Insurance: Share the risk

This is a guest post from Joanna Lahey, an associate professor of economics at the George H.W. Bush School of Government and Public Service at Texas A&M University and the National Bureau of Economic Research (NBER).

Ellen's note: Joanna has written four articles about health insurance. This is the first, and every Saturday for the next month, we'll be publishing one. Given the readers' concern over the cost of health insurance as well as the ability to get insurance, we think her articles will be a great addition to GRS.

What is Insurance?

We save for retirement in order to smooth our consumption over time. Money saved now when we have income allows us to eat more than cat food when we're retired and not bringing in as much.

Mikey eating cat food

Insurance works in much the same way, except instead of smoothing our consumption over time, we're smoothing it over conditions of the world. In the good state of the world, the one in which we haven't been hit by a bus, we spend money on insurance. In the bad state of the world, the one in which the bus hits us, the insurance company pays out money to help compensate us for our medical care.

People value this insurance because they are risk averse. For most people, losing money hurts us more than gaining the equivalent amount of money makes us happy. We're willing to pay a little extra during good times to offset the bad times.

Of course, in reality it's a little bit more complicated than that. Insurance companies have an incentive to keep you from getting into that bad state of the world, so they might pay for annual check-ups and other sorts of preventive care. Additionally, some people like the idea of using health insurance as a prepayment for expected medical expenses. However, preventive care and prepayment are not technically insurance even if they are bundled in with many policies. The point of insurance is to make the bad times less bad by paying for insurance during the good times and accepting a payout during the bad times.

In an ideal world, this insurance system would just work and the free market could handle everything. People would pay their expected cost of insurance into the insurance system and the insurance would pay out for the people who were unlucky enough to get hit by buses or have other health problems.

Unfortunately, there's a problem. People who know that they are likely to use medical care value insurance more than people who believe they will never get sick. The problem arises when people know their expected medical costs better than insurance companies do. This situation is called “asymmetric information” — one party (you) knows more than the other party (the insurance company) does.

Death Spiral in the Insurance Market

In this world of asymmetric information, there is theoretically no way for an insurance company to make a profit, or to even exist in the private market. If the insurance company sells insurance at the average cost of medical care — what it expects to pay out on average — then people who know deep down that they're healthy are going to prefer not to buy the insurance. People who know they are likely to get sick are more than willing to pay the average cost of medical care and sign up in droves. When that happens, the average cost of medical care that the insurance company sees goes up, so they have to charge higher rates for coverage. That means that the folks who expect to have ingrown toenails but no other health problems will drop coverage while the people who expect to get diabetes will stay on. That drives up the average cost of health insurance further, which means that the next healthiest group of people will stop buying coverage and only the most expensive stay on. Eventually only the most expensive person will be willing to buy insurance (and he or she probably won't be able to afford it). The market fails, and insurance cannot be offered. The private insurance market is broken.

Asymmetric information and this “lemons problem” (the term coined in an article by George Akerlof) are why it is so very difficult to get coverage on the private market and why the coverage is so expensive. It's also why private coverage deliberately doesn't cover conditions like pregnancy if it can legally choose not to.

Side note: You may have noticed that even though the private health insurance market is broken, it still exists. That's because of that risk aversion we talked about in the previous section — most people value insurance more than its expected cost. If they value it enough, they're willing to pay more and are able to get over the death spiral. Incidentally, David Cutler, one of the main architects of the Affordable Care Act, argues that the individual mandate is not needed — we just need to get the price low enough and risk aversion will get people to buy. Jon Gruber, another of the architects, disagrees — he doesn't think it is likely that risk aversion will overcome the adverse selection problem.

Why is Health Insurance in the U.S. Bundled With Employment?

The solution to the problem? Group markets for insurance. In a group market, people are in a group for some reason that has nothing to do with health insurance. Working for the same employer functions especially well because adults who work are healthier on average than adults who don't work. Everyone in the group is charged the same amount for insurance, and the average cost is low enough that the downward death spiral doesn't occur. The bigger the group, the more risk and costs are spread out and the happier the insurance company is. Large companies get cheaper insurance rates than smaller companies because it's less likely with a large company that the boss is getting insurance because he just found out his wife has cancer (and even if he did, that cost is spread out across more workers).

Doesn't that argue that we should have just one group for everybody? Well, yes. However, for historical reasons (price controls during WWII, as several folks pointed out in the comments of this Ask the Readers post), we ended up with our groups being attached to employment. That's fine if you're employed by a large firm that offers insurance (or married to someone who is), but makes things more difficult if you're not.

Why don't we just tear the system down and start from scratch? Well, it is difficult to destroy a private industry that is around 7 percent of our economy, especially when said industry has powerful lobbyists. It may be more efficient to have government-provided health insurance, but the costs of getting to that point would be large.

