David R. Henderson  

CEA on "Reforming Health Care"

The Right of Exit... A Non-State Within a State?...

The chapter, "Reforming Health Care," in the Economic Report of the President February 2010, is chock full of interesting facts and arguments. There are strengths and weaknesses.

What this chapter shares with the other 9 chapters is that it actually cites specific literature and has a bibliography at the end. I've been reading these reports since I was a summer intern at the CEA under Herb Stein in 1973 and this is the first time I've seen this. One of my frustrations, when I was working on the 1983 and 1984 ERPs, was that we didn't do this and the result was a lot of inside baseball. Facts were not made up; when we made a claim, we had a specific study in mind that backed it. But we never told the reader the names of those studies. For the first time, the Economic Report of the President is written by people who apparently have the intellectual self-confidence to invite us to check out their sources.

The chapter also gives succinctly what the CEA sees as the four primary impediments to health care markets working well. They are: (1) adverse selection, (2) moral hazard, (3) Samaritan's Dilemma, and (4) incomplete insurance contracts. I don't think the author, presumably senior economist Mark G. Duggan, argues all of these points well. But at least he tells us "where he's coming from."

What was strange about Duggan's discussion of adverse selection and moral hazard is that he ignored his own discussion later in the chapter. On adverse selection, for example, he laid out how asymmetric information leads to adverse selection, writing:

Insurers cannot perfectly determine whether a potential purchaser is a large or small health risk. (p. 186.)

But then later, in discussing the House and Senate bills, he writes:

These regulations would correct insurance market failures by preventing health insurers from responding to adverse selection by raising rates and denying coverages . . . . (p. 202)

Huh? Just 16 pages after laying out that the adverse selection problem occurs because insurers can't adjust rates to risk, he says that these regulations, which he seems to think are good, will prevent insurers from adjusting rates to risk.

On moral hazard, Duggan writes:

A second problem with health insurance is moral hazard: the tendency for some people to use more health care because they are insulated from its price. When individuals purchase insurance, they no longer pay the full cost of their medical care. As a result, insurance may induce some people to consume health care on which they place much less value than the actual cost of this care or discourage patients and their doctors from choosing the most efficient treatment. (p. 187)

But in a section titled, "Declining Coverage among Non-Elderly Adults," Duggan writes:

The generosity of private health insurance coverage has also been declining in recent years. For example, from 2006 to 2009, the fraction of covered workers enrolled in an employer-sponsored plan with a deductible of $1,000 or greater for single coverage more than doubled, from 10 to 22 percent. The increase in deductibles was also striking among covered workers with family coverage. For example, during this same three-year period, the fraction of enrollees in preferred provider organizations with a deductible of $2,000 or more increased from 8 to 17 percent. Similar increases in cost-sharing were apparent for visits with primary care physicians. The fraction of covered workers with a copayment of $25 or more for an office visit with a primary care physician increased from 12 to 31 percent from 2004 to 2009. (p. 192)

If the goal is to have people pay more attention to cost when buying health care, this is good news, right? Yet Duggan seems to lament it.

Along the way, though, Duggan does give little nuggets that suggest that health insurance markets work better than he originally claimed. For instance:

Forty-four states now permit insurance companies to deny coverage, charge inflated premiums, or refuse to cover whole categories of illnesses because of preexisting medical conditions. (p. 188)

"Inflated" in the above quote simply means high and, given the risk, it makes sense to charge high rates. Here again Duggan undercuts his own "adverse selection" critique of insurance markets.

What do the data tell us about insurance companies rescinding coverage and refusing to pay claims if individuals fail to list any medical conditions? Here's what Duggan writes:

A House committee investigation found that three large insurers rescinded nearly 20,000 policies over a five-year period, saving these companies $300 million that would otherwise have been paid out as claims (Waxman and Barton 2009). (p. 188)

Now, 20,000 sounds like a large number but remember that these are three large insurers who could easily, among them, have one million policy holders. 20,000 over five years is 4,000 a year. So taking the one-million assumption, which I think is too low, one would conclude that 4/10 of a percent of insured people every year lost their insurance in this way.

Another nugget is his number on uncompensated care, which he estimates at $56 billion in 2008. Given that approximately 255 million had insurance at any given time that year, this amounts to $220 per insured person. That's large, but it's not huge. The Samaritan's Dilemma, it appears, is smaller than many have thought.

I guess it's probably clear why Duggan couldn't write a nice consistent exposition of health economics: it would have undercut his big boss's case for intervention. That shouldn't stop us, though, from reaching a deeper understanding.

Comments and Sharing

COMMENTS (6 to date)
Arnold Kling writes:


I am glad you found something positive to say about this year's report. I thought it was the most overtly political, least educational report the Council has ever produced. Usually, after you get past the opening chapter, you get really straight-up economics that you can give to an econ class without worrying about ideological baggage. When I glanced through this report (on my Kindle, it's a free download), every page I landed on had a political talking point where there should have been some economics. The budget outlook chapter was the worst--it was all about the Mess We Inherited and Health Care Reform Is The Answer. I demolished the latter point in one minute of my talk yesterday.

David R. Henderson writes:

Thanks, Arnold. I'll keep that in mind when reading the rest. What you're saying happened is also what happened with the Budget documents under Clinton. The Budget always had somewhat of a propagandistic tone but it was slight: Clinton's people hit you with a sledgehammer. They also eliminated the generational budget that Kotlikoff had lobbied so hard for.

Glen writes:

The numbers on the Samaritan's Dilemma also require some crunching. See here for more: http://agoraphilia.blogspot.com/2010/02/uncompensated-care-for-uninsured.html

The_Orlonater writes:

I'm referring to page 192 here; well this is all good, but the cost of health care isn't being reduced by some negligible co payment increases. We need major reform.

David R. Henderson writes:

Thanks, Glen.

aretae writes:

A simple detail that strengthens your point. You say:

"Now, 20,000 sounds like a large number but remember that these are three large insurers who could easily, among them, have one million policy holders. 20,000 over five years is 4,000 a year."

The five largest insurers nationwide each have between 10 and 40 million members, which is ~4-15M policies. The next half-dozen or dozen are all million+. Survey of 3 large insurers could easily be an order of magnitude larger than you're talking about.

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