Health reform: The Road to Serfdom?

Could health reform lead to tyranny? Before you blow off this post as alarmist, please carefully consider the following news:

Humana is a health insurance company, which of course has a vested interest in health reform. Their executives believe this reform would damage their ability to provide quality, affordable insurance. In particular, they offer private insurance for seniors that adds on to Medicare (called Medicare Advantage), and current legislation will definitely alter how Medicare Advantage operates. So they sent a mailer to their customers explaining what they see as the pitfalls of current proposals.

Then the Obama Administration (via the Department of Health and Human Services) sends them a letter warning them to stop. They aren't allowed to exercise free speech, spreading lies and misinformation. Read about it yourself from the Associated Press, as well as analysis from David Henderson. The latter includes links to the actual Humana mailer and the HHS menacing letter. I'm sorry, but even if Humana was sending mailers that were flat-out wrong, they have every right to do so.

And frankly, the effect on Medicare is not clear cut (a topic I intend to address in the near future). Obama's official line is "Medicare will not change a bit;" yet he plans to pay for at least a third of his plan by improving efficiency (i.e. cutting costs) in Medicare and Medicaid! To pretend that the White House stance is the only gospel truth is laughable.

But what really frightens me here is the tactic: silencing dissent. I'd like to believe that it couldn't happen here; but this follows a very clear pattern identified over half a century ago by F.A. Hayek. This Nobel Prize winner noted that economic liberty was inextricably linked with political liberty. Once a government takes over one, it will inevitably take over the other as well. This was the subject of his book The Road To Serfdom. If you read only one book in the next year, this ought to be it. It is downright creepy how applicable it is today. In the meantime, here's a brief synopsis in cartoon form.

One important point of Hayek was to dispel the notion of Communism and Fascism being opposite extremes of the political spectrum. In the end, both were on the same side: authoritarian control. Sure, the Soviets claimed to wield power in the name of equality, while the Nazis claimed to do so to restore national greatness. But in the end, both governments proceeded by seizing economic production and destroying political freedom. Not coincidentally, the worst type of maniacs sought power in such a regime, resulting in millions dead in both cases.

The fact is that liberty can't be confined just to one area of life. If we are free to speak our minds, some of us will advocate freedom to choose our own health insurance. Thus, if a president intends to control our health care ("for our own good"), he will quickly find that he must control our speech, our exercise habits, our reading material, our occupations, etc. to reach that goal. Once you open the door to control, the unopposed government will eventually seize every liberty. The genius of constitutional government (an experiment first attempted by the United States) was to limit government power through checks and balances to prevent such a grab. But make no mistake: it can happen here, if we citizens trade in our liberty for supposed security.

As a side note, this Humana incident also reveals serious flaws in the "public-private partnership" model that has been used for Medicare D (where the government sets up a program for prescription drug insurance, but has private companies compete to implement it) and is likely part of any Democrat reform. What happens if the private sector wants to point out flaws in the government system? You would essentially be biting the hand that feeds you. The regulators can stifle dissent and intimidate critics by threatening to cut you off. HHS will conveniently realize that your company failed to follow some inane regulation, and disqualify your insurance from qualifying.

It appears Humana realizes this; they have already stopped the mailings, rather than screaming censorship from every rooftop. They clearly heard the message: "Shut up and get back in line, before we march you to the wall!"

Whatever your complaints about American health care, this can't be good for us. I want to see improvement in health insurance, but not at the cost of freedom of speech. This incident is the strongest argument yet for keeping government intervention at a minimum, and particularly against any sort of public option. I have previously said that the government will not compete with the private market; they will control, manipulate, and probably destroy their "competitors." Now, they've provided a preview of coming attractions.

Click Here to Read More..

Competition it ain't

In the last two months, the White House seized on a brilliant PR plan to sell the "public option": emphasize that it promotes competition. After all, that should appeal to those free-market types, right? Imagine the brain freeze: "I don't trust government intervention, but I do like competitive markets. What do I do?!"

In communication, this would be called co-opting a term: taking a term used favorably by the other side and using it to promote your side, perhaps with some implicit redefining. (The term is rather ironic, since the public option seems destined to be replaced by "co-ops" :-). But in a debate, one should always view co-opting with suspicion. Do they really mean competition as the word is commonly used, or are they slapping a palatable name on an inedible dish?

The dog-eat-dog world of competitive markets

Competition is the bedrock of what makes markets function well. With it, we can be certain (indeed, it can be mathematically shown) that the best products will be produced, by the most efficient methods, for the lowest possible prices. But without strong competition, we have no such assurance.

