Henry Hazlitt, in his 1946 book "Economics in One Lesson", began his treatise with what he called the "broken window fallacy". It is perhaps the central fallacy in all mainstream economics. It begins with a baker who has his window broken by a hoodlum. People congregate around the broken glass, thinking maybe this is a good thing. After all, now some glazier will have more income after fixing the window. He can use that income to, say, buy a new suit, a suit he would not have otherwise been able to afford. Destruction, therefore, equals progress.
The fallacy is inherent in looking at what Hazlitt calls the "seen" and ignoring the "unseen". What is seen is the glazier's new suit. What is unseen is the damage to the baker. Now he has to spend money fixing his window, money he would have otherwise spent on his own new suit. But now he has to use that money to fix his window.
Destruction did not bring about progress. It simply redistributed goods from the baker to the glazier. The difference then between the economy of a broken window and one without it is not the suit, but rather who gets it. But it doesn't stop there. The chain of the unseen continues throughout the economy. Perhaps the glazier would have spent his time making more glass instead of fixing the baker's window, upping the supply of glass and lowering the price for consumers. In the economy of the broken window, everyone but the glazier ends up just a little bit poorer.
What does this have to do with long-term care [LTC] insurance? That industry is infected with the same fallacy, but to such an extreme point that the industry is actually vanishing. In the last five years, 10 of the top 20 LTC insurers have bowed out of the market. The latest is Prudential (NYSE:PRU), which as of March 30th will no longer be selling policies. This follows in the footsteps of Unum Group (NYSE:UNM) which stopped selling employer-based coverage in February, and MetLife (NYSE:MET) which shut down coverage in 2010. One of the US's largest providers of long-term care insurance, Genworth (NYSE:GNW), nearly dropped out last year.
At first glance this makes no sense. Why would any company withdraw a service from a sector of the market where demand keeps climbing? The answer is the broken window. But not just any broken window. This is a really big window, it's really broken, and it's stuck in a positive feedback loop of ever more brokenness. That needs explanation.
The Very Broken LTC Insurance Window
The woes of the health insurance industry began during World War II, the mother of all broken windows on planet Earth. The federal government, ignoring the unseen, set price and wage controls on employers in an attempt to combat wartime inflation, inflation being the seen. The unseen was that employers could not attract workers because of these price controls. But the government did not include insurance benefits in its definition of wages. As a result, employers enticed workers by offering lavish health insurance benefits to compensate for the illegality of simply upping their wages.
This was exacerbated when, post war, the government exempted insurance coverage from taxable corporate income, encouraging employers to cover their workers even more and get into a lower tax bracket. Then came Medicare and Medicaid, covering even more people, and most recently Obamacare, supposedly covering everyone.
The seen in the health insurance industry of course is that more and more people have health insurance. The government touts this as an achievement. But it is not, because it causes the unseen. That is, in the causal sense, that insurance premiums keep rising precisely because of mandated coverage.
If we think about it logically, people with insurance don't care how much medical care costs, so cost keeps going up. People who don't even pay for their insurance directly, like employer-based policies, care even less, so hospitals and care centers can basically charge whatever they feel like. So what stops them from literally charging whatever they feel like? The answer, and this is the key, is again, government.
In such a manipulated market, government policies box insurance companies in on all sides. One intervention encouraging or mandating coverage ups demand, which ups price, which government then has to control on the other side. There is only so far this can go before companies simply start dropping out, and this is what is now happening. Genworth nearly did drop out of the LTC market because regulators have made it illegal to adjust cost to profitable rates for the company. It's the World War II wage and price controls all over again.
The positive feedback loop comes in the fact that the more government encourages or outright forces insurance coverage, the higher the costs of that coverage becomes. The end of this feedback loop will occur when insurance companies just completely drop out of the market. In the most extreme of cases, if theoretically nobody has insurance, long-term care providers would have to compete on the free market and drastically lower price in order to attract customers.
Why Long-Term Care Insurance Specifically is in Trouble
Of all the different segments of the health insurance industry, why are companies dropping out of specifically long-term care? The answer is that this is where the most government regulation is. Medicaid is the primary payer of long-term care in the US, and at $357B just in 2011, long-term care is one of the largest segments of the broader health care market.