Given our current political and institutional situation, we can still get to universal health care even if single-payer insurance is unlikely. In the U.S. that means something like the Affordable Care Act, with its universal mandate, subsidies, and regulations prohibiting preexisting-condition exclusions or charging prices based on anything other than age and tobacco status. I will talk more about the basics of the Affordable Care Act in a future post.

How Much Insurance Should be Provided?

In the ideal world, insurance companies would provide full insurance. They would pay 100 percent of your medical care and maybe something to compensate you for pain and suffering. You'd have to pay a larger premium to get the insurance, but it would be worth it because if you got hit by a bus you wouldn't be out of pocket for anything. Unfortunately, this is not an ideal world and people are flawed.

  • If you knew you were going to get compensated, you might be less careful about looking both ways before crossing the street.
  • If going to the doctor is completely free, you might go in for a sniffle right away just to be on the safe side rather than waiting a few days.
  • If someone else is paying, you might move to more expensive infertility treatments faster than if you have to pay the bill yourself.
  • Your doctor might decide to do extra tests that only have a small chance of finding anything, because why not?

We call these changes in behavior caused by the program availability “moral hazard.” Moral hazard occurs when people do bad things they wouldn't have done if they were bearing the full cost of their actions.

Political economy side note: The trade-offs caused by moral hazard are one of the main points of disagreement between political parties. Public programs help deserving people who need help, but they can also cause people to do bad things in order to qualify for the public programs (through moral hazard). Programs that help children tend to be popular with politicians on both sides because children don't have moral hazard with respect to government programs — they're not the decision-makers.

In order to keep moral hazard down, it is optimal to provide less than full insurance. So insurance companies don't pay the full amount of every bill. That's why we have deductibles and co-payments and coinsurance.

Terms You Need to Know

Premium: The (usually monthly) amount that you pay to the insurance company to buy insurance. (Mine is $693/month for my dependents and me.)

Deductible: Some amount of money that you have to pay before the insurance starts paying anything. (Mine is $750.)

Co-payment: A flat dollar amount that you pay when you show up at the doctor (or the hospital) no matter how much your visit actually costs. (Mine is $35 for in-network and $45 for out-of-network.)

Coinsurance: After you reach your deductible, you may still be responsible for some of the costs. Coinsurance is a percent of the costs that you pay. (Mine is 30 Percent.)

Sometimes economists will group all three of these together: deductible, co-payment, and coinsurance under the umbrella term of “co-payment.” We do this because they're all ways of cost-sharing and thus reducing moral hazard. Living in Texas, I get all three types. The bill for my daughter's birth was $750 for the deductible, $35 co-payment for the doctor, and 30 percent coinsurance of $2,345 + $191 + $218 is $826 for my share of the rest (assuming that all of the bills have finally come in). So a total bill of $1,611.

That's a lot of information about the basics of health insurance. Next time I will talk about the pros and cons of different kinds of insurance you can get in the U.S. (PPO, HMO, HDHP, ACO).

More about...Insurance, Economics, Health & Fitness

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Beverly
Beverly
8 years ago

Ordinarily I run away screaming when health insurance is being discussed, but I’m looking forward to seeing more from this writer.

Joanna Lahey
Joanna Lahey
8 years ago

I should note the standard disclaimer:

Views in the above article are my own and do not necessarily reflect those of either Texas A&M or the NBER.

Petra
Petra
8 years ago

Are you also going to discuss this: Health insurance companies know much better than the average customer how much his/her health costs are going to be. They can use that information to scare people into paying a high price for insurance (because what would happen if you did run under a bus? And don’t you know how expensive having cancer is? ).

So another problem with the free market for health insurance is that the average customer has no idea what product he needs to buy. I guess free market assumes that buyers know the true value of a product…

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  Petra

Most of the research on type of information asymmetry (in terms of costs) is at the doctor/hospital level. In my experience, the ability to choose insurance plans is limited (right now my university offers one choice, and the private market is small). I probably won’t be talking about how prices are masked for the consumer (btw, the bills weren’t done coming in yet at the time I wrote this article… there were a lot of unexpected bills from different labs) because there wasn’t enough interest on the “What do you want to know about healthcare” post compared to other topics.… Read more »

Holly@ClubThrifty
8 years ago
Reply to  Joanna Lahey

Maybe it depends on the area, but in my area prices are not transparent! A few years ago I had a back injury and was ordered to do physical therapy. My insurance didn’t cover it and I called every physical therapy office within a 20 mile radius and no one would even give me a price estimate. They didn’t have a price list and they weren’t required to give me any inkling as to what my final bill would be. Actually, I was told by several offices that they wouldn’t even tell me what the average bill is or what… Read more »

Joanna Lahey
Joanna Lahey
8 years ago

Part of our new-found price transparency is probably also that we have a lot of new emergency rooms, clinics, and even a new hospital in town. So they’re competing against each other. In Boston there were also a ton of hospitals to choose from, but little reason for an insured individual to choose based on price.