When economists make these claims, we have a very specific definition of competition. In particular, there must be:

1. Many small buyers and sellers of the product (no 800-pound gorillas in the market).
2. Similar product are offered by various sellers (there's no reason to favor one brand name over another).
3. New businesses can enter the industry without much difficulty.
4. It is easy to gather the needed information to compare products and prices.

If all of these conditions hold, we have a ultra-competitive (or, as we would say, perfectly competitive market). If one firm charges more than the others, consumers will find out and everyone will abandon that firm. If one product is of lower quality than another, either its price has to be appropriately lower, or people will stop buying it. If one firm has higher costs than the others, it will be driven out of the market after sustained losses.

It's not much fun to be a seller in a perfectly competitive industry — you won't make much profit. But there is a strong incentive to innovate. If you come up with a new product variation or a cost-saving technique, you will be rewarded with higher profits. But only temporarily; eventually everyone else will duplicate you and erode that advantage.

Even so, many people are willing to start businesses in highly competitive industries. Food production (with the exception of those that are subsidized) are good examples. Indeed, the miracle of competition explains how we have gone from having most of the population in agriculture two centuries ago, to merely 2% growing all the food we need (and then some) today.

Does the Shoe Fit?

Now that we're clear what economists consider to be a competitive market, does health insurance qualify? Unfortunately, no.

1. Although there are a large number of health insurance companies, a given individual usually interacts with just one — whichever one his or her employer has selected.
2. Most insurance companies offer a similar collection of plans, with various levels of coverage and copays. Unfortunately, there are some less visible differences, such as which doctors or treatments are covered.
3. Entry into the industry is difficult, particularly because each state has a different set of insurance regulations (several books worth!). Just because you operate in Utah doesn't mean it is easy to expand into Arizona.
4. Information gathering is not so easy, particularly on exclusions.

So clearly it would be a stretch to consider health insurance to be a competitive market. And it shows. Insurers have not been pushed to create the right incentives for their customers (see previous posts on insurance), nor have they had much motivation to innovate. As a consequence, it is no surprise that health costs are high and satisfaction with insurance is mediocre. Most people feel the same about their cable company, an industry that shares some of these limits on competition.

That said, it would be wrong to say that insurers face no competition. Even if there is a single firm in a market, sometimes the would-be monopolist can be held in check just by the threat of challenger (some nice examples are found in this article by Steve Chapman). As evidence, profit margins in health care are roughly the same as in other industries. It is safe to say, though, that the market would benefit from greater competition.

So why not let loose the 800 pound gorilla?

I accept the premise that competition is good, and that health insurance is not sufficiently competitive. So why not let the government provide that competition?

Quite simply, the "public option" does not provide the competition described above. In fact, for most people (whose employers offer health insurance), it won't even be an alternative (at least, not at first).

Check the list. Does it solve the difficulty of comparing plans? Does one more alternative make for "many small sellers"? Does it make it easier for new competitors to enter? The answer on each is no. Instead, it lets one 800 pound gorilla loose into the market, with the power to smash competitors and no fiscal responsibility.

What is this really about?

The whole "competition argument" for the public option is really a red herring. That's not what the Democrats are after, and there's an easy way to see it. If Nancy Pelosi just wanted to provide more competition, she could easily start her own insurance company. She could even make it a non-profit, with any mission of her choosing: generous coverage, no limitations on pre-existing conditions, low premiums, cross-subsidization among policy holders.

But as a private venture, it would have to be self-sustaining. She would have to charge enough in premiums to at least break even with what she pays out in claims. If not, even George Soros wouldn't give her financial backing.

They want a government-sponsored insurance plan in order to have access to the tax coffers. They know full well that their ideal plan will not be self-sustaining, requiring heavy subsidies. It would never fly as a private enterprise — not even as a non-profit.

And that is the problem. The 800 pound gorilla has no chains; it can keep burning through cash indefinitely, making it capable of undermining any and every private insurer. For those who think "No, they would never let the public option bankrupt us," just look at Medicare. It is a fiscal disaster just around the corner, and yet no one has the political will to avert the train wreck. Once the public option is available, no matter how bad it is hemorrhaging, no politician will touch it.

To make matters worse, the proposed reform will assign the government to define what qualifies as mandatory coverage. Even though Obama says you can keep your insurance if you like it, that may not actually be true. If the bureaucrats decide that your plan has too high a deductible, or excludes the wrong conditions, they will threaten to take it off the list. Then, either your insurer will have to change your plan (making it more expensive), or your boss will switch insurers (or drop coverage), or you will have to pay the tax penalty to keep your plan. What Obama really means is that you can keep your insurance plan if we like it.

