David R. Henderson  

Arnold on Health Insurance

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In a post last week, my fellow co-blogger, Arnold Kling, writes about Obama OMB director Peter Orszag's thoughts on controlling health care costs. I think Orszag misses an important point and so does Arnold.

First, Orszag. He takes as given that the government should try to control health care costs. But why? The usual answer is that health care spending as a percent of GDP is rising. But lots of spending as a percent of GDP is rising. I haven't checked lately but a few years ago spending on airline travel as a percent of GDP was rising. I didn't hear anyone call for reducing or reversing that growth. So what's the relevant distinction between health care spending and spending on airline travel? There is one and it's that so much of health care spending is people spending other people's money. This is true in one of two senses. For government programs such as Medicare and Medicaid, where spending as a percent of GDP has risen much more than private health care spending as a percent of GDP, people are spending taxpayers' money. For private health insurance, even though people contributed either directly or implicitly via lower wages and salaries from their employers, at the point of purchase most people are spending mainly the insurance company's money.

But given that that's the important distinction, our solutions should focus on that. Which brings me to Arnold's point. I don't particularly disagree with what Arnold wrote, but he started his analysis in the middle rather than at the start. Arnold asks:

Next, imagine that the best hope is a treatment that costs $100,000 and offers a chance of success of 1 in 200. Would I want her [his daughter] to get that treatment? Absolutely.

Who wouldn't? But let's ask a prior question. What if Arnold or you or I could buy health insurance that covered treatments that give a 1 in 200 chance of survival and cost $100K? Or we could buy insurance from a company that refuses to cover such high-cost, low-probability treatments. Of course, ceteris paribus, the second kind of insurance would be lower-price. Which would you buy? If the former, then fine: you paid the expected cost. What's the problem? If the latter, then fine: you didn't pay the expected cost. And again, what's the problem?


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COMMENTS (5 to date)
TMLutas writes:

The problem is that people try to take two bites at the apple. They pay for the lower insurance rates in a number of circumstances (health care, flood insurance, etc) and then when the disaster strikes, they figuratively wave their stumps in our faces and plead for public assistance to make it all better. It is a sophisticated form of begging enforced by the power of government taxation.

This is not a trivial problem for our political system nor for any 1st world political system. It may not be strictly an economic problem but that makes the issue no less real.


Kevin Dick writes:

As TMLutas notes, the problem is the two parties sufficiently defining what the policy covers a priori. The space of potential health circumstances in which an individual could find himself in the future is very large and the uncertainty surrounding the potential interventions relevant to each circumstance are very large.

The product of complexity and uncertainty makes it very hard to write a contract that fully implements the desired commitment of the parties with no wiggle room. Certainly, few individuals have the skills and time to do so. What I have suggested at http://emergentfool.com/2009/04/13/if-i-were-in-charge-health-care-edition/ is that we introduce a new intermediary that represents individuals in the insurance contract. They help define and enforce contracts with different levels of care on behalf of individuals.

Moreover, I also suggest that, to align their incentives with policyholders, they get a cut of any payouts. Then the insurance company and the individuals both have expert representatives that can negotiate a sufficiently detailed contract. There might be a role for government to provide rapid arbitration of disputes (due to the time critical nature of health care decisions), but other than that, we just have private contracts.

RL writes:

TMLutas: I agree with you completely. I recall Richard Epstein pointing out once that we'd have people take motorcycle helmet safety much more seriously if we let the next 3 or 4 uninsured people who smashed their heads in motorcycle accidents just die in the road.

hacs writes:

That reminds me the unemployed pool as incentive to not shirk, a kind of defunct pool (an enormous punishment).

Chuck writes:

"For government programs such as Medicare and Medicaid, where spending as a percent of GDP has risen much more than private health care spending as a percent of GDP..."

Isn't this because retiree's are mostly covered by medicare rather than private insurance and retirees are increasing as a percent of population?

In regard to Medicaid, couldn't this be a function of increased demand (more people qualifying) rather than simply increased costs?

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