Bryan Caplan  

Insurance as a Prisoners' Dilemma

Financial Reform, 2... I (More or Less) Agree With Kr...
I've got a little toenail fungus. 

Now that you're done cringing in disgust, let's get to the economics.  My HMO doesn't cover treatment, because the problem is "merely cosmetic."  Until recently, though, I didn't care, because they're weren't any good treatments for nail fungus.  There's a pill that works, but also occasionally causes liver damage.  No thanks.   

Then I learned about a new laser treatment that's supposed to be both safe and effective.  Now I wish my HMO covered it.  But as an economist in good standing, I'm happy to go out-of-pocket as long as MB>MC.  So I called up the clinic for more information.  When the secretary informed me that, "Insurance doesn't cover this treatment," I was positively delighted.

Why, you ask?  It's not envy - I don't mind if other people have better insurance than I do.  The reason for my delight: As soon as she said that no insurance companies covered this treatment,  I knew it would be reasonably priced!

The moral: Health insurance is, in large part, a Prisoners' Dilemma.  If everyone but you has it, medicine will seem prohibitively expensive.  Demand is high, comparison shopping is unheard of, and no one cares but you.  When nobody has insurance, though, you probably don't need it.  Lower demand and more comparison shopping make treatment affordable.  Which makes me wonder: Where would you rather live - a country where everyone has health insurance, or a country where no one does?

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COMMENTS (32 to date)
David R. Henderson writes:

Good post, Bryan. I can't stand the suspense. What's the price?

Jesse writes:

I can't believe you'd assume that I would be finished cringing in disgust at this point... ew.

But now that I am done cringing, finally, could someone explain to a lay person, and I mean really lay in my case, what is meant by "MB>MC"?

David J. Balan writes:

I don't think the fact that Bryan Caplan can effectively comparison shop for a toenail fungus treatment tells us much about how effectively most people can comparison shop for, say, brain surgery.

HispanicPundit writes:


MB>MC is "Marginal Benefit > Marginal Cost". Google it, there's alot more to it than that.

Matt C writes:

Aren't you the insightful one.

I used to live in south Texas. Lots of people got cheap and good quality medical care by going over the border to Mexico and paying cash. You could also buy pharmaceuticals without a prescription. Buying medical care seemed to be a non bureaucratic and non hysterical process where you were treated like a customer and assumed to be a competent adult.

I admit my experience was only superficial, but when people talk about how the U.S. needs to copy some other country's medical care system, I always think "yes--Mexico". Fat chance.

Joe Torben writes:

"When nobody has insurance, though, you probably don't need it."? Huh? So if nobody had home insurance, nobody would need that either?

Health care is incredibly complex, and I am by no means suggesting that mandatory insurance is any kind of solution, but suggesting that insurance (in some form, paid by someone) isn't needed is, IMNSHO, just flat out wrong.

If you do not have insurance on your house, I will give you credit for at least being consistent. I will also consider you nuts.

Joe writes:

This is asinine. A Quadruple bypass or three-month staph infection will never be affordable for families at the U.S. median household income - about $50,000. For that matter, a broken wrist from football would probably break the bank. Wake up, man!

Mitch writes:

Assuming that a society feels that 'health' is a right -- not a privilage -- then universal coverage is essential.

Additionally, if you are of the mindset that a generally healthy populace has positive externalities, then mandatroy (universal) healthcare is efficient, since we can't trust individuals (free riders) to consume as much care as they ought to (or can individually afford) in order to maintain the optimal level of health/compliance within the total market place.

Through the praxis of the prisoner's dilemma, players who fail to account for the cost/benefit of all agents affected by the transaction will potentially defect; i.e., opt out of treatment that would otherwise be beneficial to both the recipient and society because he miscalculates how much treatment is worth to all parties involved. In this particulare case, perhaps this fungus is communicable and Brian spreads his disorder to everyone at his gym/pool/shoe store because his myopic calculation extends only to his unique MB/MC rather than the complete MB/MC market calculation.

The salient question that economists must answer before distilling healthcare questions down to cost/benefit signalling is how far do we extend the MB/MC analysis - who all benefits and who bears all the costs?

Buzzcut writes:

Do Jesse, Joe Torben, and Joe read this blog regularly? Read anything by Arnold Kling?

What these gentlemen are terming "insurance" is nothing but. And Arnold's solution to our healthcare problems is a truly catastrophic health insurance plan where the little things (like toenail fungus) are paid out of pocket, and most (but not all) of the big things (like the $50k for a quadruple bypass or three month staph infection) are paid for by insurance.

True insurance is there to pay for the things that, if they happen, will bankrupt you. Toenail fungus is not one of those things.

John Thacker writes:

Indeed, the most expensive procedures to pay in cash are the ones covered by insurance where there's an extremely high nominal price and then a negotiated "discount" for all insurance providers.

In Canada, laser eye surgery and other cosmetic surgery is not covered under Medicare. Guess which types of clinics you see all other the place, and at cheaper prices than in the USA?