Price transparency is an interesting topic. In the textbooks it’s usually bundled with doctor-patient models where the doctor is an expert and the patient is an un-knowledgeable consumer.

SLCCOM
SLCCOM
8 years ago

Picking your health care providers by price alone is dangerous. You DO get what you pay for! Physical therapy? Get the wrong therapist (or, more likely, technician) and you can end up crippled for life. Pick the surgeon by price? Crippled could be one of the better outcomes!

Biff Sarin
Biff Sarin
7 years ago

Certainly no one would be inclined to ‘price shop’ for a brain surgeon. However, here are a couple of random points to keep in mind. These points obviously ONLY apply to non-emergent cases where you have the time and mental faculties to make informed choices. First, labs can charge vastly different prices for the same work AND your insurance plan may cover lab work done in the lab of the (in network) hospital where your physician resides, but not cover subcontracted lab work. Many doctors contract with outside labs such as ‘Labcorp’. KNOW your plan because it is unlikely that… Read more »

Mary
Mary
8 years ago

Very interesting introduction to this series. I’m looking forward to the next article. The background on how insurance came to be linked to employment help me make sense of the current mess. Single payer would really free people to make employment choices based on their interest in the job itself and how it fits their lifestyle.

As a person who has two chronic, inherited conditions, I’ll never be able to work at a place that doesn’t offer large-group coverage. Fortunately, I like my current job. But trying to estimate insurance costs for early retirement is nearly impossible.

Ali Lotia
Ali Lotia
8 years ago

Great Article…enjoyed it thoroughly. Can not wait for the next article.

Diane Romano-Woodward
Diane Romano-Woodward
8 years ago

I live in the UK where we have free healthcare at the point of need (it does cost and is paid for somewhere 😉 but not when you roll up at the doctor or hospital.It is called the NHS National Health Service “If you knew you were going to get compensated, you might be less careful about looking both ways before crossing the street.” No this is not the case. In the UK we are still careful crossing roads as broken bones hurt. And a lot of people look after their health preventatively to keep well. “If going to the… Read more »

Joanna Lahey
Joanna Lahey
8 years ago

Absolutely. There are a *lot* of ways that governments and insurance programs try to get around the moral hazard problem. Cost sharing is just one of them. (And it’s still unknown empirically how effective cost sharing actually is at controlling moral hazard!)

Anne
Anne
8 years ago

Diane,

I have to disagree here. Having worked for years in medical clinics, I absolutely believe that people come in much more often when they have very cheap or non-existant copays.

I saw it all the time.

Elizabeth
Elizabeth
8 years ago
Reply to  Anne

Anne, do you mind me asking which country you work in? I’m in Canada and I agree with all of Diane’s points — things are the same here. Just because we don’t pay, doesn’t mean we are any less careful than people in the U.S. (Really, who WANTS to get hit by a bus?!?) I constantly hear from friends and family in the U.S that they get more tests, more specialist appointments, etc. than we do up here. It seems excessive. I wonder if the issue is scarcity of resources? I don’t go to a clinic for a cold or… Read more »

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  Elizabeth

The theme of my health economics class a few years back was how different countries around the world deal with universal insurance. They all use different ways to keep health care costs down. Rationing is one way to keep costs from moral hazard down. There are a bunch of other things countries do as well. Some use cost-sharing, but many don’t. (NPR had a really good series on the topic a few years back as well.) And there are a bunch of things insurance companies do to keep costs down in addition to cost sharing. (BC/BS in MA covered pretty… Read more »

stellamarina
stellamarina
8 years ago
Reply to  Elizabeth

I think that there is a different culture in the US about going to the Dr….especially with children. I moved to the US about 30 years ago and found that mothers are always taking their babies and children to the doctor…or more often, a specialist pediatrician. In New Zealand where I grew up, you take the baby to a community nurse type person for checkups and shots etc. and they would only be going to a doctor if there was a real sickness.

Marla
Marla
8 years ago

It’s the same in Canada. We definitely don’t try to get hit by buses and normally I agonize for a week before going to a clinic for serious-seeming sickness.

