Frankenstein’s Monster

For a guy who claims to know little about health care, Brad DeLong gives an excellent summary of the health care reform debate. DeLong accurately represents two sides of the debate, which means that he reveals (in my view, anyway) a flaw in the Left's reasoning.

ADVERSE SELECTION   DeLong writes:

Those economists on the left tend to think that the real big problem with American health care is adverse selection: Those who know they are healthy and likely to stay that way skimp on purchasing insurance. Insurance companies work like dogs to avoid selling insurance to people who are expensively sick or likely to get expensively sick. As a result, a huge amount of people's work-time and information technology processing power are wasted on the negative-sum game of trying to pass the hot potato of paying for the care of the sick to somebody else. The more people separate themselves or are separated into smaller and smaller pools with calculably different exposures to risk, the worse this problem gets.

THE RISING COST OF CHRONIC ILLNESS   DeLong further writes:

[A]n increasing share of the increase in health care costs is going to be driven . . . by expensive chronic diseases and risk factors driven by long-term lifestyle choices. Nationalizing the health insurance sector won't diminish the costs in 2050 of treating the lung cancer that the twenty-year-old starting smoking today will develop. Increasing copays won't reduce the costs of treating the diabetes that the five-year-old today with a two-Coke and three-Twinkie-a-day habit will develop in 2045.

So here's where I see the flaw. 

1. Adverse selection only becomes a problem when insurers do not adjust premiums according to the enrollee's expected medical expenses — i.e., according to risk. If insurers set premiums according to risk, they have no reason to avoid sick people; the insurer is indifferent between high-risk and low-risk individuals. Where insurers do not set premiums according to risk, it is usually because of an express or implicit government prohibition.
   

   Many states prohibit risk-based premiums in the individual insurance market. Premiums for employer-sponsored coverage also do not vary according to individual risk, a system that is propped up by an enormous tax preference for such coverage. The Left generally likes these government interventions, which makes adverse selection their very own Frankenstein's Monster — not some inherent market failure. Allowing risk-based premiums in these areas would make adverse selection effectively disappear.

2. Moreover, risk-based premiums encourage healthy behaviors (e.g., quitting smoking) and encourage people to purchase health insurance while they are still healthy. In contrast, prohibiting risk-based premiums encourages lung cancer, diabetes, and uninsurance. (Why buy coverage when I'm healthy if there's no penalty for waiting until I have lung cancer?) Therefore, allowing risk-based premiums would help reduce the costs of behavior-induced chronic diseases about which DeLong frets. If smokers or the obese have to pay more for their health insurance, there will be fewer smokers and obese people — and those who remain will have largely paid their way.

The Left will object that risk-based premiums would mean that insurers would no longer over-charge healthy people in order to subsidize the sick, who then may not be able to obtain coverage. But those forced subsidies are coming to an end anyway, simply because people will always pursue their self-interest. One of the reasons that employment-based coverage is unraveling is that the healthy people realize they're being ripped off and they want out.

For what it's worth, I think DeLong accurately describes the regrettable "prescription of the right-wing subtribe of economists . . . [to] regulate the insurance market so that the only policies allowable are high-deductible."