Joe Torben writes:

Buzzcut: I do of course read this blog regularly. I am just commenting on the sentence "When nobody has insurance, though, you probably don't need it."

That sentence is ridiculous. Sorry, but it really is. It is good economic policy for most people with ordinary incomes and ordinary amounts of risk aversion to have home insurance.

And if your particular home insurance doesn't cover the paint job on your fence when someone scratches it, that doesn't make home insurance unnecessary.

"True insurance is there to pay for the things that, if they happen, will bankrupt you. Toenail fungus is not one of those things." is just a straw man, and a bad one at that. Who suggested it should?

Kevin Dick writes:

This is why when people ask me what to do about health care, one of my proposals is to heavily tax any form of _primary care_ insurance so that very few people have it. Relatively small and predictable costs are not what insurance is for. But having it is not simply a harmless cost transfer. It gets you into precisely the PD problem Bryan has identified. So everyone feels they have to have it and then everyone overconsumes it.

Eric writes:

Joe Torben -

Part of the confusion, I think, lies in the meanings of the word "insurance" in American English.

Meaning One - Paying a small sum in order to be insured against a small probability/high cost event (e.g. Home Insurance, or High-Deductible Health Plans).

Meaning Two - Paying a modest sum in order to have a third party pay bills that are extremely likely to occur and affordable when they do. (a subset of health insurance is all I'm aware of that does this).

I have health insurance of the first type, but not the second type. I don't expect to be bankrupted anytime soon. I'd guess my family's uncovered medical bills are $4,500 plus or minus $1,000 a year. I see no reason to pay even $5,000 per year to have someone else pay these bills. The primary reason these plans exist is tax advantage. That is, I might only pay $4,000 after tax if I buy "type 2" insurance.

Bryan is wondering if we'd rather live in a world where no one had "type 2" insurance. You're interpreting "insurance" as "type 1" insurance, and saying a world where no one had "type 1" insurance is crazy.

SWH writes:

The likely benefit of a country were no one has insurance would be that doctors would give more attention to the patient and all procedures and intervention would be preceded by more thought and contemplation than occurs today.....with the result of better care.

Bryan Caplan writes:

David - The price is $950, which includes a consultation and a 4-month follow-up with virtually no queue.

Sarge writes:

I read an article recently which makes a similar point. It turns out that medical procedures which are not typically covered by insurance tend to be the ones which innovate the fastest and come down in price most rapidly. Quick examples would be various forms of cosmetic surgury or eyesight correction.

Joe, I think you missed Bryan's point. The reason why the medical procedures you describe are so unaffordable is the fact that they are almost always paid with insurance, so there is no price competition. Hence, if you need that level of care and are one of the one's without insurance, you're pretty much screwed under the current system. If nobody paid with insurance, there would be far more incentive to "shop around", and hence much more price competition.

Clayton writes:

@Eric - Thank you for that explanation.

El Presidente writes:


Interesting observation. If the absence of insurance makes prices come down, then shouldn't we be trying to make sure that NOBODY has health insurance so that all medical care is cheaper? I mean, that would be a logical extension of your argument as applied to national policy, wouldn't it?

My advice: Try the pill. It's cheap. It's covered. It didn't hurt my liver. :-)

Joe writes:

I am doing something wrong if 950.00 is affordable....

alex s. writes:

It might be an interesting comparison to look at veterinary medicine. There's a fair amount of overlap in care and treatment (especially with drugs and lab tests). Costs are rising, in part because new treatments are becoming available and in part because people are willing to pay. Insurance is rare, but I think it's growing (or at least there are people who would like it to grow).

Sam Wilson writes:

Lasers are awesome. It seems like someone's thinking of something new to cure with them every couple of years or so. I hope that in a few short decades, armies of cybernetic doctors will roam the land, curing illnesses with laser bazookas deployed from medical gunships controlled by a hive mind based in the Mojave Desert.

"You will be vaccinated. Insurance is futile."

Adam writes:

@El Presidente

If the absence of insurance makes prices come down, then shouldn't we be trying to make sure that NOBODY has health insurance so that all medical care is cheaper? I mean, that would be a logical extension of your argument as applied to national policy, wouldn't it?

Yes, absolutely. But not all *kinds* of insurance. High deductible, catastrophic insurance shouldn't be gotten rid of. Home insurance and car insurance are of this type.

If we had car insurance that covered car maintenance and not just repairs, you'd see $100 wiper blades and $1000 oil changes.

Ramon writes:

"...The price is $950..."

I had a toenail fungus while at graduate school and no money at all.

When I tried to look for a cheap solution on the internet, I kept finding pages that described the fungus and the pharmaceuticals, always with the recomendation "you have to talk to your doctor", "the medicine is sold only with prescription". So, aparently it was impossible to avoid paying a doctor.

Then, I decided to limited my google searches to the domains .uk and .ca and voilá. The best advise came from some medical institutión in the UK: "just wait a few months to see if the fungus goes away, that usually happens."

