The Health Reform House of Cards

Posted by Nolan Miller on Feb 4, 2010

Filed Under (Health Care)

[Note:  I originally wrote this last week and scheduled it to post today.  Yesterday I read Uwe Reinhardt's post on the NYTimes Economix blog that expresses much the same sentiment with more real-world input and fewer of the blow-by-blow details.  If I hadn't written my post already, I might have just linked to his.  But, since the work is already done, I'll leave mine here.  If you are at all interested in health, I highly recommend reading everything Uwe writes at Economix.  Even when you don't agree on the conclusions, he's right on the facts and identifying the key issues.]


In the wake of President Obama’s falling approval ratings and last month’s stunning upset in the Massachusetts Senate race, I hear a lot of people saying that this is the inevitable result of Democratic hubris, and in particular of Obama and the Democrats trying to do too much on health care too quickly, especially when the country has not yet bounced back from the current, severe recession, is (still) fighting wars in Iraq and Afghanistan, and faces an ongoing a real terrorist threat.

I’m willing to concede the points in the last paragraph.  Maybe this wasn’t the time to try health care.  Arguably, though, given the Senate’s anti-filibuster rules, the chance may not come again for a long time.  I’m also not a huge fan of the bill because I don’t think it went far enough to contain cost growth, which I (and others) have said is the real threat to the system in the long run.  But, I think that those who argue that Obama and the Dems should have taken a more incremental approach to expanding access to health insurance also miss the mark.  Here’s why.

Suppose that you want to extend access to the health care system to the roughly 46 million uninsured people in the U.S. (or just the 80 percent of them who are U.S. citizens).  The least obtrusive way to do this in the context of the existing U.S. health care system would be to either expand Medicaid to cover wealthier people or to bolster the dysfunctional individual (non-employment-based) insurance market.  Now, Medicaid does a good job of providing basic care to poor people, especially children and their families, but because of its low reimbursement rates is probably not a great way to extend care more broadly.  And, any broad expansion of this government-run program would surely meet with strong opposition.  So, this leaves us with bolstering the individual market.

The individual market is the insurance market for people who don’t get insurance through their employers.  To put it bluntly, this market doesn’t work very well.  Only about 5% of the U.S. non-elderly population gets its health insurance through this market.  There are several reasons for this.  First, coverage is expensive because those buying insurance through the individual market do not have access to the economies of scale and bargaining power of employment-based coverage.  Second, those who seek to buy insurance on this market tend to be sicker than the population as a whole.  Insurers respond to this by charging higher prices based on medical history (“risk rating”), excluding pre-existing conditions, charging higher rates for coverage, putting annual or lifetime limits on benefits, or simply refusing to cover the sick.  And, in many states they can cancel an existing policy with little or no justification.

All this translates into private, individual coverage being very expensive at the same time those who might buy such policies are relatively poor.  This leaves us in a situation where the sick can’t get insurance and the well do not want insurance because it is too expensive.  As a result, there are few people for whom buying insurance on the individual market is an attractive option.

So, how do you fix it?  The first step would be to prevent insurers from engaging in the types of practices mentioned in the previous paragraph.  So, let’s require that insurers charge everyone the same price for insurance and must enroll anyone who is willing to buy insurance.  Let’s also prevent excluding pre-existing conditions and lifetime limits on benefits.  In other words, we outlaw “abusive insurance practices.”

Fine.  Now anyone who wants to buy insurance can buy it at any time.  How does a reasonable person react to this?  Well, if you are currently sick, you buy insurance.  But, suppose you aren’t sick.  A reasonable calculation would be to not buy insurance while you are well and take advantage of the prohibition on denying coverage in order to buy insurance only if you become sick.  The result of this will be that only sick people will have insurance and that, without healthy people in the risk pool to balance them out, premiums will have to be high.  So, even though everyone will be able to buy insurance, it will still be expensive to buy, and many insurers will find that it is simply not worth the trouble of insuring an exclusively sick population.

So, how do you bring down the cost of insurance?  The way to do this is to bring the healthy people into the risk pool.  After all, even though they don’t buy insurance while well, they are already benefiting from the system which guarantees them access to health care if they get sick.  In exchange for this guarantee, let’s force them to buy insurance early.  So, we mandate that individuals buy insurance.

The mandate puts healthy people into the risk pool, so now we have a mix of sick and healthy buying insurance from the individual market.  This should bring average prices down.  How might insurers react?  Well, all else equal, the insurer does better if it attracts a relatively healthy pool to its policies.  While the regulations above prevent insurers from explicitly excluding sick people, they can try to design policies that are implicitly more attractive to the healthy than the sick.  For example, they may exclude mental health benefits, refuse to cover weight-loss surgery, put their offices on the third floor of no-elevator buildings, etc.  But, these “dumping” practices are wasteful.  So, let’s prevent insurance companies from engaging in these practices by standardizing benefits.  This will have the additional benefit of making it easier for consumers to shop for plans since it will be easier to compare apples to apples.  And, if consumers become more sensitive to quality and price differences between plans, this will encourage plans to improve quality and lower price, which is an added bonus.