Combining the twin powers of endless subsidies and regulatory control, it doesn't take much imagination to see this undermining all private insurance. Indeed, Barney Frank and others have admitted that the public option is the path to a single payer system.

Real competition, please!

The aggravating thing is that there are policy changes that will promote real competition. The biggest single problem in the health insurance market is its special tax treatment. Anything you or your employer spend on an employer-sponsored insurance plan is not taxed. If, instead, you try to buy insurance outside of employment, you will be paying for it with after-tax income, making it 20 to 35% more expensive. As a result, almost no one shops for insurance beyond their employer. At best, any competition among insurers will cater to the employer, not the customer actually being insured, because the employer is the one choosing.

A simple change in tax code would eliminate this bias. This could be done in one of two ways: (1) make all insurance premiums (including self-paid) tax deductible. Currently, only the amount over 7% of your income can be deducted. (2) make all insurance premiums (including employer-paid) taxable. To keep tax burden roughly the same, one can simultaneously increase the standard deduction by the average insurance premium. (This was the McCain plan, by the way, and was supported by many Obama advisors until their campaign decided to attack McCain for "taxing health care.") Either way, an individual would be on equal footing to shop among any insurance company — and thus bring many insurers competing in your market.

A larger change would be to introduce an option to organize a private insurance firm under a federal charter. That is, create a set of federal regulations that would allow an insurer to operate in all 50 states, independent of state regulations. This will introduce more firms into any state, and will reduce the barriers to entry.

As part of that regulation, I advocate clear disclosure laws. An insurance contract is only meaningful if it can be readily understood. This includes keeping copays and coinsurance consistent across most procedures and clearly listing exclusions. Better information is necessary to unleash the power of competition.

Motivated by Profits ... AND Losses

Countless editorials and pundits in this debate have moaned that a profit-motivated health care system will obviously never act in the patients' best interests (even though these people seem to trust profit-motivated restaurants to deliver a reasonable meal, as I have previously written). Their complaint seems even more out-of-place when we consider that the majority of large health insurers are non-profit organizations (including my own insurer)!

But it is worth clarifying that concern for the bottom line is exactly what makes competition matter. If an insurer didn't care about making profits, why would he worry about losing customers to a competitor? It is only the threat of losing his income that keeps him trying to please his customers.

And this brings me to my final and very crucial point: capitalism is not just a profit-motivated system. It is a profit- and loss-motivated system. That is to say, losing money is just as important a motivator as earning profits — and maybe even more so! It's nice to get a little extra income, and that might keep someone working a little later into the evening or thinking harder of ways to innovate. But how much harder will they work when the life of their business hangs in the balance, when slacking off could result in losing all your invested effort!

In the big picture, profits and losses serve as a signal. If a firm is making unusually large profits, it will garner attention: others will start replicating their success. As they do, it tends to split up the market and drive down prices, until profits eventually return to normal.

By the same token, if a company is losing money, this also is a signal. The market is trying to say (as politely as possible) that they are doing a bad job. They are not delivering enough value to enough people to make it worth the cost of operating. Either they need to improve their product (make it more valuable), or produce it more efficiently (reduce its cost), or get out of the business.

(For a wonderful explanation and copious examples on this topic, see Chapter 6 of Thomas Sowell's Basic Economics.)

And this is precisely why we cannot allow congress to create a government-subsidized insurance plan. Whether we call it a public option or a co-op, if it is allowed access to general tax revenue, it will have no incentive to listen to the profit and loss signals. They won't have to please their customers, or deliver great value for the insurance premiums paid. Most of their enrollees will be there because they have no where else to turn (after their employer dropped insurance coverage).

But my real concern isn't lousy coverage from a public option. The real problem is that they will provide fabulous coverage, unreal coverage, the type of coverage you could only offer if money didn't matter. Insuring people for anything and everything, charging them next to nothing. Of course, they can only do that because of their backdoor access to tax revenue. No private insurer — not even non-profit insurers — can keep up with that. And that's exactly why the House of Representative's Progressive Caucus insists on a government-sponsored plan. The public option is not really meant to provide "healthy competition," and "may the best plan win." It's purpose to stack the deck against private choice, so that the public option will be the "last plan standing."

Click Here to Read More..

Fundamentals of Insurance (Part 4): The Ugly

As a capstone of this discussion on insurance, it is useful to summarize the features of efficient, effective insurance. The ugly truth is, most of us don't appreciate insurance for what insurance is actually able to do. We gripe and grumble about many of insurance's necessary features, and want congress to wave a wand to change it, magically offering better coverage with lower premiums and smaller copays. That is pure fantasy, whether provided in the public or the private sector.

