Arnold Kling  

What is Health Insurance?

Pre-Debate Disagreement... Geanakoplos on Leverage Cycles...

The issue gets discussed at Patriot's Quill.

Let me offer two choices:

(a) Health insurance is the collective provision of all health care.
(b) Health insurance is the sharing of extreme risk in health care spending.

In my view, (a) represents what most people think of as good health insurance. For example, I have a friend who says her health insurance is great because she can get new eyeglasses every year for everyone in her family for a co-payment of only $10.

We have never observed (b). (b) would mean something where you only make a claim when your expenses are going to run into the tens of thousands of dollars. Claims would be rare and large, as in fire insurance. Premiums would be low, as in fire insurance.

Since we never have observed (b), we do not know whether it is something that could be provided by the market or would have to be provided by government. I am willing to concede that it may be the latter. However, what most people mean by universal health coverage is (a), which has some pretty obvious incentive problems. [Update: see Regina Herzlinger on universal coverage.][Further update: see Michael Cannon's counter-argument to Herzlinger.]

When people cut back on health care, what happens? The evidence (from the famous Rand experiment) is that they cut back on "necessary" care, as defined by doctors (who are not exactly disinterested on the topic of how much people should spend on medical services). The result on health outcomes of these cutbacks is not visible.

Peter Orszag (now Obama's had of Office of Management and Budget), Jason Furman (an Obama adviser), and Shannon Brownlee (author of the book Overtreated) are among those who acknowledge that much of our health care spending (a standard estimate is about 30 percent) goes for medical procedures that are not cost-effective. [update: Michael Cannon emails that the claim is even stronger--that 30 percent of medical spending creates no value at all. Actually, I am not exactly sure what these folks would claim if pinned down. But Michael may be right.]

The foregoing are among those on the left who believe that government-run health care can save money. But if you believe that government can save significant money on health care, then by the same token you have to believe either:

(i) our current mix of medical services is optimal, and we could deliver it much more cheaply;
(ii) our current mix of medical services is far from optimal, with too many cost-ineffective services provided.

Most people who can do arithmetic realize that (i) is not the answer. The standard bogeymen of drug industry profits and insurance company overhead are not big enough to make a major difference. Moreover, the evidence for (ii) is broad and overwhelming.

The bottom line is that what we think of as health insurance is not going to survive if we are going to get control of health care costs. Either health insurance is going to become very intrusive about our choices of medical services (the top-down, government option, under the guise of "health care quality"), or we are going to see much higher deductibles and co-payments (the bottom-up option).

For an example of health insurance that tries to get at the insurance aspect, see Health-status insurance, by John Cochrane.

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The author at The Freedom Thinker in a related article titled Health Care Danger Signs writes:
    A well reasoned perspective on health insurance, health care, and medical care is provided as follows: What is Health Insurance? - Arnold Kling Let me offer two choices: (a) Health insurance is the collective provision of all health care. (b) Health in... [Tracked on April 13, 2009 10:34 AM]
COMMENTS (22 to date)
Les writes:

It is helpful to distinguish between HEALTHCARE and MEDICAL CARE.

HEALTHCARE includes appropriate exercise, nutritious diet, and avoidance of smoking and excessive alcohol. It is mainly preventative of ill health, and physicians can do little about it.

MEDICAL CARE includes medical tests, medical imaging, prescription drugs, and surgery. It is mainly curative, and it is what physicians do.

This is an important distinction, but often overlooked. Therefore when people say "healthcare" they often mean "medical care" rather than healthcare.

Fenn writes:

I tend to only go to the doctor if I have an illness that persists for weeks or some sort of bleeding.

Last visit, I was in the waiting room for 45 minutes. During that time 2 drug reps came looking for face time w a doc and tried to book the opportunity to take the office to lunch (they have 2 hr breaks).

The comely female managed to book an October date. This way about a month ago. I didn't get to hear the outcome for the gentleman.

Brian writes:

Health insurance does not insure health at all. It insures the financial assets of the household. The chances of being refused essential medical care for lack of insurance at any US hospital are almost nil. All children can be covered, even retroactively, by Schip. Therefore, not buying health insurance if you have no assets to protect is not irrational. Justifying a $12,000 per year major medical policy requires a higher level of expected losses than many are in a position to lose.

