How Should Health Insurance be Priced?

USA Today devoted a lengthy article this week to whether health insurance premiums should vary by age (to reflect, say, that 60-year-olds cost five times as much to insure as 20-year-olds). This is also the week’s question at the National Journal health blog:

But why be so narrow?  Let’s ask a much broader question: Suppose you could pay any premium you like for health insurance. What premium would you select?

  • Would you choose to pay the fair market price (reflecting the expected addition to total cost of adding you to an insurance pool), guaranteeing that insurers would vigorously compete for your business?
  • Or, would you choose a much lower premium, guaranteeing that no insurer would want you?
  • Or, would you choose a really, really low premium, guaranteeing that insurers really, really would not want you?

In thinking about this problem, it may be helpful to think about other products and services — since IQs tend to fall about 15 points whenever people start thinking about health care.

If you could pay any price you like for dinner at a restaurant, what price would you select?


Looking for love
in all the wrong places….

Price controls for restaurants. Suppose there were a law requiring every restaurant to charge you half-price for everything you eat? Initially you might revel in your good fortune. Then reality would set in.

Soon you would find the wait to get a table growing longer and longer. Once seated, you would observe you are the last person in the room to be served. The bread in your bread basket would appear staler than at other tables. The vegetables less fresh. The meat a bit moldy. I could go on, but this is a family publication.

There is only one equilibrium in this scenario: quality would deteriorate until the cost of your meals were equal to the half-price fare you are paying.

Before long you would begin to realize this law is doing you no favors. Eventually, you would seek the law’s repeal. You would relish the right to be able to pay market prices so that restaurants would compete to satisfy your needs.

Price controls for health insurance. Now if you agree with my analysis for restaurants, why would you expect health care to be any different?

For the Obama Administration the raison d’être for health care reform has morphed into the goal of charging people with pre-existing conditions the same premium that is charged to the healthy. I have written before about everything that goes wrong when entry-level premiums do not reflect expected health care costs. The new thought today is that price controls harm the very people they are designed to help.

If you have a chronic illness (diabetes, asthma, heart disease, cancer, AIDS, etc.), the best of all possible worlds is a world in which you are empowered to pay the full expected cost of your care. In such a world new, competitive, entrepreneurial markets would develop in which providers vigorously compete to satisfy your needs.

How can that be possible? Five reforms are needed and I will address them in a future Health Alert.

For the time being I hope I have at least convinced you that you do not want to be in a public plan that pays providers 30% less than what everyone else pays.

Comments (28)

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  1. Ken says:

    This is very clever. It’s something most health policy wonks never think about.

  2. John says:

    The point of this post is clear, but to me at least, it isn’t new. My doctor, who is excellent, doesn’t take Medicare patients because he doesn’t get adequately reimbursed for the time and care he gives – e.g., he loses money.

    But I also think that it is fundamentally unfair to require that someone who has a pre-existing condition through no fault of their own to pay lots more money for health care insurance.

    I DO very much think that those who have a pre-existing condition, or a nascent one, because of their own bad habits SHOULD pay more, just like bad drivers pay more for auto insurance. If you are a current smoker, you pay lots more. If you have quit smoking, you get rewarded with lower premiums. Hopefully there is a blood test to see if you are a smoker.

    If you are an alcoholic, you pay more.

    If you are very obese, you pay more. If you lose weight, your premium goes down.

    I understand that there are slippery slope arguments her. 300 pound people will argue that they are fat because of genetics. My argument will be that when I grew up in the 50s and 60s, I never saw an adult waddling down the street.

  3. Linda Gorman says:

    A related question is whether, if you want to improve the lot of people who can’t dine out, the goal of subsidizing people should be achieved by price controls (requiring that all dinners be the same price) or by direct subsidy (you give money to people who can’t afford to eat out so they can afford to do so at some level).

    I know which I’d pick if I were going out to dinner.

  4. Juan O. says:

    In my experience, the same thing goes for other types of insurance.

    If I take up skydiving as a hobby, my life insurance premiums would go up.

    Thinking about installing a trampoline in the back yard for the kids? Check with your homeowners insurance agent on those prices.