Jan in Bama
Jan in Bama
7 years ago

I don’t understand. Why do you have additional health insurance? Is yours a “two-tiered” system?

kc
kc
8 years ago

Great article–I’m looking forward to reading more. Just two questions and one comment: 1–Is there any chance that consumers will get real cost transparency for procedures in the future? A friend of mine discovered that she and a fellow employee–under identical health insurance plans–were billed at wildly different rates for the same procedure (a colposcopy). One, performed in a hospital associated clinic, cost three times that performed in a physician’s office. My friend, who had been charged the triple rate, argued the price down–but only because she and her fellow employee had been in a position to compare notes. 2–Would… Read more »

Kingston
Kingston
8 years ago

Doesn’t the reason why politicians on both the right and the left can both support subsidized health insurance for children have more to do with the fact that children are actually relatively cheap to insure than with there being less moral hazard where they are concerned? Statistically speaking, kids are much less likely to develop the big, costly illnesses, while adults are nearly certain to get one (or more) at some point. It’s a relatively cheap way to throw a bone to average folks. Mom and Dad may have to do without care, but at least Junior can be tended… Read more »

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  Kingston

… there is Medicare… Arguably we insure old people because they’re the most expensive. (That’s not really quite right either.) Really, so long as people can pay their expected risk, there’s no reason the free market can’t take care of any group. The problem occurs when there’s market failure– then there’s room for government intervention. Adverse selection and moral hazard are two types of things that lead to market failure. The moral hazard argument for children’s programs isn’t limited to health insurance. Although there’s recently been some push-back, many children’s programs have had broad-based bipartisan support. But yes, there are… Read more »

tekym
tekym
8 years ago

I’m sorry, but the moral hazard section is just plain dumb. Such arguments ignore that people have far more concerns that just monetary cost vs. monetary benefits. For example, nobody in their right mind is going to be less careful about crossing the street because they have better insurance, because getting hit by a bus would cost a lot more than just money. It would cost pain and possibly death, it would cost time to go to treatments, time off work to heal, time dealing with the insurance company, etc. Moral hazard and risk compensation/leveling are not the same thing.… Read more »

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  tekym

Most people will probably not change how they cross the street. However, there’s a very large literature on the effect of infertility coverage (to which I have contributed– I have a journal paper in JPAM on the labor market effects of state mandates for infertility treatment) showing moral hazard. We used to think there was no moral hazard in worker’s comp for losing a limb, but there was plenty of moral hazard for easier to fake or easier to live with things. However, the most recent public finance textbook edition by Gruber has a case study of Vernon, Florida where… Read more »

tekym
tekym
8 years ago
Reply to  Joanna Lahey

I’m not saying that moral hazard doesn’t exist. It does. But people give far too much weight to it. 50 people cheating the system just isn’t very many. Very few people are willing to go that far unless the benefits/compensation for doing so is extreme, in which case that’s a system design problem, not a moral hazard problem.

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  tekym

Sure, different things have different levels of moral hazard, and different people have different levels of how far they’re willing to go. Keeping that moral hazard to manageable levels is a big challenge.

Jonathan
Jonathan
8 years ago
Reply to  tekym

I think the bus thing was a terrible example, but there are much better and more common ones. People overeat, over-drink, smoke, etc. All these things can cause major (but often treatable) health problems, but if the individual won’t have to pay for them out-of-pocket, why should he worry?

tekym
tekym
8 years ago
Reply to  Jonathan

Because they can cause major health and quality-of-life problems. Money is not the only thing that matters to people.

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  Jonathan

I think one thing that isn’t clear in the writing is that under full insurance if you’re going to be *fully* compensated for getting hit by a car, that includes a lot of additional money for pain and suffering (time lost on the job etc.) to make things equal. It’s a theoretical example, not a realistic one because we don’t have full insurance and wouldn’t even know what it would look like. Under true full insurance you are exactly as well off after you get hit by a bus as you were before. Assuming they don’t die, many folks have… Read more »

Laura
Laura
8 years ago

This is a great article and I’m really looking forward to the rest of the series. I had never considered any of this before, and it’s explained well to boot.

Carol
Carol
8 years ago

I have been purchasing my own health insurance for twenty-five years. I must say that this is the best general article on health insurance that I have ever read. Kudos to GRS for bringing this author into the site. Joanna, I hope in the future you will cover info on the “stop-loss.” This can be very important when reviewing coverage.

Tony
Tony
8 years ago

Another quality info for everyone! not just for those wanting to be rich.

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago

This is the typical take on healthcare voiced by most of the general population, and by our politicians. It shouldn’t be surprising that it’s mostly nonsense. The idea that healthy people won’t buy insurance is nonsense. That’s the whole point of insurance: you buy it when you’re healthy for the unlikely event that you become unhealthy (hit by a bus, cancer, etc.). If you’re already unhealthy and in need of treatment, then it’s not insurance anymore. If you’re on your way to becoming unhealthy, then your premiums should be higher. The private insurance market is broken We don’t have a… Read more »

Eric
Eric
8 years ago

One problem with health insurance versus other types of insurance is that once your house burns down and you build another one, your insurance fixed it. You cant “fix” a person with cancer or other chronic illnesses. You can’t just get a new body and say I’m cured and then go back to having insurance again like nothing happened. So I don’t really think you can do an apples to apples comparison from health insurance to other types of insurance.