Adding to the problem is that long-term care is just that - very long term, and therefore very expensive inherently. For that reason government is even more politically motivated to cap costs, essentially pushing companies out of the market who cannot profit at the price control level. Government may try to make bowing out of the long-term care market illegal, but that would be too eerily like Atlas Shrugged for Americans to accept politically.
Alzheimer's Blood Tests could be the straw that breaks the camel's back
Which brings us to the latest development that may push even more companies out of the LTC insurance market - Alzheimer's blood tests. The effects will be fascinating. If the trend of insurance companies dropping out of the LTC market continues, there could be no one left, eventually. In such a case, the LTC market will return to free market conditions without insurance, and long-term care companies will have to compete and start to drastically lower prices.
How are Alzheimer's blood tests involved? About 12% of the US population is over 70, and about 13.9% of people aged 71 and over in the United States have Alzheimer's disease or other types of similar dementia. That puts the total Alzheimer's/dementia population at around 5 million, nearly all of whom need long-term care at some point. According to the CDC, 8,357,100 people were clients of long-term care facilities in 2012 (page 38, previous link). This puts Alzheimer's/dementia at roughly 60% of the long-term care market. (I am piecing these numbers together from different sources, to it is not exact. The general idea is that it is a very large portion of the market, if not the largest.)
On March 26, Howard Gleckman at Forbes wrote a compelling piece on how an Alzheimer's blood test currently in development at Georgetown University could dramatically increase LTC insurance premiums over and above current rates. Companies are prohibited from demanding the results of certain medical tests (more government intervention) but even so, the mere fact of the existence of such a test would have companies assume that those who apply for LTC care coverage have tested positive, are therefore applying, and raise premiums accordingly. They may also assume that those who test negative will not apply for LTC coverage in the same numbers, and they'd probably be right. If the government does not let insurance companies raise premiums if and when these tests become available, many more insurance companies may simply leave the LTC market.
Don't forget Amarantus's (OTCQX:AMBS) LymPro Alzheimer's blood test
Gleckman mentions the blood test being developed at Georgetown probably because it was featured on CNN back on March 9 and has made the media rounds from there. The test involves a group of blood lipids found in Alzheimer's patients but not in healthy patients. It reportedly has a 90% accuracy rating for predicting if a patient will develop Alzheimer's within 2 to 3 years.
What Gleckman neglected to mention is Amarantus's LymPro Alzheimer's diagnostic , which tests the blood for the ability to shut down premature cell mitosis. Amarantus theorizes that Alzheimer's patients' brain cells for some reason enter the cell division cycle, which nerve cells are not normally supposed to do, causing them to die and the area to be gunked up with amyloid plaque. LymPro tests for this by coaxing blood cells to divide prematurely with mitogenic (cell-division-inducing) compounds. If the body turns off the premature cell division with a biomarker called CD69, then that is a sign of a healthy patient. But if CD69 is not elevated after mitogens are injected, the blood cells then divide, signaling Alzheimer's. The test reportedly has an accuracy level of about 92% (page 14).
It is impossible to know which test will ultimately succeed, maybe both, but one thing is for certain: Amarantus is way ahead of Georgetown in the race to approval. Pilot results for LymPro are due any time now, and a 250 patient registrational trial is due for CLIA review by mid-year.
In my last piece on Amarantus, I postulated that the stock had reached an intermediate top after the Super Bowl related attention it got. It was then at $.09. It is now at $.07. I believe the intermediate dip is over, because at some point soon, I expect the main stream media to pick up on LymPro as it has on the Georgetown Alzheimer's test. AMBS shares could react very strongly to any mainstream media attention leading up to CLIA approval of LymPro.
But of much broader consequence beyond AMBS shareholders is what will happen to LTC insurance costs if this test raises premiums and forces even more companies out as Howard Gleckman argues might happen. Could we finally see what a free market (or at least freer) in direct long-term care sans heavily regulated insurance companies looks like?
I anxiously wait.
Disclosure: I am long AMBS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.