    If I sold my old pickup truck and bought a new Corvette (red, convertible, turbo charged), I suspect my automobile insurance rates would go up too. Luckily I live in a state with automated speed camera tickets mailed right to me.

  5. Larry says:

    Your analysis is particularly true if you end up with the virtual elimination of private insurance. Today, providers pass off incremental costs to private insurance to subsidize the reimbursement from Medicare and Medicaid. They can then afford to provide equivalent care.

    If there is no private plan then the public plan will have no choice but to provide less for less reimbursement.

    This leads to an additional point — why private plans will cease to exist (if they don’t exist, I guess you can’t keep what you have). As more and more people move to a public plan, the ability to shift the cost to the private plans will diminish as they will become more and more expensive to a point where plan sponsors will stop offering them or pass so much of the cost to participants that those participants will choose the public plan (they won’t want to keep what they have). Follow this and other delivery issues at

  6. Joe S. says:

    What’s at issue here is whether we are going to allow a real market for risk. In a real market, risk is priced accurately. When it is not, people face perverse incentives and they engage in perverse behavior.

  7. George says:

    Dear John,
    Re: your “through no fault of their own” contention.
    Consensus is emerging that the outcomes of disease have four major causal components: 40% personal behaviors, 30% genetics, 20% environment, and 10% medical interventions. Which of these components are unfair, in the sense that other parties should bear the responsibility (which I take to be your meaning)?

  8. Jennifer Siefert says:

    I agree that insurance companies should be able to charge a higher premium for people with pre-existing conditions. However, is it okay for insurance companies to flat-out deny coverage to those people?

    I do not think a government-run option that underpays providers is the solution. However, I think states need to provide guaranteed issue policies to any individual leaving creditable coverage such as an employer’s group health plan. Sure, charge more premium if the person is not a good risk. But if someone had heart surgery or another serious condition years ago and has taken good care of themselves since then, it does not seem right that they have no safety net other than COBRA, which is finite. For example, no one should have to self-insure all of their medical expenses from the time they retire (and lose their employer’s plan) until the time they become eligible for Medicare.

  9. Bart Ingles says:

    To Dr. Goodman: Smorgasbords have been a very successful restaurant niche. In fact, if you think about it, the only restaurants that don’t follow this model are those who expect everyone purchasing a given menu item to consume the same amount of food.

    Although I wouldn’t favor a law requiring every restaurant to be a smorgasbord. At least not unless I could watch the food being prepared at every step.

    I really don’t care if my insurer wants to compete vigorously for my business, so long as it reimburses my provider fairly. I think the analog of “spitting in one’s food” is more of a problem with individual plans (see rescission) than it is with group plans.

    Note that I’m not in favor of pure community rating, nor of a legal mandate for community rating of any kind other than to qualify for a tax break, as is currently done with employer-sponsored insurance. And I have nothing against price penalties for risky behavior, so long as they are supported by actual science.

    But if risk rating is such an unqualified good, and risk adjustment a universal evil, do you also view such things as guaranteed renewal and rating protection as evils (setting aside the question of whether it would be right to prohibit such contracts)? After all, if everyone were to purchase “guaranteed renewal at class-average rates” and keep it current long enough, eventually the system would grow to look exactly like one with some form of community rating. And even with rating insurance, wouldn’t one then be free to let one’s health deteriorate after purchasing the rating coverage?

  10. Bart Ingles says:

    “…if you want to improve the lot of people who can’t dine out, the goal of subsidizing people should be achieved by price controls (requiring that all dinners be the same price) or by direct subsidy (you give money to people who can’t afford to eat out so they can afford to do so at some level).”

    I think the third option would be an indirect subsidy, analogous to employer-sponsored coverage. Healthy people overpay for coverage, but are more-or-less reimbursed by the tax exclusion. Sicker people are subsidized both by the tax exclusion, and by the cheaper-than-rated coverage.

    The smorgasbord metaphor may work here. Although there is no government subsidy, restaurants following this model have a cost savings in the form of reduced waste. Conventional restaurants must use portion sizes large enough to satisfy a large majority of customers; for light eaters, much of the excess food is then scraped into the disposal.