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago
Reply to  Eric

It’s still the exact same principle. Sure the health insurer may have the potential bill spread over a long period (until you die), but that’s no different than the fire insurance company, who may have to make a large payment all at once. If you live next to a fireworks factory, your fire insurance premiums will be higher than someone who lives next to a lake. If your house catches on fire because of the factory, then, you can expect your premiums to rise (unless you’re locked in at a certain price, of course). It’s still all of the same… Read more »

Eric
Eric
8 years ago

Ok. Then it’s still insurance even when you are getting treated for a medical condition. You still have insurance when your car is being repaired, and when your house is being repaired. I’m not sure what you are trying to get at. Maybe I’m just dense.

tekym
tekym
8 years ago

The Supreme Court, the ultimate arbiter of constitutionality, has ruled the ACA constitutional. Therefore, it is by definition constitutional unless and until such time as they review it again and reverse their decision.

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago
Reply to  tekym

You’re technically correct. But, it doesn’t change the fact that the SC was wrong in its ruling. It’s not infallible. The ACA is not constitutional in the logical sense, the way it’s supposed to be. The SC could theoretically decide that murder is constitutional, and by your logic, it would be right. Your argument begs the question.

tekym
tekym
8 years ago

Very true, but that’s the way the system works. People can argue until they’re blue in the face that the Supreme Court made the wrong decision, but by definition what the court says is constitutional is constitutional, period. It’s circular by design.

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago
Reply to  tekym

Forgot to mention this: Roberts ruled that since the penalty is less than premiums, it doesn’t compel anyone to buy insurance. Once this gets abused enough, they’ll raise the penalty so that the premium will be the better financial choice. Thus, the ACA will inevitably be enforced in a manner that was just ruled unconstitutional.

Holly@ClubThrifty
8 years ago

The other problem I have with this is that health insurance companies consider anything that they possibly can a pre-existing condition. My husband had a colonoscopy in his early 20’s because he was having constant stomach pains. It was found that nothing was wrong except that he has IBS. His IBS is solved by not eating dairy products. Yet, when we applied for health insurance on the open market he was denied again and again. They claimed that having a colonoscopy was a pre-existing condition. We finally ended up having that doctor the performed his colonoscopy write a specific letter… Read more »

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago

I’m sorry to hear that. But you have to understand that if the insurance company thought that it was worth it to cover your husband, they would. If covering a certain type of person is statistically unprofitable, then covering those people will ruin the business, and you’ll lose your coverage anyway because the company won’t have any money! It’s not sustainable. It may not make sense to you that IBS precludes coverage, but, believe me, if a businessman thought it was worth it to cover you, he/she would. Perhaps there’s an entrepreneur out there who would find a way to… Read more »

Holly@ClubThrifty
8 years ago

That’s the problem with everything that you’re saying. You don’t offer any solutions. You don’t think my husband shouldn’t ever be covered, yet you don’t think that insurance companies should be required to cover him. You blame the government for regulating health insurance companies, yet if they do not then this is exactly what happens. If government doesn’t regulate health insurance companies, only extremely healthy people will be covered and everyone else will be out on their ass.

Joanna Lahey
Joanna Lahey
8 years ago

Adding on to what Holly is saying, insurance companies *like* some of the regulation. They are perfectly happy to insure someone like Holly’s husband, but *only* if they’re not the one insurance company that’s doing that. That’s the devastating power of adverse selection. A specific example (the canonical example) would be genetic testing. Any individual insurance company would love to be able to use genetic tests to keep from insuring people. However, they do not want the entire industry to be allowed to use genetic tests, because all of a sudden there’s a ton fewer people to buy insurance. They… Read more »

Matt at Healthy N\' Wealthy
Matt at Healthy N\' Wealthy
8 years ago

I think the solution is for people like your husband to be able to get coverage for anything that the private market won’t cover through the government. But, for someone like me, should I fall ill, and not have insurance, I shouldn’t be covered. If I can get coverage after I get sick, then what’s the point of buying coverage? Someone like your husband is different: he didn’t skimp on coverage because of a moral hazard. He was the victim of a dumb system that the government set up. Just like social security. Just because someone is dependent on it… Read more »

Holly@ClubThrifty
8 years ago

So you’re proposing that anyone with a pre-existing condition should get coverage by the government? Like single payer- except only for people with pre-existing conditions?

That sounds awesome. Sign me up.