It did

Zombiehero writes:


"If we had car insurance that covered car maintenance and not just repairs, you'd see $100 wiper blades and $1000 oil changes."

Dang right...Imagine if we had a food insurance, where everyone just paid a monthly premium and then could binge on whatever they wanted?

Do you think they'd still make spam if that happened?

Joe Torben writes:


I don't think the second definition of insurance is standard by any means. As I and others have pointed out, that's not how car and house insurance works, and we can all agree that it would be a mess if it did - coincidentally the same mess you currently have for health care. (I'm in Europe, so we have a whole different mess. Not sure it's better, but let's not go there for now.)

I think it's very sloppy to use the term "insurance" to cover the second case. In fact, I would like the leading lights, and Bryan is certainly one, to be more precise and describe why current health care solutions are not "insurance" in the way we usually look at it.

Eric writes:


I agree that it's sloppy to use insurance for "type 2" insurance, but it's certainly standard in American English. When we talk about "National Health Insurance", we're really talking about a "prepaid medical plan", i.e. "type 2" insurance.

I wish we had a different term, too. Being "uninsured" sounds horrible. Being without a "prepaid medical plan" doesn't sound nearly as bad.

Joshua Lyle writes:

Using the word "insurance" what Eric refers to as "type 2 insurance" is mostly an Americanism. In Britain, for instance, there is a distinction between "insurance" (generally conforming to the type 1 definition) and "assurance" (generally conforming to the type 2 definition).

Says wikipedia:

The specific uses of the terms "insurance" and "assurance" are sometimes confused. In general, in these jurisdictions "insurance" refers to providing cover for an event that might happen (fire, theft, flood, etc.), while "assurance" is the provision of cover for an event that is certain to happen. "Insurance" is the generally accepted term, however, people using this description are liable to be corrected. In the United States both forms of coverage are called "insurance", principally due to many companies offering both types of policy, and rather than refer to themselves using both insurance and assurance titles, they instead use just one.

Eric writes:


Thanks. I'm sure this is just a semantic issue, and I hate trying to "prove" what a word means. I'm pretty sure, though, that Bryan meant "pre-paid health plan" or "assurance" or "type 2" insurance when he said insurance. It would make the health care debate a lot more clear in the U.S. if we had a word for "pre-paid health plan" that is different than "insurance". If you do a U.S. google search for "health insurance" you find a number of sites offering "pre-paid health plans" with small deductibles.

El Presidente writes:


Yes, absolutely. But not all *kinds* of insurance. High deductible, catastrophic insurance shouldn't be gotten rid of. Home insurance and car insurance are of this type.

Mr Smith says:

"There is not, however, a more certain proposition in mathematics, than that the more tickets you adventure upon, the more likely you are to be a loser. Adventure upon all the tickets in the lottery, and you lose for certain; and the greater the number of your tickets the nearer you approach to this certainty."

So, if we pay to insure for everything we are guaranteed to lose money. It would seem that Smith agrees with your assessment.

I have more questions though. Who decides what is a high deductible and a catastrophic event? In the cases of cars and homes, these judgements would be functions of risk tolerance and of income relative to prices, right? Would we forbid people to purcahse any other type of insurance because it tends to increase prices generally, even if it tends to increase their utility?

Floccina writes:

"$50k for a quadruple bypass "

The provider will give you terms. You will make the payments after the service rather than before. You will look for a bargain (see: Apollo Healthcare etc.). Also if a person can afford a $100K home and $20k car why can they not afford a 50k surgery?

BTW some doctors including Dr Nortin Hadler author of "The Last Well Person" doubt that heart bypass yields net benefits to health. He says in his book that heart bypass is rarely done outside of the USA.

Steve writes:

Isn't it well established that the problem with health insurance (true financial insurance, not just a 3rd party payor plan) is adverse selection? I mean, some of the problems with the health care market are undoubtedly caused by the types of plans that people have. But even if you write health insurance policies like auto insurance policies, the problem of adverse selection would still cause underwriting problems for traditional health insurance plans. Maybe a creative solution would be developed (pre-natal lifetime health insurance policies for your kids?).

Anyway, what is the libertarian or libertarian-lite solution to adverse selection? Or what is the least bad solution if you take it as a given that everyone will get health insurance that covers X% of expenses above $X?

And as for those talking about how health insurance policies need to be more like high deductible auto and home policies... are auto and home policies really "high deductible?" Isn't a typical auto policy deductible often 1% or so of the value of the vehicle? And homeowners insurance often has a deductible of around .1% of the value of the home, doesn't it?

Steve Roth writes:

>Where would you rather live - a country where everyone has health insurance, or a country where no one does?

Are we talking actual countries or hypothetical ones?

If actual, the answer is pretty obvious, don't you think?

France, or Somalia? Hmmm....tough choice.

If hypothetical, should we assume that a thriving libertarian utopia exists in this hypothetical world, an entity that has never emerged in the real world? Is there any way to realistically envision such a utopia?

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