  11. Bart Ingles says:

    …So the real choice should be between direct and indirect subsidy (assuming there is to be a subsidy at all). I suppose I can see advantages and disadvantages for either, but the indirect subsidy seems far simpler and has a longer track record.

  12. Bart Ingles says:

    “In a real market, risk is priced accurately.”

    The problem is that what is often called ‘risk’ is really just ignorance of actual conditions. Unlike the probability of nuclear decay for an atom of uranium, much of health ‘risk’ is just not knowing all the facts about an individual’s health, either involuntarily because we don’t understand the condition well enough yet, or voluntarily as when we agree not to use available date such as genetic screening.

  13. HD Carroll says:

    Since we will undoubtedly see “insurance reform” that means insurers will be compelled to ignore health/medical history and status for BOTH acceptance AND rating, the ONLY acceptable response that can serve as a quid pro quo is mandating coverage, never mind squabbles over how to enforce it as that is an essentially solvable challenge, as is using vouchers or tax credits to deal with the “affordability” issue (the bigger issue is WHO decides what is affordable to whom).

    So, now we have an invigorated marketplace, but one in which the clearest actuarial “discrimination” of rating class has been eliminated – the one that says you are too sick or likely to be too sick to cover. Once we have added everybody to the pool, and health history and status are no longer a parameter in underwriting or rating the insurance product, it makes no sense to then try and justify age or gender rating, even though they are totally actuarially justified. It is not “older” people who generate more claims than “younger” people. It is sick people. There are plenty of younger persons who will generate more medical claims than MOST older people, and plenty of older people who will generate no more claims than the “average” younger person. Of course, one might argue that “healthy” older persons are MORE LIKELY to BECOME sick in the next year than a healthy younger person, and that somehow justifies it. But, the fly in the ointment is you can’t say which ones those are, hence, it is an injustice to lump people together.

    Now, this is a little tongue in cheek, but the argument is exactly the same one used for society to “justify” the equalization of pension annuity rates between men and women of the same age that came about after ERISA. The biological facts (and actuarial interpretation of those facts) were ignored because it was considered socially unacceptable to pay women less per month from the same lump sum than men because, on average, they live longer.

    Hence, the precedent is more than established to do away with, or at least significantly modify, the age rating in health insurance once we don’t distinguish between healthy and sick individuals. This is the social pact argument. Mind you, I haven’t said I agree that health insurance, or health care provision, are “rights” to begin with (I haven’t said they aren’t, either), I am just pointing out that that the practical consequences are there once the determination has been made de facto.

    The primary concern to me seems to be over worrying about those poor healthy young people and how they either don’t have (we can deal with that), or WANT to spend, the money for health insurance at all, let alone at a level that is perceived as subsidizing old people. It is really subsidizing SICK people, that is the whole point of a social insurance pool. “Old” people don’t have the money to pay the age rated premium any more than young people have the money to pay a “group” rate that is charged to everyone. Financing and allocating the “cost” is another, though again solvable, challenge.

    By the way, this is totally doable within the context of a (mostly) free private market environment without the distortion of a “public” or other option necessary. And wait until you see the logical consequences of the individual mandate and rating regulation over in the employer “group” insurance market! Well, a group is nothing but a bunch of individuals, right? Looks like no more group underwriting to me, after all, it is unacceptable that one employer with a younger bunch of employees should have a lower medical insurance plan cost than the employer with an older group, right??? Is that a “fair” market advantage? Oh, what fun there is to come.

  14. Don Levit says:

    If we consider eating out a luxury, and health insurance a necessity, we are comparing apples and oranges.
    Median household income is between $50,000 and $60,000.
    Average family group premiums are $12,000-$13,000.
    If these figures are correct, then premiums are 20-25% of median household income.
    It seems to me that the vast majority of households are going to have to be subsidized under the present arrangement.
    If we don’t have more innovative, affordable arrangements, we will have to subsidize, to a great extent, a necessity that is priced as a luxury.
    There is no such thing as a free lunch, but there should be more and better places to eat!
    Don Levit

  15. Dr. Mehdi says:

    There is nothing wrong with unitary pricing for a health plan in which membership is unversal and compulsory. Adverse selection is eliminated, and the law of large numbers makes it easy to price. Those who are currently paying more for a premium (because of their youth) will find that as they age, they are now paying less than the actual cost to insure them (because of their age). The only difference is that layers of bureaucracy and associated costs are eliminated, reducing (or at worst, slowing the rate of growth of) total healthcare expenditures.