Matt At Healthy N' Wealthy
Matt At Healthy N' Wealthy
8 years ago

Holly, I’m not gonna pretend to know exactly what the solution is for those with pre-existing conditions. Just because I understand what caused the mess doesn’t mean I know what would be best to clean up every aspect of it. I feel the same way about SS: I would never propose ripping the carpet out from old ladies, but it doesn’t mean that the system should be kept running long term. I think we need to somehow treat these people like your husband. But for young people like me, we shouldn’t set the precedent that you can just get insurance.… Read more »

Matt At Healthy N' Wealthy
Matt At Healthy N' Wealthy
8 years ago

Joanna, why would a company want to insure Holly’s husband, if probability (statistics) suggest that they will lose money, unless they charge an absurd premium? Your example of genetic testing represents a common misunderstanding of the free market. Obviously companies would prefer to use genetic tests. Obviously they don’t want the rest of the industry to have the same advantage. If one company starts using them (assuming consumers would even agree to it), then their initial profits would attract other entrepreneurs. Prices, and profit margins, would decrease because of competitive pricing. The industry is always better off when it is… Read more »

Matt at Healthy N\' Wealthy
Matt at Healthy N\' Wealthy
8 years ago

Joanna, why would a company want to insure Holly’s husband, if probability (statistics) suggest that they will lose money, unless they charge an absurd premium? Your example of genetic testing represents a common misunderstanding of the free market. Obviously companies would prefer to use genetic tests. Obviously they don’t want the rest of the industry to have the same advantage. If one company starts using them (assuming consumers would even agree to it), then their initial profits would attract other entrepreneurs. Prices, and profit margins, would decrease because of competitive pricing. The industry is always better off when it is… Read more »

Joanna Lahey
Joanna Lahey
8 years ago

Matt, I find your tone insulting. I assure you, I am not the one with a “common misunderstanding” of the free market. I teach an entire class on market failure. I get it. I thank you for your comments. If you’d like to have an open mind, then I’d be happy to talk more about what you’re not understanding about how adverse selection works. In the mean time, I suggest you read up on “adverse selection” and “market failure.” Because you’re also disagreeing with George Akerlof and the committee that gave him a Nobel Prize for his work on how… Read more »

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago

Joanna, I really don’t intend to be insulting, so I apologize for coming off that way. And in all seriousness, please send info, homework problems, etc. [email protected] Just because you teach a class about the free market doesn’t necessarily mean you understand it. If one thinks health care is broken or the housing bubble happened because of the free market (and not the government), then one definitely doesn’t understand it. Our entire country is run on a Keynesian economic system, so I disagree with many smart, intelligent, highly educated, Nobel prize winning individuals. Paul Krugman’s a great example. In fact,… Read more »

Joanna Lahey
Joanna Lahey
8 years ago

Now I’m pretty sure you’re just trolling. But I’ll indulge just this one last time for the greater knowledge. 1. Adverse selection has nothing to do with Keynesian economics. It exists because it’s something humans do in asymmetric information settings no matter what the economic system being used. 2. There are many things upon which I do not agree with Krugman (particularly in my area of expertise), but that thing he got a Nobel Prize for that isn’t in my area of expertise– I assume he knows more about it than I do. 3. The easiest case with the most… Read more »

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago

Joanna, I’m not arguing that adverse selection doesn’t exist. I woud argue that it does exist, and is a good thing, because it incentivizes proper behavior on both the part of the insurer and the consumer. It’s not a problem and shouldn’t be “fixed” by the government. You’re stuck on this idea of adverse selection, and you seem to think that it somehow justifies Obamacare and other government interventions. What about the rest of the healthcare industry? Wasn’t it broken due to government manipulation way before Obama ever stepped into office? Is anything I’m saying about payroll and tax deductions… Read more »

Sara
Sara
8 years ago

Matt – There’s one thing I’d be interested in hearing you explain your take on. The issue of health insurance has sort of a societal moral component that isn’t an issue with other kinds of insurance. If you don’t have car insurance and crash your car, you lose your car, and possibly some additional money. If you don’t have home insurance and something happens, you lose your house. Those things suck, but you can recover and probably learn your (very expensive) lesson. But if someone doesn’t have health insurance, and gets sick, that person is screwed. Forever. He might even… Read more »

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago

Hi Sara, This is a problem, and first off, I think kids should always be covered, period. The reason is that incentive doesn’t apply to them. They don’t earn money, so they can’t even choose to be covered or not. If the parents can’t afford it, then the government should pay for the coverage. This same logic applies to the disabled. For everyone else, I think the freedom to fail is the most important freedom of all. If someone is able to buy health insurance, chooses not to, and gets sick, then they shouldn’t get treated unless they can afford… Read more »

Peach
Peach
8 years ago

I agree Holly, and the only reason this is done is to protect the insurance company and maximize their profit margin. Unfortunately a lot of people aren’t aware that much of their medical history is on file at MIB and can be used to deny coverage, even if the condition existed years and years ago.

Peach
Peach
8 years ago

I totally disagree, and this is the problem when people inject their brand of political polarity into a business industry. I worked in the insurance industry for over 30 years and I can say unequivocally that it was ONLY after government got involved in the insurance industry that many of the inequities that we used to hear about on an everyday basis were addressed. Denying claims because they didn’t want to pay out large settlements, overcharging premiums, redlining and discriminating against neighborhoods which were non-white, accusing insureds of pre-existing illnessness with no proof, the list is endless. Insurance companies would… Read more »

Holly@ClubThrifty
8 years ago
Reply to  Peach

Don’t forget rescission- where they go back and retroactively cancel people’s coverage after they get sick!!!