In fact, let’s push that idea further.  In order to encourage insurers to compete more vigorously, let’s set up insurance markets, or “exchanges,” where people can easily shop for plans.  This will also help people choose a health plan, an extremely complicated decision.

Finally, we need to face up to the fact that the uninsured are primarily poor.  This means that many of them will not be able to afford coverage no matter how well the individual insurance market works.  If we want to them to have access to private insurance, we’re going to have to help them pay for it.  So, let’s subsidize poor people to buy insurance through the private market.  We can do this in two ways.  We can either directly subsidize purchases of individual insurance policies or force employers to expand their insurance offerings by requiring employers to offer insurance or pay a penalty if they don’t.  But, if we’re going to subsidize individual insurance purchases, the money is going to have to come from somewhere.  So, we’ll have to increase taxes in one way or another.  (Aside: Clearly, the best way to do this is through a tax on tanning salons, as proposed in the Senate Bill.  The only question I have is why we didn’t come up with such a brilliant idea sooner.)

And there you have it.  If you want to expand coverage and you want to use the private market to do it, you quickly find yourself with a very big piece of legislation.  It’s a house of cards, and without any of the pieces it will quickly fall apart.  (Another aside: many people feel the penalties paid by individuals and employers who choose not to buy/offer insurance are insufficient in the current legislation, so the house of cards may be destined to tumble, anyway.  See this op-ed by Martin Feldstein.)

While going all the way may be too far, it is unclear whether there would have been a way to ease into reform.  Unfortunately, the one part of the bill that can be chopped out without jeopardizing the short-run goal of covering more people is the one that we really need to address to ensure the long-run viability of the system — the cost reduction part.  Even if we expand coverage in the short run, without addressing cost and especially the rate of cost growth, we’ll be right back in the position of insurance coverage being unaffordable for an ever-increasing segment of the population in a matter of years.

One Response to “The Health Reform House of Cards”

  • jerry l. carson says:

    i follow your logical steps but arrive at a slightly different end point.

    if i can remember–which is getting harder these days–the main teaching of my u of i insurance 101 course was: the only economical use of insurance is a very large unbiased insured base with catastrophic (significantly relevant) deductibles.

    in my opinion applying this basic tenet to the current healthcare situation means that:

    the federal government covers the entire legitimate population. now you have the largest, most unbiased insured base.

    the catastrophic deductions are defined as flat stated percentages of each insured’s taxable income–say 0% for under the poverty level; 15% above poverty to $250,000 and 20% above that.

    i’m confident that the premiums for such a policy will not only be the lowest possible but will be a substantial net savings to the government versus what we have today with medicare and medicaid paying from almost dollar one.

    your suggestion for standardizing benefits should be added by simply including any products/services that the fda evaluates as having healthful benefits–price levels to be determined by the free market. the only exception to this policy is that if an individual is in the 0% category the list of covered services/products is severely reduced to bare life-saving essentials–socialized medicine.

    the premiums for this mandated healthcare coverage are tax-deductible to the individual. no other healthcare premiums are tax-deductible for either individuals or corporations. any corporate paid insurance premiums beyond this basic mandated coverage are considered as income to the individual and the same applies if the corporation reimburses the individual for the basic coverage.

    all expenses beyond the catastropic deductions are tax deductible for the individual and carried forward for 20 years if unused in a given year. they also can be carried back for 3 years.

    to prevent any “free lunch” or “system gaming” aspects of this approach all unpaid premiums of any of the three deductible groups are accumulated individually on a lifetime basis and netted against any individual healthcare tax deductions or carryforward/backward tax allowances; any other federal granted individual benefits; and finally added to any estate taxes.

    private market insurance companies can sell on a nationwide basis any additional coverage to anyone wanting it. again these premiums are not tax deductible and the paid benefits reduce the carryforward/backward allowances.

    now in my humble opinion you have:

    universal coverage against a catastropic event
    lowest cost premiums
    premiums based on ability to pay
    standardized broad coverage for the paying insured
    socialized coverage for the non-paying insured
    unlimited personal liability for unpaid premiums
    liberal allowance for uncovered losses
    additional private market coverage available
    additional premiums and all benefits are competitively priced
    personal involvement to control costs with catastropic deductibles

    since i’m sure you took many courses beyond my insurance 101 i would appreciate your comments,

    jerry l. carson