  16. Robert Kramer says:


    Equating health care to paying for a meal in a restaurant is terribly demeaning to those of us who still believe that medicine is a profession, not an insurance controlled business. The physician’s value has been so diminished that this just adds insult to injury. There must be a better analogy.

  17. Devon Herrick says:

    One problem with schemes that attempt to subsidize one patron at the expense of another is that the party getting the subsidy likes the arrangement more than the party providing the subsidy.

    For instance, I don’t typically like all-you-can-eat buffets because I do not enjoy consuming large portions of food at a setting. Thus, I cannot get as good a deal for my money as someone who prefers to eat much larger portions than I do. So I tend to opt for restaurants where I can have smaller portions of a higher quality – often at a lower price. As a result of me, and people like me, buffets probably experience “adverse selection death spirals” when buffets are increasingly patronized by people who prefer portions larger than an a la carte restaurant typically provides. To keep profits stable, quality has to fall while prices must rise. Just imagine how bad the food would get if patrons had to pay a monthly fee in order to dine at the buffet.

  18. Bart Ingles says:

    Devon, are you saying that you believe all buffet-style restaurants to be teetering on the edge of bankruptcy?

  19. Don Levit says:

    I don’t think he meant that.
    Buffer-style restaurants tend to have death spirals with people who are relatively thin.
    If enough fat poeple continue to flourish, buffet-style should do just fine, right Devon?
    I wonder if my being accurate is a slim chance or a fat chance?
    Don Levit

  20. John says:

    In answer to George, who asks:

    “Consensus is emerging that the outcomes of disease have four major causal components: 40% personal behaviors, 30% genetics, 20% environment, and 10% medical interventions. Which of these components are unfair, in the sense that other parties should bear the responsibility (which I take to be your meaning)?”

    I think it would be unfair for the general public to pay for pre-existing conditions caused by personal behaviors. One of the commenters said that your premiums would go up if you made skydiving a hobby. For me, it is more the smoking/drinking/letting yourself get morbidly obese personal behaviors that would justify requiring individuals to pay higher premiums.

    But it seems to me that if the causal components of disease aren’t the fault of an individual, then the individual shouldn’t have to pay more. For the other three general causal areas you note, here’s an environmental example. Poorer people tend to live in the poorer parts of cities, and these tend to be where the major roads are. Recent environmental science shows higher degrees of cardiovascular mortality and morbidity for those living within 100 meters of major roads (after taking into account socioeconomic and personal behavior characteristics). If someone has to live where the rents are low, and they get cardiovascular disease because of diesel emissions, it seems unfair to make them pay for that which they can’t control. But if they also weigh 300 pounds and as a result have given themselves diabetes and a heart condition, then we shouldn’t pay for their behavior.

    Thanks for asking my views, George,


  21. John says:

    What is missing in almost all the debates about health care, in necessary degree of emphasis, is the fact that all health care will get worse over time, for everyone, if we don’t get a handle on cost growth.

    Don Levitt makes this point:

    “Median household income is between $50,000 and $60,000. Average family group premiums are $12,000-$13,000. If these figures are correct, then premiums are 20-25% of median household income.”

    How can we pay for this? The inevitable outcome will be poorer health care for almost everyone, no matter what system we get.

    I don’t think the country is really focussed on adequate health care for everyone until a road map for reducing health care costs is proposed, has public hearings all across the country, and is then made part of legislation.

    This cost discussion should be the focus of health care reform, not an afterthought or a fifth priority.

    Here’s a question: the Mayo Clinic provides excellent care, at about the lowest cost in the country for institutions of their size. They apparently do so because they put their doctors on salary instead of paying them by the procedure or the test (they do so by pooling all the payments they get from all sources).