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago
Reply to  Peach

They get the power to do such things because they have lobbyists in Washington, and the end goal is to crush competition through legislation, rather than outcompeting other companies. That’s why we have huge insurance companies who face virtually no competition. As long as Washington has the power to dole out special privileges, the companies will be there to beg (and pay) for the goodies.

SLCCOM
SLCCOM
8 years ago

Matt, we’ve had this discussion about magical thinking before. It is magical thinking to believe that a “healthy” diet (about which we know little or nothing beyond virtually-meaningless correlation studies) and exercise will somehow “prevent” illness. Our bodies are designed to DIE. Something will give way, and it is inevitable, unless you die young of severe trauma.

The idea that someone who is “on their way to becoming unhealthy” should pay higher premiums is nonsensical except in terms that older people pay higher premiums. And we do already.

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago
Reply to  SLCCOM

Since this article isn’t about diet, I won’t respond to that part of your comment.

People with bad credit pay higher interest rates because they’re statistically more likely to default. People with certain health attributes (high blood pressure, insulin resistance, etc.) are statistically more likely to require more health treatments. Therefore, their premiums are higher. If that’s nonsensical to you, then I suggest you don’t start a health insurance company. You’ll fail.

Annelise
Annelise
8 years ago

Thanks for giving the other side of the story, Matt.

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago
Reply to  Annelise

My pleasure. Thanks for the kind words.

Tom Murin
Tom Murin
8 years ago

I agree this is s good basic article. The moral hazard example could be better, of course (I think it is better for P & C than health insurance). I hope the future articles address HSA/High Deductible plans. I have one and I think they are going to grow considerably in the next few years.

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  Tom Murin

You are in luck! Look forward to a full article on HDHP w/HSA. And I agree, they are going to grow considerably.

Meagan
Meagan
8 years ago
Reply to  Joanna Lahey

Thanks for the article Joanna, and I’m looking forward to more info about HSA-compliant plans – my husband owns a small business and I’m researching health insurance.

Thanks!

tosajen
tosajen
8 years ago

Thank you for the beginning of what promises to be a very interesting series. At the end of the year, we are moving from corporate/COBRA insurance coverage (covered for life, so far) into the market for individual coverage with pre-existing conditions. I expect that our least-healthy family member will be on the state plan, and I’ll do the best I can on the open market with the rest of the family. With COBRA, medical insurance is by far our biggest monthly expense, and I don’t expect that to change much on the open market. I’m looking forward hopefully to 2014… Read more »

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  tosajen

You’re right on all counts. Clinton was not the first president to try to get universal health coverage– previous presidents, both Republican and Democrat, tried and failed. But at the time they had opposition not just from the insurance industry, but also from unions who felt that the health insurance benefit was one of their reasons for existing. Now that health insurance has gotten so expensive, unions are happier about the idea of someone else taking over that obligation. Re: self-employment, etc. That’s called “job-lock” and there’s a huge literature on that (including a paper of mine with Melissa Boyle… Read more »

tosajen
tosajen
8 years ago
Reply to  Joanna Lahey

The issue of job mobility and insurance appears to be part of your dissertation as well. 🙂

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  tosajen

Yeah, the JPubE pub was the third paper in my dissertation. The published version is much improved from the original, however. We’re currently working on what happens to the younger wives when the husband becomes eligible for government health insurance as a companion paper.

Peach
Peach
8 years ago

Good information. I worked in the insurance industry for years and always wished they’d provide info to customers that would help them understand how insurance worked and why or why not they were going to pay a claim.

Jessica
Jessica
8 years ago

I’m very excited about these future articles. Insurance is confusing so having a nonbiased, intelligent source of information will be a blessing. Thank you for writing these. Also, Matt, your logic is somewhat nonsensical. Joanna has used case studies for all of her points which make them based in fact. Unlike yours which seem like you’re disagreeing solely because it doesn’t jive with your world view.

catherine
catherine
8 years ago

This is great.. The author is saying so lucidly exactly what I’ve always believed, especially with regard to a couple of points: 1) The empoyer-based insurance paradigm: The insurance system was kind of cobbled together over the past hundred years in a way that could be compared to tacking on renovations to your house, but then winding up with a weird, non-sensical collection of rooms with no real flow or cohesion. Blue Cross built the industry, and then the industrialists started to offer it as perks for a competitive edge. If someone at that point had the foresight to stand… Read more »

El Nerdo
El Nerdo
8 years ago

This is an awesome interesting introduction to the subject and discussion, and I am so tremendously sad it appeared on a Saturday when usually we have no GRS articles (hence I didn’t see it). So much good information, I’ll need time to process it, but– bravo! Looking forward to the next installment.

