The Case for Health Insurance
I’m one of the very few health policy wonks you know (maybe the only one) who believes everyone should have access to health insurance the same way they currently have access to life, disability and homeowner’s insurance. In fact, I often refer to my blog as about the only health policy blog on the Internet that believes real health insurance is a legitimate business.
Wait a minute, Goodman. How can you say that? What about the Commonwealth Fund and Families USA? Don’t they believe everyone should have health insurance? What about everyone in Congress who supported ObamaCare? What about the president himself? Aren’t they all promoting the business of health insurance?
The short answer to all those questions is “no.” Real insurance involves a pooling of risks. The insurer must make sure each new entrant to the pool pays a premium that reflects the expected costs that entrant brings to the pool. Otherwise, the insurer won’t be able to pay claims. The business of insurance is the business of pricing and managing risk.
The organizations and people noted above don’t believe that “pricing and managing risk” is a legitimate activity. In fact, they went a long way toward completely outlawing the practice in the health reform bill. The only legitimate purpose of insurance, in their view, is to collect money and pay bills. For public insurance, this means collecting taxes and paying expenses. Their view of acceptable private insurance is to copy government insurance — a sort of private sector socialism.
Okay, Goodman, let’s accept that distinction for the moment. Doesn’t pricing risk mean charging me a premium that reflects my health status? The less healthy I am, the more I have to pay. Why should I want to buy insurance from a company that does that?
Because if your insurer doesn’t do that, a lot of bad things will happen.
httpv://www.youtube.com/watch?v=ENPkLAeMJ5E
Against the wind
Remember the phrase, “You’re in good hands with Allstate”? It was the voiceover at the scene of an auto accident where there has been catastrophic damage. The ad speaks volumes about what happens in real insurance markets. Basically, insurance is unimportant to you until things go very wrong. It’s at that point that you want good service.
Contrast Allstate’s ad with the kind of ads federal employees are subjected to during the fall open season for choosing a health insurance plan. What you never see in Washington are ads saying, “You are in good hands with [Aetna, Cigna, UnitedHealth, etc.] if you get [AIDS, cancer, heart disease, etc.].” Instead, the typical open season ad pictures young families with healthy children and no apparent health problems. The not-so-subtle message is: “You’ll be in good hands with us if you look like the people in these photos.”
Why is the health insurance market so different from auto insurance? Answer: health insurers are not allowed to charge federal employees premiums that reflect their health status.
Since the health overhaul legislation plans to make the federal employee health benefit system the model for health insurance exchanges nationwide, it’s instructive to stop and consider the incentives the health plans in these systems have. As explained in a previous analysis, if insurers have to take all applicants for the same premium, they will obviously try to attract the healthy (on whom they will make profits) and avoid the sick (on whom they will incur losses). After enrollment, their incentive is to overprovide to the healthy (to keep the ones they have and attract more of them) and to underprovide to the sick (to encourage them to leave and discourage enrollment by others just like them). If a TV ad could summarize how this health insurance market works, it would say, “You’re in good hands with us, unless you really need us — then we hope you will go somewhere else.”
And the reason this works is because people really can go somewhere else if they get sick — paying no extra premium.
So the incentives of the healthy employees are: Find plans that have lots of services for healthy people — knowing that if they get sick, they can always enroll in some other plan. The incentives for employees with a serious health problem (or more likely, a family member with a health problem) are to seek out plans that are the best at treating costly illness. But, as in a game of musical chairs, no insurer wants to be chosen.
In such a world, comparative effectiveness research, FDA rulings on drugs, end-of-life counseling and so many other controversial issues of late become very relevant. Insurance companies can’t just dump their sickest patients out on the street. They need cover. They need reasons not to pay for the latest cancer drug or the latest expensive test. Given the slightest encouragement, denial is in their self-interest.
Okay, Goodman. This is all very persuasive. But if my premium reflects my health status, what happens to people who are too poor or too sick to be able to afford those premiums? And what happens if a healthy person gets really sick (high medical costs) and wants to switch insurers?