    Apparently, this allows the doctors to spend more time with patients who need more time, and vice versa. Health outcomes are actually better than in areas where costs are higher and more operations are done, in part because in places like McAllen, TX, the doctors make money from the operations, even if not done by them, because they own the hospital. Many unnecessary operations are done as a result, but health outcomes are not better (see New Yorker article by Dr. Atul Gawande in one of the June issues, you can google it easily and it is free).

    So the question is, how can we create more places in the country with the care and costs of the Mayo Clinic? If we can, we can cut cost growth a great deal. What do commenters think?

    I’ve boiled down a complex situation to a paragraph, so I understand that I’ve left nuances and details on the table, but I think this is a decent summary.


  22. Jennie Fiedler says:

    Okay. Restaurants and health insurance are not quite the same. If I’m strapped for cash or on a budget, I can forego going out to eat. If I’m in need of medical care, well…not so easy to skip. Read the PBS interview between Bill Moyers and Wendell Potter, the former CIGNA PR executive turned whistleblower and that will open your eyes to the REAL costs of health insurance. By law, insurance companies were required to use 98% of every premium dollar to pay health claims. Example: You buy a 40.00 dinner and your food cost the restaurant 30.00, it keeps 10.00 for itself. Health insurance companies used to get 2% of every premium dollar. Now, typically they get 23% of your premuim dollar, and 77% goes to pay your health claims. You buy a 40.00 dinner and get 5.00 worth of food so the restaurant keeps 35.00. Where does all that money go? Exhorbitant salaries, private jets, bonus (to find ways to deny your claims), overhead, and fat profits for institutional investors on Wall Street. So their explanations about how high deductibles, copays and premiums being all the policy holder’s fault is a load of crap. If my health insurance company used 98% of my premium dollar to pay my health claims, I wouldn’t have the thousands of dollars of out-of-pocket expenses every year that I do. My parents would have been bankrupted under the same laws we have today, but they had health insurance that actually paid their claims. Reregulate these “hogs at the trough”, or get rid of them and go single payor by way of expanded Medicare, which is paid for by everyone and includes everyone. Check out the websites for HR676: “Publically funded, PRIVATELY delivered healthcare for all”. Ignore the disinformation and propaganda spewed by private health insurance companies about “socialized medicine”, another load of crap, and get the real facts.

  23. Frank Timmins says:

    Jennie says, “By law, insurance companies were required to use 98% of every premium dollar to pay health claims.” That’s an interesting statement Jennie. Say, I wonder if you could get us all a little more information on that law, perhaps even cite the actual wording, or perhaps just give us a link to something.

    In the meantime, it may be helpful as we discuss the obvious problems of health insurance (such as what to pool or not pool, to medically underwrite or not medically underwrite, and how to deal with the fiscal cost of whatever it is we decide we need) to hone in on the fact that what everyone is calling health insurance is really pre-paid healthcare. Nothing is going to work cost wise until everyone stops dragging “health insurance” and/or “insurance companies” into every conversation about how to pay for medical costs.

    The term “insurance” is only valid when there is a true “risk” to be considered. A “risk” translates to a “rare” and “unexpected occurrence”, and that doesn’t include 90% of all physician encounters. Nor does it mean having insurance companies involved in any medical expenses below a “catastrophic deductible”.

    So Jennie, you really don’t need to bash insurance companies for doing what they do when you have asked them to do something that they don’t do well (manage your healthcare expenses). By the way, an even worse organization to assign those duties are government bureaucrats (surely we don’t need to discuss why). So the question is who the hell should be in charge of managing these expenses so that “obscene profits” are not taken out of your hard earned dollars. Jennie, do you have a mirror?

  24. Ray Gitmo says:

    To Jennie:

    I have been in the health insurance field longer than I can even remember, yet I do not remember that 98% law. If you can show me any business that could possibly run all their administration and make a profit using only 2 % of their revenues, I will eat the contents of your mental colostomy bag. Do you realize that they could simply stick their money in even one of our present day lame banks, not run the business at all and make more money?…get a grip!