Paul Zrimsek writes:

Either health insurance is going to become very intrusive about our choices of medical services (the top-down, government option, under the guise of "health care quality"), or we are going to see much higher deductibles and co-payments (the bottom-up option).

If you're implying that these two options are logically mutually exhaustive, I think you're mistaken. In theory, the government could cut down on cost-ineffective services simply by not paying for them-- a top-down decision, but not the sort of thing people ordinarily have in mind when they talk about government being "intrusive".

If, on the other hand, you're merely skeptical about whether the government would actually do this-- join the club.

DC writes:

Health insurance, be it private or medicare, serves to guarantee payment to physicians/hospitals/etc. Sure, lots of the treatments, procedures, office visits may be individually cost-ineffective, but they keep the system open.

Take for example a neurosurgeon. Be it trauma surgery or intracranial tumor removal, many of the procedures are 'cost-ineffective' in their own right. But, when you have your car wreck or brain tumor, you hope there is a well trained neurosurgeon on staff for your case when you come in, to get you back to your economically productive life.

You see medical treatment is unpredictable on many levels, not the least of which is incidence of disease. Part of the unwritten social contract where indigents and others get basically free care, is that often medical students, residents, and other trainees are trained while providing that care. That way, when they are your treating physcian 10 years down the road at a swanky suburban hospital, they've had tons of practice. Staffing levels must be maintained because it takes a long time and lots of resources to train a physician/surgeon.

So yes, a significant number of treatments are cost-ineffective in isolation, but keep the system functioning. Sort of like a standing army. In peacetime, spending money training troops and housing them, etc., may be cost-ineffective at the time -- but your sure hope they're ready when you need them.

Thomas DeMeo writes:

The only thing that could work is a third way; for the individual patient to directly employ an organization to make the decisions on their behalf, balancing the economic and health directives of the customer. This function must be decoupled from the other actors in the system in order for it to work. This would be something like a primary care physician, combined with an aggressive buying organization.

JP writes:

Arnold -- GREAT post. This is the kind of thinking and writing that makes "Crisis of Abundance" such a terrific book.

Great point Les and great post. I've read somewhere that 2/3 of medical costs are diseases (diabetes, STDs, heart disease, etc.). Most diseases are preventable due to diet, lifestyle, etc.

Therefore, to me a discussion of controling medical care costs must be a discussion of controling individuals diet and lifestyle. This to me is a scary thought...

I wonder economically how the government can incentivize society to participate in a healthy lifestyle. You can only take a horse to water...

Statistically have their been any programs that have demonstrated providing social welfare programs that take care of the outliers while influencing the majority to change behavior?

Milton Recht writes:

We are medically over insured and paying excessive premium costs because of it. We also need to distinguish between private health insurance purchased by employers and individuals and the government entitled medical care systems of Medicare, Medicaid and other government-mandated health programs. They are two different problems with two different solutions.

The private insurance system is fixable without a need to resort to a government medical health care system. It requires a reinstatement of market pricing mechanisms. The government medical entitlement system, Medicare, etc., is much more difficult to fix. Obama's call for government medical health care is really an attempt to broaden the coverage base of the Medicare system to include all individuals under 65. It would increase the tax base, dilute the voices of seniors about benefits and costs, and allow for an increase in premiums and a decrease in medical benefits to seniors.

Fifty years ago as a child, my family had major medical insurance. It covered the in-hospital costs of the hospital stay, including doctors, medicine, diagnostic procedures, surgery, anesthesia, etc. It did not cover doctor visits to his office or prescription medicines filled at a pharmacy. We paid the out of pocket costs for medicines and doctor visits. It did not cover voluntary surgeries, but it did cover the hospital costs of a pregnancy including birth. The insurance was affordable.

Thirty years ago, my employer only provided major medical and it covered the hospital and doctor costs of the birth of my children. We paid for doctor office visits and medicines. We did not overuse the health care system because we were aware of the costs to us.

A decade ago, I attempted to purchase a major medical insurance policy for my family and myself. I could not because no insurer in my state offered that type of coverage. I recently saw a TV advertisement for an ala carte medical plan where I could choose my own medical benefits. However, my state does not allow insurers to offer that coverage to its residents. My state is forcing me to buy more health insurance than I want. I am forced to buy a comprehensive health insurance policy that covers doctor visits and medicines.