These are good questions. I will answer them in a future Health Alert.
Most policy wonks don’t understand that “pooling of risk” is not the same as coercing young, healthy (i.e. low risk) people into the risk pool to subsidize older (i.e. high risk) people with much higher costs. Cross-subsidies are never efficient because the patient; the insurer; and the provider all have the wrong incentives. An insurer cannot efficiently compete on price if it is prevented from pricing risk. A provider is unlikely to compete on price if someone other than the patient is paying the bill.
I often liken the solution to our health care problem to the lifecycle theory of investing for retirement. People are healthy when young so their health risk is low. As a result, most of their health insurance dollars should go into a personal health account. Peoples’ health deteriorates as they age. But they could pay the higher (risk-adjusted) premiums (and associated out-of-pocket costs) using the accumulated HSA balances once their health status deteriorates in late middle-age. All the while, patients would have an incentive to be prudent consumers of medicine. And providers would have an incentive to compete when faced with price-sensitive patients. Assuming the coverage is personal and portable, insurers could sign long-term contracts. People pursuing unhealthy lifestyle habits could also be penalized (or those pursuing good habits could be rewarded). At the very least such a system would improve the incentives of all parties involved. A uniform tax credit would also ensure most people could afford the core benefits they need.
People can’t afford health insurance? Give them cash.
Subsidies become transparent, and markets are left to do what they are good at–organize production and manage risk–without doofus government officials putting stupid constraints on them. Plus, providers have to work on pleasing individuals to get the money rather than wasting such enormous resources on rent-seeking lobbying.
Health care as a new entitlement program without actually reforming the health system essentially voids insurance of mathematical justification. As Dr. Goodman says, insurance is based on risk. Actuaries calculate the probability of their company paying, given an individual’s likelihood of needing a service, and existing conditions influence premiums as risk is suggestive of future consumption.
Why do males under the age of 25 have higher car insurance premiums?…because based on actuarial science that group has a higher probability of being involved in collision (A risk pool). This pool has both good drivers under 25, and drivers who continuously crash. In relation to other groups, this population has more car accidents. For the ability of car insurance companies to pay claims, they adjust premiums to represent the higher risk drivers.
By fixing premiums, without a conscious effort to reduce risk or cost (actual health reform) removes insurance from a business and makes it an entitlement. Back to car insurance, why do car insurance companies reduce premiums for taking defensive driving? From a statistical standpoint that lowers ones risk or crashing, lowering the probability of the insurer needs to pay, and encouraging people to be safer drivers.
Now in the perspective of current entitlement programs, what do the actuaries say about the long-term fiscal health of these programs (Social Security)? People need to be given the opportunity to receive affordable health insurance and care, but fixing and limiting revenue, while cost and risk continues to increase, with no increase in supply is not economically and mathematically justified.
An underwriter/actuary/health insurance company has the tough task of pricing a policy low enough to encourage the young and healthy to participate in the rist sharing, yet high enough to pay the extremely expensive new technology, new drug, new procedure for those that get a dreaded disease. It’s a tough balancing act – premiums too high don’t attract the young healthy’s to subsidize those few who get the $3 or $4 million dollar claims. Those who get a long term/permanent diagnosis feel someone else should help subsidize more of their costs – they feel they have contributed all those premiums all those years, why do they have to pay more now that they are sick. Those that have had absolutely no claims wonder why they get a rate increase when utilization increases, technology/drugs are always better and more expensive (at least we are sold that they are).
Due to the unbalanced tax incentives for employer-sponsored health insurance, until recently a large percentage of Americans got their health insurance through the employer benefit package. There was no personal risk rating; therefore, there was no concern that one’s unhealthy lifestyle would warrant a higher premium or denial of coverage. All employees in the same bracket of coverage received the same premium. As the cost of health insurance rose and small business employers dropped health insurance, more Americans discovered the private marketplace. Suddenly they realized that their tobacco use raised their rates 30% higher than their nontobacco friends. Their 37 BMI raised their rates 50% higher than others who maintained a healthier build. As they personally were paying for the premiums and the claims, we saw a shift toward HDHPs and healthier lifestyle changes. In states where risk rating is allowed and state mandates are few the private market has grown and rates have been kept low. Exchanges are the noose that will choke the private marketplace.