    To John:

    You accept that we should not subsidize the premiums of people with bad health as a result of poor personal behaviors (obesity, substance abuse etc..) but you feel we should subsidize (or guarantee issue) those whose conditions are caused through no fault of their own. Your argument is very humane, until you consider that the reason many of these people cannot get or cannot pay for the insurance, is because they opted not to have it back when they were healthy. I am not aware of any single state where it is legal to drop an individual or to rate-up an individual just because their health has changed. (Unless of course they were running around without insurance before their health changed). This is a point that too many people miss in these arguments. If you are allowed unrestricted access to insurance when you get sick, what possible incentive would you have to carry insurance before you get sick.

  25. Ray Gitmo says:

    To the topic of pre-existing conditions:

    I live in Florida, and hurricanes are part of the risk we must carry in order to live in paradise. We have pre-ex conditions when it comes to storms as well. Once there is a storm “in the box” , no company will issue a homeowner’s policy until all the storms have passed. The “box” is an area that covers the Gulf of Mexico, all of the Caribbean and the Atlantic north to Bermuda and east past the Lesser Antilles.

    Insurance is about covering risks…it is not about shooting fish in a barrel.

  26. Bart Ingles says:

    Don Levit:

    Sorry, I was overly terse with my last comment. I’m probably failing in the opposite direction now. But it hasn’t been my experience that buffet-style restaurants serve food of lower quality than other comparably-priced restaurants. If anything the quality is at least as good as any other trans-$10 establishment, and the variety generally much greater.

    “Unlimited consumption equals poor quality” is a reasonable hypothesis, but the experiment doesn’t seem to confirm the prediction. More interesting is the “why?” Probably because customers are encouraged not to waste food, table turnover is generally higher than a traditional restaurant leading to economy of scale, service is “self-directed” leading to low labor costs, and most people don’t show up intending to gorge as much as possible (and from what I’ve seen those that do tend to load up on low-cost items like pasta and casseroles). Others go there for the opportunity to sample small amounts of a variety of items, or because they can choose items in precisely the desired proportions.

    The point is that it’s not reasonable to rely on a single economic equation and ignore other factors, nor to confuse hypothesis with outcome.

    Is there a parallel with health care? Try this: if the prediction that “lack of risk-rating leads to poor quality” then the U.S. must have poor quality health care indeed, since most (90% ?) of its citizens do not have individually-underwritten plans; instead they have employer-sponsored group plans or Medicare or Medicaid. Only a small fraction of the public currently holds individually-underwritten coverage.

  27. John says:

    To Ray Gitmo:

    You are talking, in part, about gaming the system, about someone who doesn’t pay for health insurance, even though he or she could have at relatively low cost. Perhaps someone who could have opted into an employer’s plan but opted not to, if that situation exists. Then, upon realizing they need a $150 K procedure, they want to opt in at the average cost. In this situation, I agree with your implication, that you shouldn’t be a freeloader and then expect everyone else to pay for you when you get an expensive illness and you decide to opt in. In this situation, you should be able to get health insurance but to pay what the market bears, which might be the equivalent of paying for your procedures out of pocket.

    I don’t know if this example would hold for 20 somethings just getting started, in a case where they would have to buy expensive insurance on their own (no employer coverage), and they need their scarce funds from a starting job to pay off college loans. There are gray areas, however, for example a kid starting off with a $70 K job, where the kid could clearly afford basic health insurance at age 24 or so.

    Here’s a question, though: I read about people who lose their job at a company which offers health insurance which they have signed up for. The former employee or his or her spouse have a pre-existing condition. Either when unemployed, or at their next job (not offering health insurance), they are then denied coverage because of a pre-existing condition. This seems very unfair, because they had been uninsured and hadn’t been freeloading. In such a situation, these people should have the opportunity to opt into health insurance at the same rate as everyone else. Unless, of course in my formulation, they are smokers or alcoholics or grotesquely obese, in which case they pay more.

    What is your take on this balance?


  28. […] At the top of my list of foolish things is the idea that no one should ever have to pay the real cost of his own health insurance. The most popular alternative is having everyone pay the same premium although, as previously reported at this site, community-rated premiums are not even good for sick people. […]