Designing Health Insurance: Politicians vs. the Market

Every health insurance policy purchase represents a compromise between premiums and the amount of financial protection offered. Policies with higher out-of-pocket expenses via higher deductibles or co-pays generally have lower premiums. Pairing low premiums with coverage for even routine health expenses often requires limiting the total amount that the policy will pay to a relatively small amount, say $50,000, rather than the roughly $2 to $5 million that is the current commercial standard for individually purchased policies.

People’s insurance needs depend on their incomes, their assets, their health, and their tolerance for risk. These change throughout a person’s life. Some people need protection against small losses, others can afford larger ones. Some people have very small yearly health costs that they can pay out-of-pocket. They prefer low premiums for plans with large deductibles. Others want certainty. They prefer high premiums for plans that limit their out-of-pocket costs.

Existing evidence suggests that when politicians or their representatives design health insurance, they favor coverage of small expenses even though this increases claims processing overhead and overall costs. To keep premiums low, they often prefer to increase the amount people will have to pay in the event of a catastrophic loss.

The preference for paying for small items even at the expense of unlimited financial exposure makes good sense if you are a politician. [link] More people have small costs than large ones. Only a very tiny fraction of voters is likely to be exposed to the higher losses at any given time, and many of them may soon be dead. By having government health insurance pay for well child exams and routine dental care, a politician can buy more votes than using the same amount of money to cover the catastrophic expenses incurred by people with rare, but extremely expensive diseases.

Medicare is an illustration of government plans that pay for relatively inexpensive items while leaving people exposed to potentially unlimited costs. In 2006, more than 184,000 Medicare beneficiaries had liabilities of $15,000 or more for Medicare covered services.

A good source for data on how much average people spend on health care is the federally run Medical Expenditure Panel Survey.  It shows that most people have reasonably moderate medical expenses. Making them buy insurance for those expenses probably increases costs by adding insurance company overhead for charges that most people could pay out-of-pocket. This increases costs without providing much benefit, a point that those who talk about people with large deductibles as “the underinsured” prefer to ignore.

In 2002, for example, an estimated half of the U.S. population had annual medical expenses that were less than $664. Eighty percent of the population had expenses that were less than $3,219. For those under 65 in 2003, the median health care expense, including dental care, was $817. The median expense for the uninsured was $393.

Furthermore, many of the expenses discussed above are already paid for by health insurance, Medicaid, or another third party payer. The following table shows the amount of health care expense that the insured and uninsured actually pay for out-of-pocket. For good measure, the table also provides information on the 90^th percentile of out-of-pocket costs. Only 10 percent of the population has expenses that are larger than the 90^th percentile expense.

The table shows that 90 percent of the uninsured who paid for medical expenses in 2004 had expenses that were less than $1,872. According to the 2004 Consumer Expenditure Survey, this is roughly the amount that households with one person spent on food eaten away from home, and only a few hundred dollars more than the amount spent on entertainment.

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