Do Private Health Insurance Companies Have an Incentive to Reject Claims?

Bryan Caplan argues in this post that a profit maximizing insurance company does not necessarily have an incentive to reject expensive claims, because there is a reputation cost for doing so.

I wouldn't choose an insurer that was known to abuse or abandon its sickest customers. Would you? And why would word of mouth, advertising, and other conduits of reputation be less potent here than in other lines of insurance?

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Insurance companies want a good reputation for taking reasonable care of their customers. However, they can live without a reputation for paying for everything, no matter what. Some companies might want to be known as "generous," and charge their customers correspondingly higher premiums. But most insurers prefer a reputation for decent but cost-conscious care. If that means affordable premiums, customers will happily buy cheap - then complain if their budget insurer makes them wait or tells them no.

Am I saying that health insurance companies never play dirty tricks on their customers? Of course not. It's a big world, lots of bad stuff happens. What I'm saying, rather, is that reputation works well even in industries where firms have big, lumpy liabilities. There are plenty of examples. What reason is there to think that health insurance isn't one of them?

I agree with this completely. The only problem is that the "reputation cost" factor is not as pronounced in health insurance as it is with other types of insurance because we have an employer based system, and as a result, people do not get to choose their health insurance company. By creating our employer based system, the government has interfered with what would otherwise be a healthy free-market check on the abusive practices of insurance companies.

To work toward eliminating the employer based system and putting people back in control of their own health care, see my previous post.