Effective Insurance

Insurance works best when it is limited to large, unexpected expenses.

If you start covering 100% of small expenses, moral hazard becomes a serious problem. People have less incentive to weigh costs versus benefits, so they (perhaps unwittingly) choose more expensive options. They don't shop around for the best price on identical service. And they might even take less care in avoiding health issues. (Why diet and exercise if gastric bypass surgery is covered 100%?)

If you start covering health expenses that are highly likely to occur, you invite adverse selection among your clients. In particular, if you must charge all clients the same premium, only the ones who anticipate high health expenditures will be willing to sign up, resulting in high premiums and many people uninsured. On the other hand, if you can charge different rates depending on their expected health needs, insurance can handle high-probability health expenses, but the coverage will be expensive. In effect, the premium will be pre-payment of the doctor's bill.

One exception that should be made is on preventative care. Well-child checkups, mammograms, and similar routine screenings can catch issues early or encourage behavior changes, when intervention is still cheap. Thus, even though these are small and anticipated expenses, most private insurance plans cover them fully (perhaps with a small copay). Indeed, those evil profit-mongers actually have an incentive to keep you healthy!

All-you-can-eat Health Care Buffet

Unfortunately, Americans seem to generally view insurance as if their premium should be paying for an all-you-can-eat health care buffet. No copays, no coinsurance, no limits on trips to the salad bar. We want it all.

But if insurance (private or government) is set up that way, it will cost through the roof. We will be gluttonous, choosing expensive procedures with little added benefit. And those who only need a dainty snack are either priced out of the market (in private insurance) or forced into the smorgasbord (in government insurance).

The insurance we have

Of course, you might be thinking, "But most private insurance doesn't seem to meet that ideal. Hasn't the market failed us?" It is accurate that most private plans don't encourage much consideration of the cost. Only 10 to 11% of patients pay a percentage of the prescription drug or office visit cost, rather than a flat copay. Less than half pay a deductible before insurance kicks in. (These have been slowly increasing over the last decade, however.)

As a consequence, doctors aren't used to being asked, "How much will this cost?" or "Is it worth it?", and generally have no clue what price the billing department will slap on any given test or procedure. But if a significant fraction of patients started asking (some of whom would change doctors depending on the answer), they would learn the information rather quickly. It is no different than an auto mechanic who has to inform you of your repair options.

So why aren't we there already? There are several factors that have led us to the insurance we have today. The first is government regulation. In countless ways, state and federal governments have imposed rules on coverage and pricing. These can directly prevent insurers from offering the ideal insurance contract. But regulation can also distort incentives for the insurance company, indirectly leading them away from ideal coverage.

The Health Savings Account was one attempt to encourage more cost-consciousness. This offers insurance with a high deductible, so perhaps the first $5,000 was paid out-of-pocket, though full coverage was provided thereafter (we call this catastrophic coverage). In addition, you could make pre-tax contributions to a savings account (much like a 401k), to be used exclusively on health expenditures until retirement. This was a huge step towards ideal coverage described above, but it ran into all sorts of regulatory hurdles, and hasn't been widely adopted. And it appears that federally, democrats have it scheduled for the chopping block.

The second is limited competition among private insurers. Extensive competition in a market generally leads to the most efficient type of product — giving the greatest value to consumers at the lowest cost. Even though there are many insurance companies out there, there are only a handful able to compete in any particular area. State regulation is partly to blame: since each state has its own multi-volume set of insurance laws, it is difficult for insurers to operate across state lines. Employer-based insurance bears the rest of the blame. Most people only consider the couple offerings available through their employer, because their employer pays a large chunk of the premium and even the employee portion is paid from pre-tax income (neither of which are true of outside insurance options). But that means I am not going to shop outside of my employer.

Limited competition always reduce the market's natural push towards efficiency. In this case, insurers can get a bit of extra profit from their clients by offering lower coinsurance or deductibles (a point made in my academic research), even if it encourages moral hazard.

The final reason we might be far from the ideal is because that is what consumers asked for. We all know how unpopular deductibles and copays are. We want all-you-can-eat! But even though that sounds good from an individual perspective, if we all behave that way, we are worse off in the end. There is a reason our premiums are skyrocketing, and the reason is us. Perhaps the reform we really needs is in Americans' attitudes toward insurance.

Click Here to Read More..

Fundamentals of Insurance (Part 3): The Bad (Adverse Selection)

The other complication for health insurance is that not everyone has the same likelihood of getting sick. The magnitude of this problem depends on how well the insurance company can identify these differences. Insurance works most effectively when the insurer is better informed (a fact that doesn't sit well with those behind the current reform).