Good post. Very rational, as usual.
John,
If Earth is the insane asylum for all the crazy people from another planet, then your spaceship must have made a wrong turn. You are far too logical to be on this planet. I know you have discovered that the more logically you write, the more vigorously the left opposes you.
-Blake
I think I know what Dr. Goodman will write in his sequel, so let me throw in a little twist. I was not previously convinced of the view that replacing employer-monopoly health benefits with a personal tax credit, as opposed to deduction, was a “slam-dunk”. (I’m still not convinced that it is the right reform to propose from a political, tactical perspective).
Nevertheless, public policy should not incentivize wealthy people to over-insure for health. In fact, I think high income people should be encouraged to go without health insurance. So, if we implement Dr. Goodman’s idea of a personal tax credit, ordinary people would get a credit if they bought a state-approved health policy (designed along consumer-driven lines).
However, people who could prove that they had assets sufficient to cover their own health spending – no matter what cost – would get the credit without having to buy a qualifying HDHP. Let’s ignore, for now, how high that dollar-figure would be or how the IRS would audit it. (Like the economist who opens a can of peas on a desert island by “assuming a can opener”).
The benefit of this is that the high-income earners would pay cash for everything – even organ transplants and the most complex cancer therapy. The result? Normal price formation, which would result in prices that health plans would use when establishing premiums.
This is not a perfect solution but it addresses the problem that health insurers would still have if health insurance was real insurance: What should a medical service cost? Auto insurers do not face this problem because the prices of cars, and the inputs into cars, are determined by normal market processes.
John, thank you for once again framing the concept [of risk] so well. We could absorb great losses financially and medically if more people don’t understand the science behind insurance.
For those seeking a historic view of risk control you should pick up “Against the Gods” by Peter Bernstein, He “chronicles the remarkable intelectual adventure that liberated humanity from oracles and soothsayers by means of the powerful tools of risk management.”
Many “insurance people” don’t appreciate the precision and effectiveness insurance as a financial tool can bring to civilized people.
John Graham,
I agree that policy should not incentivize wealthy people to overspend. But to say they should be discouraged from buying health insurance (implicit via policy) is like using a finger to hold back what’s behind a leaky dike.
Informed wealthy folk will be looking to purchase high deductible heath plans and use the savings to shop, just as HDHP and HSA owners do now on a different scale. Let’s promote policy that gives the wealthy higher deductilbes, and let natural incentives flow.
Another good one John, keep it up!
Devon is right in that pooling is not understood by most. It makes a nice slogan on a bumper sticker, but small group reform forced insurers to pool “risks” to dollar one thereby penalizing healthy groups that invest in employee wellness.
Some employers have taken on HRA’s in order to move the pooling level to $5000 or more per employee, and this is a very good thing, unfortunately many actuaries are still pricing their entire block and doing a global increase by type of coverage, not by pooling level.
The easy answer is ERISA plans with a HDHP where allowable
In my view, Obama is actually in a very good political position to dictate on health care reform. If he were to propose a bill from the White House that was much closer to what he campaigned on, included elements of the new law everyone likes anyway, and jettisons the individual mandate, while coming a little way down the road to the Republicans, they’d have to vote for it. The Democrats wouldn’t dare vote against it.
Although I push for straight up vouchers, I largely agree with you that we can dramatically reduce the scope of our health care sector problems through rather modest reforms that unleash non-distorted pricing and competition. I have an earlier Op-Ed to that effect if you’d like to see it.
-David
Beverly and John, great photos. I’ve got to figure out how to do that.
In pooling risk, the decision to assign premiums based on an individual’s risk is purely arbitrary, albeit it is convenient for those marketing the traditional business model of insurance – “real” health insurance, as John Goodman calls it.
