Why You Don’t Have Real Health Insurance
David Palmer is the actor I remember best for playing the president of the United States in one of the Jack Bauer “24” series. You probably know him better as a spokesman for Allstate. In one commercial he is standing in front of a town that looks like it has been devastated by a tornado. He begins by saying, “It only took two minutes for this town to be destroyed,” and he ends by saying “Are you in good hands?” Allstate also has a “mayhem” series, featuring all kinds of things that can go wrong.
Allstate isn’t alone. Nationwide has a clever commercial in which catastrophe is caused by a Dennis-the-Menace-type kid. In a State Farm ad, a baseball comes through a living room window. Nationwide’s “life comes at you fast” series features all kinds of misadventures. And of course, the Aflac commercials are all about unexpected misery.
Now here is my question to you: have you ever seen a commercial for health insurance that focused on why you actually need health insurance? That is, have you ever seen a health insurance commercial that told you that you need a really good insurer in case you get cancer, heart disease, AIDS, etc.?
My bet is that you haven’t. In fact, I bet you don’t see many health insurance commercials at all.
Can’t go on,
Everything I had is gone,
Stormy weather.
One place where a lot of people do see health insurance television and print ads, though, is Washington, D.C., in the late fall. This is the period of “open season” when federal employees have the opportunity to choose a new health plan. Once a year, members of the Federal Employee Health Benefits Program (FEHBP) can choose among a dozen or more competing health plans. At this time, participating insurers compete to lure new customers.
Unlike the casualty insurer commercials, however, the health insurance ads for federal employees are never focused on what can go wrong. They are all focused on what can go right. Instead of picturing victims of cancer or heart disease, for example, they show photos of young families with healthy children. The implicit message: if you look like the family in this photo, we want you.
The contrast could not be more stark. Casualty insurers are trying to sell you insurance based on your need for their product. Their implicit message is: we know you don’t think about insurance until something goes wrong, and that’s when you are going to need us. Health insurers, on the other hand, never even talk about why you might actually need their product — unless by “need” you mean services that healthy people want (wellness checkups, preventive care, exercise facilities, etc.).
So what’s going on?
The short answer is: the casualty insurance market is a real market in which real insurance is bought and sold. The health insurance market, by contrast, is an artificial market in which the product being exchanged is not real insurance at all. Instead, it is prepayment for the consumption of health care.
In the casualty market, each buyer pays a premium that reflects the expected cost (and risk) that the buyer brings to the insurance pool he is entering. Insurers compete to sell the insurance features of their product, because that is what buyers are buying. Federal employees, by contrast, never pay a premium that reflects their expected cost. What they are buying is the opportunity to consume care with other people’s money. As a result, health insurers compete to sell the consumption features of their product and they are only interested in selling to people who don’t plan to consume very much!
Why is the federal employee health benefits program so important? Because it is the “managed competition” model for how insurance will be bought and sold in health insurance exchanges under ObamaCare.
Under the model, insurers offer a product and charge a set premium that cannot vary by the buyer’s health status. In the federal system, every buyer is charged the same premium. In the Obama state-based exchanges, premiums will vary somewhat by age — but not enough to reflect the full expected cost differences that aging generates. Also, there will be some “risk adjustment,” under which funds will be redistributed from plans that have healthier populations to plans that have sicker populations. But such risk adjustment is highly imperfect.
Bottom line: As in the federal employees’ program, everyone who buys insurance will face the wrong price from the point of view of pricing risk and expected costs accurately. This will create perverse incentives on both sides of the market.
On the buyer side, those who are undercharged will have on incentive to buy more generous insurance than they otherwise would, while those who are overcharged will buy less generous insurance. Put differently, the undercharged will over-insure and the overcharged will under-insure. These perverse incentives will have the unfortunate side effect of making everyone’s premium higher than it would have been.
Bad as this is, it pales in comparison to the effects of perverse incentives on the seller side. You don’t even have to be in the business to know intuitively that if everyone is charged essentially the same price, insurers will make profit on the healthy (who will be overcharged) and incur losses on the sick (who will be undercharged.)
So the first reaction of the insurers will be to try to attract the healthy and avoid the sick. That’s why we see the kind of ads we see during open season in Washington. And that’s why these differ so starkly from the typical television ads we see sponsored by casualty insurers.
Furthermore, after enrollment the perverse incentives will not end. Health plans will have strong incentives to overprovide to the healthy (to keep the ones they have and attract more) and underprovide to the sick (to discourage the arrival of new ones and the departure of the ones they already have).
