Old Medicine In A New Bottle

This article appeared in Forbes on September 10, 2009.

Before the president's speech we noted a few hopeful objectives: It must allay the uncertainty that many fear — that a sweeping reform will tug the health insurance rug from under their feet. It must convince us that Obama's reforms can achieve the two conflicting objectives that Democrats have emphasized — to extend health insurance to the uninsured and to reduce health care cost growth. We hoped that it would contain a new initiative or two that could bridge the wide chasm separating supporters and opponents of the president's approach. Unfortunately, despite its soaring rhetoric, it did none of the above.

The key to making effective health care policies is to get the economics right: Unfortunately, several areas of the president's approach get the economics wrong.

Insurance companies are in the health-insurance business to make a profit. Kill their profitability and the capital they employ will migrate elsewhere, creating exactly the opposite outcome: higher insurance costs and even more uninsured individuals.

But under the mantle of "greater stability" for the already insured, the president rattled off a series of stricter regulatory measures concerning coverage for pre-existing health conditions, preventive treatments, the use of health ratings, continuation of coverage upon losing or changing jobs, limits on out of pocket expenses and so on.

Sure, insurance companies attempt to improve their risk pools by basing premiums and coverage on health conditions. But this encourages people to live healthier lives for lower premiums, costing the system less. Imposing more stringent regulations will only induce higher premiums and fewer people will be able to afford private coverage, whether individually or through their employers.

For the uninsured, the president offers insurance coverage at competitive prices through new health-insurance exchanges — including a publicly funded option. According to the Congressional Budget Office, the per-capita subsidy for this would equal $4,600 in 2014, rising to $6,000 by 2019. Multiply those numbers by the 30 million or so uninsured citizens and we're talking about rather massive increases in annual deficits.

The president claimed that the subsidies and the public plan option offered to the uninsured would be paid for out of premiums, cost savings from eliminating fraud and abuse and new taxes on insurance and drug companies and expensive health plans. New taxes on individuals would not be used. However, the president offered no concrete solution or mechanism to achieve cost savings. Moreover, the public insurance agency's "not-for-profit" operation will render private insurance companies uncompetitive — with the (un)intended consequence of driving them out of business rather than increasing competition. Indeed, evidence from expansions of Medicaid coverage shows that take-up by the uninsured — those whom the expansion targets — is small, but the shift by those already insured from private to public insurance is very large.

Then there's the canard that the young impose costs on others by opting out of health insurance. In fact, the likelihood of requiring health insurance is extremely low for those younger than age 45. Their choice to forgo health insurance reflects a reasonable assumption of risk. If they fall sick, they can access the emergency room at a cost to others. But this cost source is small, contrary to the president's claim. A recent study by Jonathan Gruber of MIT shows that for physicians' services, about two-thirds of the uninsured pay list prices whereas the insured pay much lower prices. Indeed, even accounting for those uninsured people who don't pay, the uninsured as a whole do not impose net costs on the rest.

If the young were forced to purchase insurance, they would be charged a premium based on the population's average probability of falling sick, and the average cost of treatment (given sickness) for the general population — both of which are much larger than the average likelihood and cost for the young alone. Thus, the premiums that young uninsured people would have to pay would be much larger than those reflecting their actuarially fair costs of coverage. In effect, they would be paying the fair premium plus a hidden tax. Meaning the young would be taxed to pay for care services to the old, the nonsmokers for the smokers, the salad-eaters for the Big Mac eaters and so on.

The president strongly and correctly criticized the use of the term "death panels." We believe that term to be a misnomer for a necessary mechanism — to make choices about public funding for treatments under specific conditions, rationally considering the health benefits that would result from the costs incurred. But the president trotted out the same mechanism to achieve this goal — a medical advisory panel — that the Congressional Budget Office has declared would be ineffective.

The one item we agree about with the president is that Medicare and Medicaid costs are rising too rapidly. Unchecked soon, they could drive out other public services or cause taxes to rise to economically destructive levels. Without an effective mechanism to reduce health care cost growth — especially in the government's large entitlement programs — we will eventually be forced to adopt what really would be appropriately named "death panels": Limits on public coverage and treatment determined not rationally, but arbitrarily.

It's clear that reining in "auto-pilot" entitlement expenditures is the key to sustaining balanced future provision of public services and ensuring a robust economy. Unfortunately, the president's speech provides yet another example of politicians adopting soaring rhetoric designed to soothe us into accepting half measures, hidden taxes and un-needed programs. Rather than cutting existing and overextended budget commitments, the president's approach would dig a deeper fiscal hole.