zeal. This botched case crowns the illegitimacy of the whole fiasco of criminalizing backdating.

Update: Business Week's Peter Burrows, whose coverage of this case has been on target from the beginning, has similar sentiments.