As noted in the previous section, the easiest way to overprovide to the healthy is to offer services that healthy people consume: preventive care, wellness programs, free checkups, etc. The way to underprovide to the sick is to strictly follow evidenced-based protocols and be slow to approve expensive new drugs and other therapies.
Beyond that, a health plan can underprovide to the sick and discourage their enrollment by not having the best cardiologist and the best heart treatment centers in the plan’s network, by not having the best oncologists and the best cancer treatment centers in the network, etc.
What has been the experience of the federal employees program? There has been some evidence of backing away from expensive procedures, with the government’s approval. But perverse incentives are held in check somewhat by the Office of Personnel Management (OPM), which operates like a large human relations department. Similarly, where managed competition has been implemented for state employees, for university employees and for employees of large corporations, the employer usually acts to try to prevent the worst abuses.
What would happen, though, if the OPM went away and the FEHBP were opened up to everyone in Washington, D.C., in addition to the federal employees? What I would expect is a big mess — with insurers having perverse incentives to undertreat the sick and with no one there to stop them from acting on those incentives.
Of course, there are countervailing forces: professional ethics, malpractice law, regulatory agencies. But ask yourself this question: Would you want to eat at a restaurant that you know does not want your business? You should think the same way about health plans.
With the advent of ObamaCare, these perverse incentives will be set in place nationwide. Tens of thousands of employees will leave their employer plans and enter no man’s land where the healthy will be desirable and the sick will be vulnerable. Those with serious health problems will find they no longer have an employer who acts as protector and defender. Their problems will be made worse by the inexorable federal pressure on the health plans to keep premiums from rising, so as to contain the expense of the taxpayer-funded premium subsidies.
But, you may ask, won’t federal regulators step in to protect the seriously ill from undertreatment and other abuse? Unfortunately, the government’s incentives to do that will be very weak. More on that in a future Alert.
Good post. One of your best.
I like Lena Horne.
The type of insurance common in American features the worse form of third-party payment. Third-party payment comes with all manner of perverse incentives. Pre-paid medical care is common only because of the tax exclusion for employer-sponsored insurance. It’s amazing what a mess our health care system became almost entirely due to the tax exclusion for employer health insurance.
Why is it wrong for health insurers to “follow evidenced-based protocols and be slow to approve expensive new drugs and other therapies”? Should they pay for services that haven’t been proven to work? Should they cover every new fad drug or therapy the healthcare industry invents, no matter how high the costs or how uncertain the benefits?
Good post,but John, as a long time resident of Texas, you know that the casualty insurance market is not a “real market” here. Insurance companies own the Legislature and most state offcials. What is competive about home and auto insurance rates here? Where do we rank in terms of the costs of auto and home policies in relation to other states?
The other comparison to P&C is the concept of indemnity. The insurer indemnifies the claimant for a loss up to stated limits. Contrast that with healthcare where the insurer pays for services without regard for costs, other than copays and coinsurance.
You make this all so understandable — as a layperson, I appreciate that. Too bad Congress doesn’t see it that way. And what hope do any of us have that this mess will be fixed? Not much.
If we could start all over, a fundamental re-conceptualization of health insurance would be the place to start, taking your observations into account. But we’re not yet in such a revolutionary period. So given the two basic models we have — FEHBP and traditional Medicare — FEHBP wins hands down. And if OPM had really understood what it was doing, it could have made the managed competition model that much better. (which makes me share your concern over the way the Exchanges will operate.)
Best post yet!
Another very important difference between typical P&C coverages and Health Insurance is that a lot of the risk “events” in Health Insurance do not have a true analogy to, say, home owners or auto insurance – it would be like a house that never stops burning and incurring losses continually. This is when a person changes health “status” into some form of ongoing chronic state where the expectation of high ongoing costs does not end. Many health events are, of course, acute, one offs, but many more, and those that drive much of today’s costs, are not – they represent a form of “disabled status.” It would behoove the industry to develop policy format that follows and insures the real “time” needs of medical conditions, probably using as a basis something along the long term disability model, with a trigger to start a disabled “status,” elimination period (either time or dollars or both), followed by a “benefit” status, where payment for treatment continues as long as the disabled status remains. Cost sharing components could be designed for such a product, and it would be especially effective to avoid the policy renewal issues that haunt the group health insurance market place. Current policy formats impose the artificial cut off of 12 month “policy periods” that have nothing to do with the way medical conditions occur or treatment rendered, but allow the insurer to play games every 12 months. Compare with group LTD insurance.