Under a major medical plan, I would save money even if I paid the full costs for my daily medicines and regular doctor visits. I buy more coverage than I want or need. I overpay and I have an economic incentive to get back the value of my overpayment by visiting the doctor more often than I would with a less comprehensive but more affordable policy. My medical coverage unnecessarily increases my use of medical services and increases health care costs. Also, I am subsidizing the patients and doctors who overuse the medical system and they have no economic incentive to monitor their costs. In addition, neither major medical nor comprehensive health insurance covers my potential need for long-term care and catastrophic insurance.

In all other types of insurance, I have freedom to design my own plan. I can choose and purchase basic minimum coverage and add extra benefits for an additional cost. In health insurance, the available benefit options are much more limited.

A simple change that would permit an insurer to offer a minimum policy with add-ons in all 50 states would lower health insurance costs. Also, changes that allowed policies that distinguished between hospitalization and doctor visit benefits would lower costs. Additionally, consumers would have a true incentive to monitor and restrain medical costs because there would be more patients paying their own out of pocket medical costs. Those patients that want full medical coverage could get that type of policy but at much more realistic costs, that reflects their usage patterns. Employers who offer medical benefits would also offer both types and employers would see a cost reduction because some employees will choose the less expensive option.

Health insurance costs are excessive because the market pricing system is not working. Part of the failure of the market pricing mechanism for health care is due to our tax system of allowing employers to deduct the cost of employee medical benefits and part is due to restrictive state regulations. Changing both would allow market pricing to work and influence demand and costs at the consumer level.

Fixing government entitlement medical systems, such as Medicare, are much more difficult to design. These programs are the real costs problems facing our government and taxpayers and not private health insurance. Political ramifications constrain the choices and discussions of changes to these government medical systems. The fix however is not to bury this problem in a broadened government entitlement health care system.

Floccina writes:

@The Freedom Thinker the evidence is that the preventive measures that you suggest increase life time medical spending. The evidence is also that most costly diseases in industrialized countries are mostly not preventable. (I used most and mostly in the same sentence because because diabetes, one the expensive diseases, could be prevented by keeping weight down in some cases but in most cases.)

@DC I think you are misunderstanding what Arnold means by not cost-effective. See Hanson on Health

DC writes:

"Fifty years ago as a child, my family had major medical insurance...The insurance was affordable."

Well of course it was affordable. 50 years ago, if you had a heart-attack, the extent of your care was, 'rest and hope you survive." Now we have heart caths and pacemakers and stents and bypass surgery. People have heart attacks and get back to work and productive life. 50 years ago, if you had lymphoma, you were dead. Now odds are you'll be cured. 50 years ago, if you couldn't walk because your hip or knee was worn out, well, off to the rocking chair for you. Now you can return to an active life.

Sure, your insurance was affordable 50 years ago. But you didn't get much for that 'affordability'. A Schwinn bicycle is affordable, but it's not great for international travel. Chicken McNuggets are affordable, but they're hardly a great meal. If by affordable, you mean, not getting much, well, medical care can be affordable, just don't avail yourself of any treatments developed in the last 50 years.

Dan Weber writes:

for the individual patient to directly employ an organization to make the decisions on their behalf, balancing the economic and health directives of the customer. This function must be decoupled from the other actors in the system in order for it to work. This would be something like a primary care physician, combined with an aggressive buying organization.

You are close to my thinking, which is that care can be administered at the level of "hospitals." Mayo Clinic and VHA are two good examples. Whether they bill me annually or the government pays them is irrelevant. But the doctors are all salaried, and a GP is "in charge" of my health, backed up by an army of nurses with huge medical records.

Professor Kling, I think you over-estimated Shannon Brownlee's urging of government-run care. Yes, her book describes some well-run public care institutions, but she also describes very poorly-run public care institutions.

Floccina writes:

@DC to take just one of your examples:

Hadler on Heart bypass surgery

I think bypass surgery belongs in the medical archives. There are only two reasons you’d ever want to do it: one, to save lives, the other to improve symptoms. But there’s only one subset of the population that’s been proved to derive a meaningful benefit from the surgery, and that’s people with a critical defect of the left main coronary artery who also have angina. If you take 100 60-year-old men with angina, only 3 of them will have that defect, and there’s no way to know without a coronary arteriogram. So you give that test to 100 people to find 3 solid candidates—but that procedure is not without complications. Chances are you’re going to do harm to at least one in that sample of 100. So you have to say, “I’m going to do this procedure with a 1 percent risk of catastrophe to find the 3 percent I know I can help a little.” That’s a very interesting trade-off.

