In a paper released today by the Cato Institute, University of Chicago finance professor John Cochrane argues that yes we can have secure, long-term protection against the costs of expensive illnesses and give consumers complete freedom to choose any health plan they wish.

Cochrane’s paper, “Health-Status Insurance: How Markets Can Provide Health Security,” builds on his classic 1995 Journal of Political Economy article, which remains among the most innovative in health policy.  Here’s the executive summary:

None of us has health insurance, really. If you develop a long-term condition such as heart disease or cancer, and if you then lose your job or are divorced, you can lose your health insurance. You now have a preexisting condition, and insurance will be enormously expensive—if it’s available at all.

Free markets can solve this problem, and provide life-long, portable health security, while enhancing consumer choice and competition. “Heath-status insurance” is the key. If you are diagnosed with a long-term, expensive condition, a health-status insurance policy will give you the resources to pay higher medical insurance premiums. Health-status insurance covers the risk of premium reclassification, just as medical insurance covers the risk of medical expenses.

With health-status insurance, you can always obtain medical insurance, no matter how sick you get, with no change in out-of-pocket costs. With health-status insurance, medical insurers would be allowed to charge sick people more than healthy people, and to compete intensely for all customers. People would have complete freedom to change jobs, move, or change medical insurers. Rigorous competition would allow us to obtain better medical care at lower cost.

Most regulations and policy proposals aimed at improving long-term insurance —including those advanced in Barack Obama’s presidential campaign — limit competition and consumer choice by banning risk-based premiums, forcing insurers to take all comers, strengthening employer-based or other forced pooling mechanisms, or introducing national health insurance.

The individual health insurance market is already moving in the direction of health-status insurance. To let health-status insurance emerge fully, we must remove the legal and regulatory pressure to provide employer-based group insurance over individual insurance and remove regulations limiting risk-based pricing and competition among health insurers.

Read the complete paper here.  Cochrane is the Myron S. Scholes Professor of Finance at the University of Chicago Booth School of Business and a Research Associate at the National Bureau of Economic Research.  (You can see him commenting on the stimulus package in this Cato video.)