The ultimate pooling of risk would be one national pool that includes everyone. Yet average medical costs for a worker’s family of four is now over $18,000 (Milliman), when median household income is $50,000. A middle-income individual can no longer afford an equally-allocated premium plus out-of-pocket costs for that risk pool, much less a premium that is adjusted upward for higher risk.
Many of of us who do believe that everyone should have access to health care free of significant financial barriers understand that the traditional concept of “real” insurance no longer works. If individuals with health problems are priced out of risk pools, then how can they possibly pay premiums for the pools that concentrate high-risk individuals? And don’t say that you merely have to set up state-run high-risk pools. Not only have they already been proven to be ineffective in seriously addressing this problem, they would still have to be funded by us anyway, through the tax system. If we moved most high-risk individuals into these pools, that would consume a major portion of our national health expenditures (i.e., much of the 20 percent of people who consume 80 percent of health care).
In fact, think of our largest risk pool – the collective pools of employer-sponsored plans. These are largely composed of the healthy workforce and their young healthy families (the 80 percent of people who use only 20 percent of health care). Yet these low-cost pools that benefit from favorable selection (opposite of adverse selection) are already straining the budgets of employers and their employees. Isn’t it kind of silly to pool together these massive numbers of healthy people, while leaving out most of those with greater needs, and pretend that somehow we have provided the nation with “real” insurance? That serves the insurance industry well, but not the people.
Since average-income individuals can no longer afford their equally-allocated portion of our national health expenditures, funding will have to be progressive, based on income. The least administratively complex and a less expensive method of doing that would be to establish a single risk pool, and fund it through progressive tax policies.
If our goal is seeing that everyone gets the care they need, then we really do need to discard the antiquated business model of “real insurance” and adopt a single payer system – an improved Medicare that covers everyone.
John,the architects of healthcare reform spent woefully little time considering the unintended
consequences of this bill. American’s are for the most part, pretty savvy when it comes to their personal spending. So, ask your self, if in 2014 I can pay a minimal penalty for not purchasing health
insurance, rather buy a limited benefit plan to cover incidental medical expense, and know that if something
happens medically that would result in large medical expenses, I can purchase a subsidized plan on an exchange on a guaranteed issue basis. Why wouldn’t I??
This is simply one example of many that will be an unintended consequence of PPACA.
I believe that most of what one pays in premiums should go to pay one’s claims and not for private jets, gourmet meals, and million-dollar salaries. If you don’t believe that’s where your money is going, listen to whistleblower Wendell Potter, the former PR man for Cigna. Pretty black and white. If insurance companies ran their businesses legitimately, that would be the case, and like auto and life insurance, there would be incentives (ie lower primiums), for healthier lifestyles. Obamacare is not the answer, but private health insurance helped create that monster, and can help discreate it by running the way they should. Enough said.
JF and Don M – Anyone who thinks that real corporate overhead at health plans/insurers makes up more than a minuscule portion of the total health care spend and therefore if we just did away with insurers and their illegitimate administrative costs and profit margins everything would be fine is totally deluded of reality. Do you know what the “loss ratio” on the clothes you buy or the food you eat and pay for really is? I bet it is a heck of a lot less than 80 or 85%. 15-20% is a heck of a bargain to get an entity to put forth capital and serve as the “banker” for a risk that isn’t guaranteed to come in under budget in the first place, and very often hasn’t. There is a severe limit on the profit that can be made, but losses are practically unlimited. And anyone who thinks that the government programs here or in Canada operate at something less than a TRUE administrative and fraud cost of 10% or more are easy to manipulate with numbers and statistics. Hence, the differential is not that great, and at least some insurers do a fair amount extra in terms of the services they provide versus the DMV style service you get from Medicare or Medicaid. And ultimately, a single “payer” system will mean single “provider,” and we will be in the same mess with controlled prices and service shortages. Single payer means no innovation, no motivation for efficiency, creativity, and productivity. Where would the incentive be? I am not saying the current insurance structure is the best it can be, heavens no, but lets fix it instead of creating a Frankenstein of a single payer system. Force “all payer” pricing on the entire system, and allow the market to work. No discounts to any third party payer, insurer, or government sponsor, other than one-offs solely between the provider and the patient paying for the service after third party payments have been made. With a fair playing field that eliminates price control distortions, innovation in both insurance products and medical technology and care provision (and payment structures) can at least start bringing that cost curve under some control.