Babs
Babs
8 years ago

Thanks for this great article. Looking forward to reading more.

Hanah
Hanah
8 years ago

Oh friends – you really must get some kind of universal coverage. I’m another Canadian weighing in, and while there is no perfect health care system out there, our single-payer system works extremely well on the whole. Moral hazard doesn’t seem to be a big issue because the total cost of our health care is much less than in the US. Just think: no armies of actuaries and claims adjusters, easier billing for the doctors..how can it not be cheaper? There’s a lot of scare-mongering about “rationing” but in fact it’s only non-emergency care that takes a bit longer. A… Read more »

chris
chris
8 years ago

Thanks for this great post. I’m more likely to keep coming back if there is something new to learn. I look forward to the next post on this topic.

El Nerdo
El Nerdo
8 years ago

Hi Joanna, Here’s my followup response… a bit late and not complete but it’s something. It was interesting to read about insurance from the point of view of amortizing costs. I have never thought about it that way because I tend to look at insurance as some sort protection against life’s horrors. In other words, the way I think of insurance it’s not to spread out the cost of things but a kind of anti-lottery ticket to protect me in case of catastrophe. For example, I don’t buy car insurance with the expectation that I’m going to wreck my car;… Read more »

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  El Nerdo

Thanks for your comment! As it says in the article, that preventative care and the pre-paid health care are not technically insurance, they’re just bundled with insurance. Yes, insurance is there to make you closer to whole when times are bad. You’re sharing the risk across good and bad states of the world. The peace of mind you’re talking about is risk aversion. Moral hazard was definitely a problem with Wall Street executives. But it’s also a potential problem with public programs. Different programs have different ways of trying to mitigate it. (For example, WIC gives in-kind food from a… Read more »

El Nerdo
El Nerdo
8 years ago
Reply to  Joanna Lahey

Ah yes… I see it was mentioned. The thing is I was thinking more about this and I realized why it’s a big problem. The insurance company is basically a middleman. When you have to deal with catastrophe it’s one thing to deal with authorized repairs and so forth, but when you have to deal with them for every little health decision a) it gives away control over your own health care, b) it increases costs because the insurance has to have their cut of every little procedure, not just the emergency ones. Anyway, thanks for the article and the… Read more »

Joanna Lahey
Joanna Lahey
8 years ago
Reply to  El Nerdo

I think the next post talks a bit more about insurance company as middle-man. (Or at least it does now… the post was running long so if the editor cuts it down, that’s a natural place to cut it.) You’re absolutely right! Though, as that post explains, their middle-man status actually cuts costs occurring from moral hazard and lack of price-based-competition.

El Nerdo
El Nerdo
8 years ago

Hi Joanna, Here’s my followup response… better late than never, yes? It was interesting to read about insurance from the point of view of amortizing costs. I have never thought about it that way because I tend to look at insurance as some sort protection against life’s horrors. In other words, the way I think of insurance it’s not to spread out the cost of things but a kind of anti-lottery ticket to protect me in case of catastrophe. For example, I don’t buy car insurance with the expectation that I’m going to wreck my car; I don’t buy renters… Read more »

AdamWickPrk
AdamWickPrk
8 years ago

The problem with Obamacare and the individual mandate is that it makes no economic sense to me as a young / healthy person. Due to community rating, gender rating, and bloated minimum coverage requirements, I’m being forced to pay a wildly disproportionate share of the costs relative to what I use. Actuarial tables go out the window. It’s like asking someone who drives a Ford Escort to pay premiums on a BMW. The fine to opt out is so small as compared to the forced monthly premiums, it makes sense to opt out and buy insurance only when needed. I… Read more »

SLCCOM
SLCCOM
8 years ago
Reply to  AdamWickPrk

Adam, if you choose to go this route, and millions of other ostensibly healthy people do this, there will be NO COVERAGE for anyone. Any insurance is based on the vast majority of people paying and not collecting. Think of it as a poker game. How do you think your buddies would take it if you play hand after hand without anteing in, and deciding to join the game when you get that royal flush. And how well do you think it would work if you wait until your house burns down to get homeowners insurance? Or buy auto insurance… Read more »

Matt at Healthy N' Wealthy
Matt at Healthy N' Wealthy
8 years ago
Reply to  SLCCOM

Millions will abuse it, and it will make us all poorer, and less people will wind up with coverage and treatment. What people like you, SLCCOM, don’t understand is that in a free-market-based system, selfish ends require selfless means. A normal person wants health insurance in the event that he or she becomes ill. He goes out and finds someone willing to take on the risk of his future medical bills. Obviously no one is willing to do it for free. He must pay a price for this coverage. On the other side of the equation, a capitalist wants to… Read more »

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