David R. Henderson  

Gorman on Health Reform

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This month's featured article on Econlib is by health economist Linda Gorman. Gorman points out that Blue Cross was given an important tax advantage over commercial insurers early in the game and that Medicare and Medicaid were modeled on Blue Cross. Gorman also discusses a sector of the U.S. health-insurance market that seems to be working well, namely, the market for individually-purchased health insurance.

Excerpt:

Direct-purchase markets pool risk extensively, charging high risk people far lower premiums than their health status might indicate. Most direct-purchase policies are renewable without additional underwriting. This means that as long as he pays the premium, an insured person can keep his policy no matter how sick he gets. Contrary to popular claims, state laws generally prohibit raising a sick individual's premiums unless an insurer also raises the premiums of everyone else in his rating class.
Pauly and Herring report that direct-purchase insureds who had medical expenses about 4 times that of other people enjoyed premiums that were only 1.6 times as high. People who buy a policy and become ill have a strong incentive to continue paying. This may explain why age and sex were generally better predictors of direct-purchase premiums than chronic conditions. Marquis et al. concur, reporting that the individual direct-purchase market is "an important source of long-term coverage for many who purchase it" and that "there is substantial pooling" that "increases over time because people who become sick can continue coverage without new underwriting."

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COMMENTS (7 to date)
spencer writes:

The article says:

In states that are so wedded to the Blue Cross model that they have community rating laws requiring that premiums be the same for everyone in a given geographic region, premiums are higher for everyone. In a study of 26.8-million commercially insured people, Willey et al. found that just 0.8 percent of the population was severely ill. That group had average annual expenses of $29,273. Those with less-serious chronic disease spent $8,225 a year. Half of the population had expenses below $989 a year.

Isn't this exactly how insurance is suppose to work? You pay a premium knowing full well that you probably will not collect.

You do not want to collect on your home owners or auto insurance. So why should health insurance be different?

I do not understand what point you are trying to make.

David R. Henderson writes:

Dear Spencer,
Yes, I do think health insurance is supposed to work that way. I took her to be making an empirical point about the distribution of health expenditures.
Best,
David

kebko writes:

The article seems to include a nice history of the industry, but the excerpt seems naive at best. A market where once you need the service, you are stuck with one provider, is not a market. There are plenty of ways for the insurance company to harrass you or to provide legal avenues for low cost members to find better coverage while high cost members are stuck with increasing premiums.

BT writes:

The concept of insurance is great until you actually need it. Then try getting insurance. Go to any cancer survivors group and candidly ask about health insurance.

Colin K writes:

Spencer: "You do not want to collect on your home owners or auto insurance. So why should health insurance be different?"

Because most health insurance is more like a new-car warranty than collision insurance. We prefer if a car never has a hiccup but we have no incentives other than inconvenience to defer maintenance or repairs.

A true insurance model would be one where a person purchases a policy that guarantees reimbursement of up to $1m of expenses in the policyholder's lifetime for a fixed payment of $X per month for life. In other words, exactly what life insurance is, except you can withdraw benefits in smaller increments before you die.

A policy defined in terms of straight cash benefits would eliminate all fears relating to "will my insurer deny this scientifically-unproven-but-lifesaving experimental cancer treatment?" Whether you spend the money on medical care or a fancy new car to drive to the treatment center is up to the IRS to worry about.

John Fembup writes:

Spencer: "You do not want to collect on your home owners or auto insurance. So why should health insurance be different?"

But surely that is not true.

There are some who see the purchase as you suggest. But I think most people seek insurance because they WANT to collect on it. Because they want insurance to pay for virtually all their medical expenses, at little personal cost. That's hardly a surprise, is it?

And most people aren't really satisfied with, and don't want, "insurance" anyway - I mean a policy that reimburses mainly the large, unaffordable, or unbudgetable expenses. Say, a policy with a deductible of $1,250 or so per year - - a deductible like Medicare's in other words.

No, I think most people want full or virtually full reimbursement even for minor or routine medical services - office visits, lab tests, pharmacy, or even vitamins, glucosamine, immunizations required by law, or any number of so-called health products advertised on the late-night AM band. The resulting costs are of course built into insurance premiums, meaning that we are simply trading premium dollars for reimbursements of small expenses and think we're benefitting from our "coverage". In fact, this whole process has turned most insurance into an expensive kind of insulation - just not the fiberglass kind.

Dan Weber writes:

A policy defined in terms of straight cash benefits would eliminate all fears relating to "will my insurer deny this scientifically-unproven-but-lifesaving experimental cancer treatment?" Whether you spend the money on medical care or a fancy new car to drive to the treatment center is up to the IRS to worry about.

This doesn't sound like insurance; it sounds like a savings plan. The only way someone wouldn't collect is if they died suddenly (and convincingly so there were no efforts to resuscitate). $1m in coverage would cost $1m in premiums to a first-order approximation.

I wasn't aware that state laws often required insurance companies to keep rates the same if I get sick. This is a tremendous relief. As kebko points out, there are still ways that companies can mess with the pool. For example, jack up rates very high on every one, and then solicit the low-risk members to move into a new low-cost pool. They won't do that every day, but over the course of 20 years I could see them pursuing those goals, even if not consciously.

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