It seems the policy wonk forces are out today. Until we admit that health care does not perform to market standards we can’t really try to tackle this issue.
As a cancer patient I was only told of the treatment available to me but not the cost associated with that treatment. This raises the question? How can a market dictate the lowest price when consumers are not informed of that price and what other options are available to them at differing costs? There is no meeting of the minds in this contract negotiation.
How do I know (as a layman) that my chemo/radiation doctors followed best practices to ensure I was not over overcharged for duplicative exams I did not need but made my doctor feel more comfortable with their treatment of my cancer? I say this while I truly respect and honor both my cancer doctors.
I do understand that a major obstacle to PPACA is that in the future doctors will probably be associated with ACO’s and will be on a payroll and not independent. And yes, that will limit your income. On the other side, doctors may price themselves out of business. Which is the same claim being made about outsourcing and unions. Only in the case of health care it will mean more H1B doctors who will undercut your prices anyway. Everyone is getting a haircut on this one.
The problem lies not with compensation but with health deluvery to patients with common and sometimes more complicated illnesses. Physicians must be required to be responsible for the care of their patients 24/7 to cut down the need to go to ER’s and walk in clinics or see other physicians unfamiliar with their problems. . This causes great expense and needles delays in proper treatment. If all doctors were required to care for their patients in sickness as in health, the way i did when i weas a pediatrician, the costs of care would fall dramatically and the care would improve.
A. H . Felman, M.D.
thanks John, you nailed it again. All this “health care talk” should be illness care. You won’t know what you have until you make a claim, and most people can’t print money.
“I have insurance,” is a meaningless claim, to me. A clever claims processor can deny or postpone payment on many types of claims, and someone, either the provider or patient will be a big loser.
Please continue writing your common sense articles. I hope the taxpaying public can catch on. Those who pay no taxes have no economic stake in the game and will keep voting for free medical care.
Jennie Fiedler,
That’s nowhere near enough said. How did private insurance companies create the “monster?” I am very curious to know what you think they did. As far as I can tell, the cause of the “monster” was misguided government intervention in every aspect of the health/medical market at the federal, state, and local levels. The fact that the insurance companies reacted rationally to the various government restrictions placed upon them does not make them evil or responsible for any monsters that may have been created as a result.
Bravo, John. Health insurance missing the point. Insurance today is “sickness” insurance.
Think of all other insurances, that one is rewarded for keeping your home safe, you car safe, etc. It is a good health or sick insurance that should reward those who do what is necessary, with certain caviots for those who have such problems that even with trying their best, they are not helped. To coin a phrase; God helps them who help them selves because some folks feel that it is an entitlement, which they deserve regardless of what they might be suffering from and not helping themselves.
I would love to share the podium with you. Let me know.
-Dr. Kramer
I only have a couple points to make today relative to the health insurance or care reform debate: One, if Congressman Ryan believes that cratering Medicare and Medicaid and relying on the “private sector” to provide us insurance options, then what are the names of the private insurance companies willing to “underwrite”, with all of the meaning it connotes, individuals above Age 65? Two, if one of the pertinent definitions of insurance is “the transference of risk” from one party to another (tax law definition and standard), then how are the likes of the Blue Cross Plans, Cigna, Mutual of Omaha, et al, who “administer” Medicare on a cost-plus basis inclined or incented to accept the ‘transference of risk”?
Though Congressman Ryan may have been a congressional aide at one time, it appears that his preparation for his current assignment and advocacy is woefully inadequate. Ideological polemics are not normally solid bases for public policy.
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