Paying for what you get

Imagine an alternate universe in which insurance companies are allowed to review your health history and habits, and quote you a premium accordingly. (For health insurance, this is essentially outlawed in most states. For life insurance, however, it is completely allowed.) In such a world, your premium would reflect your average medical costs. If my family history reveals that I have a higher than average chance of prostate cancer, I will pay correspondingly higher premiums. If my non-smoker status indicates that I have a lower than average chance of lung cancer, I will pay correspondingly lower premiums.

In essence, I am simply paying for what I get. If the insurer is likely to pay out more on me, it's hardly unfair that the ask me to pay more for their service in my premiums.

I'm guessing that most people agree with that concept when it comes to health issues over which a person has significant control, such as smoking, obesity, or pregnancy. If you decide to smoke or have a child, you should be willing to bear your added health costs as part of that decision.

Where people get worked up is for things outside of personal control. Should I really be penalized with higher premiums because of the genes that I inherited? Admittedly, it seems unfair (I dealt with this issue in applying for life insurance, and it bothered me). But the real question is, what is the alternative?

Suppose we insist that insurers cannot discriminate by charging different premiums based on health history. In other words, we are saying that for some of their clients, the insurer must knowingly expect to spend more than they will earn. Would we force a restaurant sell dinner to some clients for less than it costs to produce? Doing so is a sure way to bankrupt and close down the restaurant.

Cross subsidizing

People justify this by saying we can cross-subsidize among clients: if everyone is charged the same premium, healthy people will pay more than their average cost, and that make up for unhealthy people who pay less than the average cost. The first issue with this argument is that we have now moved beyond insurance. It is now welfare.

Note that in using the term welfare, I intend it only in the technical sense: an involuntary transfer of wealth from one group to another. This is not meant to pass judgement (i.e. I'm not saying welfare = bad); the topic of redistribution will be addressed in a future post.

People's feelings on redistribution may differ. At least this seems to transfer the wealth in the right direction (to those who are worse off). However, mixing insurance with redistribution could make both less effective: it may not help the unhealthy as effectively as a direct subsidy, for instance. And it can significantly harm the way insurance operates.

Opting out

Typically, if the insurance company can judge your health risk, so can you. If I am a young person with a clean health history, I expect my health costs to be quite low. But then if I can only buy insurance under a cross-subsidization scheme, I will be charged far more than my expected health costs. Even if I can afford the premium, I could rationally choose to stay uninsured. Indeed, as many as half of the 47 million uninsured fall into this category, deciding that insurance isn't worth the premium.

Of course, this behavior will undermine the cross-subsidization scheme. The only people who actually sign up for the scheme are those with higher costs, which pushes the premiums higher still. Put another way, the insurer has to assume (and set premiums accordingly) that only the least healthy clients will ask for insurance. (Economists call this phenomenon adverse selection.) This leaves many people uninsured, and limits how much redistribution actually occurs too!

The left argues that adverse selection necessitates a single payer insurance program. The government has the advantage of guns and prisons — it can force healthy people to keep paying their premiums, even if they won't get their money's worth. But that is only true if one assumes (as the left does) that redistribution must be integrated with insurance. If insurers are able to customize their prices and their coverage, they can provide insurance (and only insurance) quite effectively.

In practice, since they are not allowed to charge different premiums, private insurance companies instead limit coverage on people with higher risk. In particular, pre-existing conditions are situations in which a disease is almost highly likely to be a continuing problem. Again, many people spit venom over these limitations. As for me, if I had a pre-existing conditions, I would prefer having coverage with a higher premium over having those conditions completely uninsured.

In it for the long haul

One more topic deserves to be addressed. What about the information we obtain about ourselves as life progresses? Should an insurance company be able to change rates or coverage on you once you have come down with a particular disease?

In some ways, this is merely a rephrasing of the original question about charging different premiums based on different health conditions. But here there is an initial uncertainty when you first buy the insurance. No one knows if you will have cancer in the future; and that sort of uncertainty is exactly what insurance was designed to handle.

At your initial enrollment, one can imagine two possible insurance contracts you could sign. In one, you are promised that your coverage and premiums will stay constant for the rest of your life. In the other, you are warned that premiums will rise when long term health issues arise.

The first contract would have to cost more than the second, because the insurer is taking on a bigger commitment. At the same time, clients would value the first contract more, since it smoothes out more of the risk. So it's a question of whether the added cost is worth the added benefit, and I'm sure some people would think so. Auto insurers are starting to offer long term contracts of the first style (AllState's accident forgiveness, for example).

