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Health Care, Cost, and Insurance Theory--Posner

By Richard Posner

The focus of the Administration's health-care plan, and of its campaign to enlist public support for the plan, is dissatisfaction with health insurance. To see the problem--or whether there is a problem--compare health insurance to fire insurance. Almost everyone has fire insurance (even if he doesn't want it, invariably it is required by the mortgagee, if there is one). The reason is that a fire can wipe out a big part of most people's wealth, and, given declining marginal utility of income, which makes most people prefer a certainty of obtaining a million dollars to a 50 percent chance of obtaining $2 million (and a 50 percent chance of nothing), the cost of fire insurance is a good investment. The insurance company knows how much it may have to pay if there is a fire because the insurance policy has a dollar limit.

If someone is convinced that his house is fireproof and therefore fire insurance would be of no value to him, and therefore refuses to buy it, the insurance premiums charged the buyers of fire insurance will be slightly higher (because his being in the pool would have reduced the expected cost to the insurance company). But no one is concerned with this, because very few people opt out of fire insurance.

Health insurance is different superficially because of the extreme variance in costs of medical treatment; some people have medical conditions that cost literally millions of dollars to treat. But this is a problem in other forms of insurance as well, such as liability insurance in which the insurer undertakes to pay the insured's legal expenses, which can be astronomical; and insurers deal with such difficult-to-estimate risks through reinsurance and large deductibles.

Health insurers, if left to themselves, generally refuse to insure the cost of treating pre-existing conditions; but that is no different from a life insurer that refuses to issue a policy (or charges more for it) to someone whom a medical exam reveals to have a short life expectancy. Prudent people buy life insurance when they're young and in good health.

Health insurers often cancel an insurance contract, or refuse to renew it, after discovering that the insured is in bad shape and likely to cost the company a great deal in the future. Fire insurers and automobile insurers often do the same thing. If people want to have lifetime protection, they have to pay higher premiums but it is hard to see why health insurers would refuse to offer such contracts; in fact some people do have such health insurance.

There are several puzzling aspects to health insurance, one of which, however, is rather easily solved, and that is the fact that a significant fraction of the population has no private health insurance. If your house burns down and is uninsured, tough luck. But if you get sick and have no insurance and no money, you can still get treatment at the nearest hospital emergency room. (You will be billed, and if you have enough money you will have to pay the bill.) If you have no money, you're a free rider, but the amount of free riding is kept down by the cost that emergency rooms impose on patients by making them wait--and a queuing cost is a real cost to the people forced to stand in the queue.

Many of the uninsured are young and healthy; they are like the person with the fireproof house. If they were forced to insure, therefore, premiums for health insurance might fall, though this is highly uncertain. Many of the uninsured, rather than being young and healthy, are uninsured because of pre-existing medical conditions that imply that these people will incur abnormally high costs of treatment in the future.

Medicaid, charity treatment in emergency rooms of hospitals, and Medicare when utilized by indigent people constitute a form of poor relief. There is no reason why Medicare shouldn't be means-tested; people who can afford medical care should pay for it themselves.

The fact that, because of tax subsidy, most health insurance is offered as an employment benefit screws up the health-insurance system considerably. Not only does the subsidy result in giving people more medical benefits that they would want if they had to pay the full, unsubsidized price. They lose the insurance if they lose their job or if the employer cancels the group insurance policy, and when they seek new insurance they may find themselves turned down, or made to pay a very high price, because of their age or because they now have a pre-existing condition.

If people were willing to pay high premiums, and accept high deductibles and copayments, they could buy health insurance policies that would give them lifetime protection against all major medical problems they might encounter. But people are not willing to pay high premiums or (mysteriously) to accept high deductibles and substantial copayments. They prefer to take a chance on their employer-supplied health insurance and on making it to 65 (Medicare eligibility age) without going broke as a result of a medical condition for which they are not adequately insured. And if they have no employer-supplied health insurance they may decide to do without and hope for the best even if they could afford to buy an expensive individual policy.

Repealing the deductibility of employer-supplied medical benefits from federal income tax, and instituting a means test for Medicare, would reduce the demand for, and therefore total cost, of medical services and reduce the federal deficit as well, since Medicare costs the federal government more than $300 billion a year. Since Medicare would cover fewer people, there would be less need to institute procedures designed to limit expense by limiting treatments--something people fear, whether rationally or not.

It is doubtful whether any other measure consistent with American culture and values would reduce medical costs substantially, though one can imagine a series of modest reforms that might add up to a net savings, including limiting liability for medical malpractice, imposing large deductibles for medical treatment for injuries experienced in dangerous recreational activities, reducing highway speed limits, and taxing fattening foods and beverages. None of these is likely to figure in any health reform enacted by Congress at the present time, however.

The opposition to the Administration's health plans is understandable, though some of it is uninformed and even irrational. The Administration's problem is that it wants to expand insurance coverage, and this will increase the cost, including the public cost, of the health-care system, but that the only serious way in which the Administration can imagine limiting the cost increase (as there is insufficient public support for terminating the tax subsidy of employee health benefits, let alone for limiting Medicare to people who can't afford private health insurance) is by curtailing treatment. And that upsets people, since they don't trust the government to decide what medical treatments are cost-justified. (And why should they?)

In all likelihood, moreover, the Administration is underestimating the cost of expanding coverage. It wants to push as many of the currently uninsured as possible into insurance plans, and this will not only cost a lot in subsidies, as well as in higher costs to employers; it will also increase the demand for and thus the aggregate cost of medical services (because supply is inelastic). Once a person is insured, the marginal cost (which includes the queuing to which the uninsured are subjected, as well as monetary cost) to him of treatment drops to the copayment or deductible. The government also wants to forbid insurers to deny coverage on the basis of pre-existing conditions or to rescind policies after paying a large claim to an insured (and foreseeing future such claims). This will increase the cost of health insurance, and the government will doubtless end up picking up the tab, because there is great resistance on the part of the public to paying higher insurance premiums.

The cost of the projected health reforms cannot be estimated. One reason is that no one seems to know what is actually in the literally thousands of pages of health-reform bills drafted by different congressional committees. Or if they know, they are not telling. Another reason for uncertainty about cost is that no one outside government (maybe inside it as well) knows what the Administration is likely to settle for in its negotiations with the various interest groups and legislators.

But worse than not knowing the cost is not knowing how it is going to be paid. Higher taxes, unless trivially higher, seem politically infeasible, which means that health reform if enacted will add to our soaring national debt--and probably add a lot, though we cannot know how much.

Full post as published by Becker-Posner Blog on August 17, 2009 (boomark / email).