OPM wasn’t helping to control insurer behavior when I was in FEHBP. A lot of plans were offered in the booklet but most of those were HMOs or for union members. PPOs for unaffiliated employees were very limited. In some areas there may not be any choice, a topic that FEHBP boosters prefer to avoid discussing.
In my case, one of the limited possibilities had no out-of-pocket limit. This was explained in very fine print and I thought it was an error. When I checked, the first level of customer service said that there was a limit and that I was, in fact, reading it wrong. It wasn’t until I got to the third level of the customer service hierarchy that they admitted that yes, there was no limit.
Only people used to running Medicare could possibly consider a plan with unlimited losses “insurance.”
Oh, and the nightmare of opening up FEHBP to all comers may come true in states that have opted to let the feds run their exchanges. The ObamaCare pre-existing condition pool was, at least in one case, planning to enroll people in one of the FEHBP insurers. Why not use the FEHBP for the federally run exchanges, too? How else will the feds construct a set of subsidized policies by 2014?
John,
After all these years, you still don’t understand the Federal Employees Health Benefits Program. This post has too many errors to warrant comment. I give up!
@HD Carroll: What you are describing has was designed and proposed very clearly by John Cochrane of the University of Chicago way back in 1995, under the term “health status insurance” (http://faculty.chicagobooth.edu/john.cochrane/research/papers/Cochrane%20time%20consistent%20health%20insurance%20JPE.pdf).
Why no significant change since 1995? Political, bureaucratic, and social inertia. The “industry” cannot develop these products under the status quo because annual contracts are all that can really be developed under employer-monopoly health benefits.
If individuals owned their own insurance, decentralized decision-making would result in an equilibrium whereby carriers would incentivize some preventive care, but not all preventive care. The equilibrium would evolve as new therapies and procedures are introduced.
Jim Morrison, I for one would be interested in hearing your critique. I hope you will weigh in.
John,
Do you remember in 60s. when insurance companies said they were not interested in health or medical care insurance. It was seen as a way to secure insurance buyers for other insurance policies. It was merely a way in the door.
Is insurance a ponzis scheme? Silly question?
New books on how american or world capitalism works – Collins.. Handbook or Guidebook for Dictators. He compares how corporation operates like a dictatorship and how the our two parties in USA are a vaiation of the model. Good read perhaps. USA divided in congressal area.. where there in less competition for reelections. much like a board of most corporations.. .
How lower worker in corporation get less pensions, poor health benefits, poorer health care plans, etc while the upper management .. banker bonuses.. are much like Cuba, Russia, Mexico. They all take care to pay off their small circle.of supporters.
Stan
One of your better posts, Dr. Goodman. And I HAVE asked myself the question, Would I want to eat at a restaurant that I know does not want my business? It strikes me as obvious that there is an inherent conflict of interest between the main business objective of a for-profit health insurer, and its fiduciary duty to its enrollees to provide access to care. Can’t make a profit if you enroll too many sick people. And the problem with Medicare as a viable insurance product is that the 80:20 low-cost:high-cost ratio isn’t there – almost all of the Medicare beneficiaries are sick. So why not expand the risk pool to include EVERYONE in Medicare?
I’ve been asked to elaborate on my earlier comment, which pertained solely to the federal employees Health Benefits Progra.(FEHBP) John’s post contained two statements (among others) that illustrate his lack of understanding of the Federal Employees Health Benefits Program:
(1)”Implicit message– If you look like the family in this photo, we want you”
(2) “Federal employees, by contrast, never pay a premium that reflects their expected costs. What they are buying is the opportunity to consume care with other people’s money”
The first statement attempts to make the point that FEHBP health plans solicit, by ads (and otherwise) only the healthy, young employees. The fact is, since the beginning of the FEHBP in 1960, exclusions for pre-existing conditions,health status, or any form of individual underwriting, has been prohibited by law. And profit is severely restricted. The operative dynamic among FEHBP health plans is to compete for EVERY enrollee, regardless of health status.
The second statement about FEHBP premiums is just flat-out wrong, without any evidence. Some federal employees are enrolled in HMOs with geographically appropiate rates and some are enrolled in national plans with national rates. Actuarial standards, expected costs and financial solvency are major factors in determining premiums.
Jim,
On your second point, that has always bothered me about FEHBP. HMOs may charge geographically appropriate rates but FFS may not. So federal workers in Lincoln, Nebraska pay the exact same FFS premium as those in New York City even though health care costs are far lower in Lincoln. That gives HMOs a big advantage in low cost areas.
On the first point, if healthy enrollees are charged the same as sicker ones I don’t see how plans could help but prefer the former. I don’t know if they do anything to explicitly attract the healthy ones, but the incentive is clearly there.