Whatever the contract says, I firmly advocate enforcing it. If they promise lifetime coverage and then renege, they should be taken to court. But by the same token, if a client signed the second contract, he has no right to complain when 10 years later, something bad causes his premiums to rise. After all, for 10 years he benefited from a lower premium than in the first contract, precisely because the insurer didn't promise to hold rates constant. You can't have it both ways.

Long term insurance contracts are almost uniquely problematic to the health insurance industry — it is easy to find long term rate commitments in life insurance, disability insurance, and to a lesser extent, in auto and home. Much of this is due to the way health insurance is tied to employers (a strange accident caused by government intervention, to be discussed in future blogs). Most of us change jobs several times in our life, and thus won't be insured by the same firm long term. As we shall see, this single feature causes many of the problems at the heart of the debate.

Click Here to Read More..

Fundamentals of Insurance (Part 2): The Bad (Moral Hazard)

The previous post explained the basic purpose of insurance (and should be read first). There are two limitations on how well this can be accomplished. The first of these is addressed here.

Spending Other People's Money

While insurance is great at smoothing out random expenses, it runs into trouble if those expenses are not entirely random. With health insurance, patients have some control over the outcome. In particular, we can choose how a particular health issue is treated, which could drastically affect how much the treatment costs.

Of course, in our other consumer activities, we make choices like this all the time. When we want seafood, do we buy fish sticks? Salmon? Lobster? We certainly think about the quality difference, but we also consider the price difference. In the end, we will buy whatever gives us the greatest net benefit (value minus price).

Generous insurance coverage stops us from thinking that way. It's like we are spending other people's money, so why should we deny ourselves the lobster? We choose the option that gives the greatest benefit, completely ignoring the costs. Suppose I cut my finger while woodworking (a pure hypothetical :-), and I need stitches. If I pay the same copay whether I am sewn up by an ER doc or a hand specialist, I'm going to choose the specialist — even if it costs my insurance company ten times as much and even if it is unlikely to have any effect on the quality of the stitch.

Unfortunately, many insurance plans have exactly this type of effect. Insured patients pay for a tiny fraction of the actual cost, and thus have very little incentive to compare the relative costs of various options to their relative benefits. (We economists label this problem moral hazard.)

It occurs in other ways as well. If our insurance company is picking up the bill, we have very little reason to shop around for the best price (such as with prescription drugs). Did you know that different pharmacies have dramatically different prices for the same drug? For most insured Americans, probably not. 88% of us pay the same copay at any pharmacy — while our insurer picks up the rest.

Wasteful Medical Spending?

You can fight moral hazard in one of three ways.

(1) Reduce coverage, by which I mean leaving the insured person responsible for a larger fraction of the medical bill. If a person has a personal stake in controlling the cost, surprise surprise, he will start thinking about the cost! The downside is that this leaves people exposed to more of the shocks of life (i.e. insurance won't fully smooth out the bumps). The upside is that insurance will be much less expensive.

So it's a balance between the value of insurance and the costs of moral hazard. My own academic research suggests that it doesn't take much to get patients cost-conscious — perhaps as little as 20% out of pocket. But it gives remarkable cost reduction — drug prices could fall as much as 50%! And it encourages the most effective use of medical resources.

(2) Deny coverage, by which I mean, the insurer inspects every treatment you intend to receive and decides whether you've made the right choice. If they think not, they refuse to cover it. This feature seems to be the most common source of hatred for private insurers, but don't think it disappears in government-run programs. Ask anyone on Medicare, or anyone in Britain. This is the main weight that governments use to keep costs from ballooning into the stratosphere.

This is where worries about choice start cropping up. Will I be able to pursue the medical treatment that my doctor and I feel are appropriate? The more we use option (1), the answer is yes. Your preferred treatment may be expensive, and you'll be paying a chunk of it, but not all of it. The more we use option (2), the answer is no. Your preferred treatment may be expensive, and if you still want it, you'll have to pay every cent of it. (Under HillaryCare back in the 90s, even that wouldn't have been an option. You would not have been allowed to circumvent your government-appointed HMO, even on your own dime.)

(3) Do nothing. We could just let everyone choose the lobster. But it's going to be expensive. And the insurance company will have to charge a premium that assumes you will choose the lobster. And with expensive premiums, many people (who don't think they need the lobster) will prefer to go uninsured.

The other problem is that it is wasteful. Many conditions can be treated almost as effectively in a much less expensive way. A friend of mine who is uninsured recently needed a medical issue examined and had a CAT scan. Because my friend asked about the cost, the doctor leveled with him, saying that the much more expensive MRI would provide very little additional information. Lobster isn't always best!