Dave writes:

Eh, standard "health insurance" is weird from a usual market insurance perspective but I think it's a good idea. This year, I'm being treated for sleep apnea. It will have cost $7,000-10,000 by the time I'm done.

Actuarially, I'm sure this treatment is the right thing to do and well worth the cost. But I would have experienced a lot of hesitation and stress over spending that much money. Having health insurance made it a lot less stressful and easier to make the right decisions. This is even moreso for people that don't have a small cash savings cushion.

People need to understand that "health insurance" is just a funny name for a service package that includes prepayment, insurance, price negotiation with providers, and determination of medical necessity and benefit of therapies. All those services are "needed" (i.e., beneficial). I guess they don't in theory need to be bundled but I suspect there are good economic reasons (e.g., economy of scale) why they are.

floccina writes:

My links did not work. Here they are:

Hadler on Heart bypass surgery:

Hanson on Healthcare:

[I fixed them for you. You forgot to put quotation marks around the URLs.--Econlib Ed.]

Thomas DeMeo writes:

Dan Weber writes: "You are close to my thinking, which is that care can be administered at the level of "hospitals."

Your description doesn't sound like we agree at all.

The system is failing because we don't have buyer/seller entities working from opposing positions to meet at a price/value proposition. You position has the hospital taking both sides.

I grant you that a hospital is the smallest entity that can take full responsibility for the overall healthcare picture of an individual, so it is a good thing to eliminate the hierarchies above that level. However, there are still serious incentive issues with the setup you describe.

Patients need an advocate that is not associated with the providers or the insurers.

Milton Recht writes:


I was trying to make the point that insurance for doctor visits, medical tests and medicines is bundled with hospital medical care insurance and they are not available separately. Unbundling the two will increase the size of the class of cost conscious buyers for doctor visits, tests and medicines.

I do believe that major medical insurance is much cheaper than comprehensive medical insurance. The costs of most medical improvements over the years is not the cause of our high medical premiums.

The two examples you mention, and similar treatment improvements, do not occur frequently enough in the population to increase overall health insurance premium costs.

The yearly cancer rate in the US is 467 per 100,000 individuals and about 5 percent are lymphomas. Lymphomas patients are 2 hundredths of one percent of the population. Without decreasing the number to remove those with aggressive cancers with a few months life expectancy that do not respond to treatment and those that have cancers that do not impact life expectancy and do not require any treatment, the cost impact to the premiums of the entire insured population is still tiny.

Heart attacks benefit greatly from beta blockers, aspirin, statins, diet and exercise. You will aslo find the cost impact of pacemakers and stents to the overall insured population insignificant.

Yes, there are expensive medical procedures, but most are not used on enough of the population to significantly impact premium costs.

Additionally, most of the expensive medical procedures are in the over 65 group covered by Medicare and they do impact private health insurance premiums for the under 65 age group. Likewise, the poor have extra medical costs because of lack of medical care and poor health habits (eg, higher smoking rate, poor prenatal care, etc) and they also do not impact private insurance premiums because many are covered by government health programs for the poor and are not insured by the private health sector.

Overuse and unnecessary or ineffective medical tests and treatments for the majority of the population are a substantial cost factor in the private insurance market because it involves a greater number of individuals in the private health insurance market. It is not knee or hip replacement operations or stents or pacemakers.

Floccina writes:

The efficacy of stents, beta blockers, statins and diet are being hotly debated. We are not sure that any of these have any net benefit to health.

Evan writes:

What do you think about insurance companies charging higher premiums by race? I.E. african americans have a higher probability of a stroke...

Larry writes:

While I agree with Arnold most of the time, here's at least one counterexample on the question of whether cutting expenses affect care. Check this AP story out which documents the fall in spending on diabetes treatment since the crisis hit.

Dary writes:

When people cut back on health care,what happens? The evidence is that they cut back on necessary care, as defined by doctors who are not exactly disinterested on the topic of how much people should spend on medical services. The result on health outcomes of these cutbacks is not visible.

George writes:

With apologies to John Wanamaker:

"I know that a third of medical spending is wasted — I just don't know which third."

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