Of course, Obama routinely criticizes wasteful medical spending, but he usually just blames it on greed. That's not fair at all — it's all about moral hazard. Patients have no incentive to consider the costs, and certainly doctors don't either. Only the insurance company can intervene, and when they do, they get demonized for reducing coverage.

Unfortunately, government intervention almost certainly will do worse. Governments rarely encourage option (1); it's not popular to make people pay for their government goodies. Governments may lack the political will to even do (2). But rest assured, the moral hazard problem would exist in a "public option" just as much, if not more, than in private insurance. After all, they are spending other people's money.

Click Here to Read More..

Fundamentals of Insurance (Part 1): The Good

These days, private insurance executives must feel pretty lonely. They are the villains in the official White House storyline. Most of the public has at least a few complaints about some experience they had with insurance claims. And in congress, even those in opposition to the current reform don't want to be on the record in praise of insurers.

Don't look here for a love-fest either. There are significant problems in the health insurance market that make it less than ideal. But before we shackle, dismantle, or dismember these villains, we would be wise to carefully examine what insurance is supposed to do. Frankly, some of the things people expect of insurance are really the job of welfare or maybe the tooth fairy. So let's look at the purpose of insurance (how it functions at its best) and why it is ill-suited to play other roles.

Mommy, where does insurance come from?

Insurance has a role in our world because of two basic truths: (1) Big, expensive things randomly happen to people. (2) But not to everyone at the same time.

The first truth establishes a need (i.e. demand) for insurance. Those big events (like heart surgery) are scary enough without contemplating how to pay for it. Thus, we are willing to pay a much smaller amount every year (even when we are perfectly healthy!) so that, if it should occur, we won't be the one paying the bill.

An extreme case of this is life insurance. If I pass away in the next 15 years, not only would wife and children mourn my loss, but they would be in a much worse financial situation without my income. Thus, I am willing to pay a small amount each year for a life insurance policy that would cushion the financial blow. Now, I'm a healthy guy, so it's quite likely that at the end of 15 years, I will be alive and kicking — meaning I wasted several thousand dollars in life insurance premiums, right? No. Even then, they provided me a service those 15 years: peace of mind. And at the price I was quoted, it was worth it to me.

The second truth is what makes it possible for someone to offer (i.e. supply) insurance. DMBA isn't insuring me out of a concern for my well being, or a desire to bless the human race. This is how they earn their living, so they need what I pay in premiums (their income) to be more than what they pay on my claims (their costs). The difference is their paycheck.

In actuality, my premiums don't have to cover my costs every year — surely some years I will get sick more often or have an accident, and others I won't. But they have to balance out on average. And in fact, the insurance company can average these premiums and costs over alltheir many clients. Thus, their income and expenses stay rather steady, despite all the randomness among the clients they insure.

There are two major complications that can arise in insurance, described in the next posts.

Click Here to Read More..

What's so special about health care?

Over the last six months, you have almost certainly heard or read a claim that, "We can't trust greedy insurance companies to act in the patient's best interest." Now, if this were coming from Karl Marx, I'd understand — he thought this about EVERY industry, not just health care.

But what confuses me is that most of the time, these people that distrust the profit motive in providing their health care completely trust it to provide their lunch! They walk into a Taco Bell and order a burrito without worrying that Taco Bell is only after their money, with no care for their personal interest. Where's the disconnect? What's the difference?

Put another way, why aren't we having a debate about universal food care, or a single-payer food insurance system?

First, be assured that you can trust the profit motive to provide your lunch, because Taco Bell only gets your money if you think the burrito is worth it. They have to deliver enough value to keep you coming. If they start skimping on quality without reducing price, they'll lose customers. Just recall how quickly they reacted to the E.coli problem back in 2006. (Have you seen a green onion in their restaurant since?) This was the central insight of Adam Smith: the individual pursuit of their own self-interest can actually leave everyone better off.

By the way, it's worth considering the other side of that transaction, too. It's not like you, the consumer, choose Taco Bell out of a sincere concern for their corporation or employees. You only go there if you think it is in your best interest. Your self-interested decisions are the mirror image of the profit motive.

Economists can attest that competitive markets do a great job providing the goods that consumers want. Our question, then, is how does selling health care differ from selling food?

Most people start by saying, "Health care is a matter of life and death." But so is food. In fact, you can suffer through many medical issues without health care; you'll die a lot sooner without food.

"Health care is expensive." So is food. The average family spends 11% of their income on food, but less than 5% on health care. (Check your own budget!)

"It's harder to know what health care you need." Now that is true; it's much easier to decide (by experience) what food is worth it. But this still has parallels to another well-functioning market: auto repairs. Most of us have no clue whether our brake pads need to be replaced (and that is just as life threatening as some medical issues!).

So are we at the mercy of the mechanic? No, because reputations matter. After moving into a new town, one of your first questions to neighbors is likely to be: "Do you know an honest mechanic?" The auto shop that tries to invent extra repairs usually doesn't survive very long, and the same would certainly apply to medical care.

"Health care has huge disparities." True; people in different socioeconomic situations have lamentably different experiences with health care. But the same is true in the market for food. You don't see poor families eating steak every night! I'm not saying that this inequality is okay (in fact, I regularly donate to help families in need), but that it is something true of all markets. Those with less money get less stuff. One can combat this by direct subsidies and by helping them increase their earning potential (i.e. education). This might be an argument for welfare (which will be addressed in future posts), but not an argument for seriously regulating the health care market while leaving other markets untouched.

Now, there is one significant distinction between health care and most other markets: certain health events are very costly and random. No one knows when cancer will strike, and when it does, the cost of treatment are enormous. It's hard for a family to absorb a sudden huge expense. This is why insurance plays a critical role in the health care market: you pay premiums even when you are healthy so that the insurer will pick up most of the additional expense when you are sick.

Insurance is valuable, since it allows us to smooth out some of those big lumpy expenses. And an insurer is able to offer that "smoothness" because they insure a lot of people, only a fraction of whom come down with cancer at the same time.

Unfortunately, insurance distorts some of our choices. If the insurance company picks up the tab every time we go to the doctor, we become less judicious about when to go to the doctor, what prescriptions to fill, or what procedures to do. We also become more reckless about caring for ourselves, less likely to exercise. And we don't shop around for the best doctor at the lowest price — we just look for the best doctor.

Yes, the health care market has unique problems — all of which are caused by the heavy presence of insurance. The White House has one thing right: what the health care market needs is health insurance reform. Unfortunately, as we will see in future posts, the proposed reforms will take us in the opposite direction: more coverage, less personal incentive, more reason to ask for more.

My future posts will dissect the problems of insurance, the effects of the current proposal, and real solutions to the problem. Let me just conclude by saying that I do understand the antipathy most people feel towards health insurers. Costs are high, exclusions are aggravating, and uncertainty is unnerving.

But these did not randomly spring up; they are the natural consequence of incentives that insurance has created. Moreover, this insurance structure is the natural consequence of incentives that government policy created! We will trace the problem to its roots. For now, I will say that if home owners insurance were structured the way health insurance is, we would be debating universal plumbing care right now.

Click Here to Read More..

The purpose of this site

Nothing causes me more intellectual angst than trivial debate over serious issues. It is certainly easier to ignore good arguments while attacking straw men, or demonize the opposition rather than address their concerns. But when a policy will affect millions of people and may be irreversible, we can't afford shallow thinking.

We need to be guided by good philosophy (identifying the values that we hold dear). We need to understand the true nature of the problem before we can craft a policy to fix it. Once proposed, we need careful reading of the actual legislation. And we need objective, honest assessments of the policy consequences (both intended and unintended).

The purpose of this blog is to provide my views on all of the above, as related to current efforts for US health care reform. It will be readily apparent that I am not impressed with current legislation, but I am also displeased with the incoherence of the opposition. It seems many people (on both sides) are just having gut reactions, without careful reasoning or analysis. I hope my posts can offer some clarity.

I am an economics professor at Brigham Young University, having received my Ph.D. from the University of Minnesota. My life is engrossed in the study of how people respond to incentives and how markets function. Some of my research is directly connected to health care.

I also have a good spectator's seat for the health care market because my wife is an extraordinary registered nurse. Her work experiences provide a steady supply of food for thought, highlighting the problems and successes of health care.

And, of course, I am a participant in the market as well. Between home improvement accidents and kids' viruses, I've provided employment for a fair number of doctors.

My hope is that this site offers rational debate. One pleasant peculiarity of most economists is their ability to objectively consider touchy subjects. I think this is because they approach a disagreement like an excavation, trying to dig up and examine the logical structure and underlying assumptions on which their opponent's argument relies.

Not that they'll accept any random opinion. If it the assumptions or the logic are flawed, they'll let you know. But there's a certain civility about respect for logical, well founded arguments — and it even makes debates on religion or politics enjoyable! But I think our profession has not done well (particularly in the last year) at communicating what we know to a broader audience. This is my attempt to lead by example.

Click Here to Read More..