Providing Secure Health Insurance to American Consumers

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Mr. Chairman, members of the subcommittee, thank you for thisopportunity to present my perspective on providing secure healthinsurance to American consumers.

The Marvel of Voluntary Health InsuranceMarkets

Every year in the United States, thousands upon thousands ofAmericans walk or are carried into hospitals. Some are in extremepain. Some are close to death. Using the tools of modern medicine,doctors routinely heal their pain and save their lives.

No less marvelous, however, is the fact that the bill is oftenpaid, voluntarily, by complete strangers. These benefactors do notknow the patient. They do not know her illness. They may notpractice the same religion or speak the same language. Were they tomeet the patient, they might not even like her. And yet, withoutanyone pressuring or forcing them to do so, these people repeatedlypurchase lifesaving medical care for complete strangers. Indeed,they play a role every bit as important as the doctors andhospitals. By some marvel, this wonderful phenomenon occurs everyday in the United States.

That marvel is health insurance. When individuals choose topurchase health insurance, they make an agreement to pay for themedical expenses of those in the insurance pool who become sick orinjured. They uphold that agreement by paying a periodic premium toan insurance company. To be sure, it is not compassion for othersbut self-interest that motivates most insurance purchasers: eachwants to have her own medical bills paid in the event of acatastrophe. Yet that only makes health insurance all the moremarvelous. Health insurance harnesses the self-interest of millionsof strangers to produce an unquestionably compassionate result.

Of course, such generosity inevitably invites opportunisticbehavior. If the insurance pool paid for all their medical care,some patients would consume more medical care than they need. Andwhy not - those other people in the pool are just strangers. Healthcare providers could try to sell those patients more medical carethan they need. If individuals can tap the pool members' generositywhenever they chose, many would not contribute to the pool untilthey became sick. By the time they join the pool, their medicalexpenses would well exceed their contributions. Before long,premiums would spiral out of control, and no one would want toparticipate. For these reasons, members of the insurance pool hiresomeone to protect them from opportunistic behavior.

Health insurance companies are essentially intermediariesbetween members of the pool. Insurers charge higher premiums toenrollees who purchase more extensive coverage, because thosemembers will draw more money from the pool. Insurers requiremembers to pay part of the cost of their own medical care (throughdeductibles, coinsurance, and copayments) to ensure that membersaren't careless with other members' money. Insurers look overphysicians' shoulders (with managed-care tools like capitationpayment, preauthorization, and utilization review) to ensurephysicians are being careful with their members' money. Insurersalso calibrate each new member's premium to her expected claims. Ifan individual waits until she is sick to join the pool, herpremiums will therefore be much higher than if she joined whilehealthy. Risk-based premiums thus promote compassionatebehavior, because they encourage individuals to contribute to thepool while they are still healthy - so their premiums can help savethe lives of strangers. Once in the pool, however, insurers don'tincrease members' premiums when they become ill.

Insurers compete and innovate to see who can best manage thesefeatures, and provide members the protection they desire at thelowest possible premium. That competition is the market's way ofnavigating what economists call "the Samaritan's dilemma," or thehuman tendency to take advantage of other people'scompassion.2

Do Health Insurance Markets Fail?

Critics claim that unregulated insurance markets do not providesecure access to medical care; that risk-based premiums are unfair;that insurance companies drop people when they get sick; thatmarkets will not provide health insurance to everyone; and thatgovernment must create pooling arrangements that correct thesealleged market failures.

Evaluating the performance of unregulated health insurancemarkets is complicated by the fact that most Americans obtainhealth insurance in markets heavily regulated or distorted bygovernment.

  • Nearly all seniors obtain health insurance from governmentthrough the federal Medicare program.3
  • Due to large tax preferences for employer-sponsored insurance,about 90 percent of nonelderly Americans with health insuranceobtain it through an employer.4
  • Only 10 percent of the nonelderly insured (about 16 millionpeople) obtain insurance directly from an insurance company, i.e.,through the "individual" market.

In addition, many states impose significant regulations on theirindividual health insurance markets. Even if a state does not,administrative costs and premiums in that market will be higherthan necessary because government diverts most consumers into theemployment-based market.

Researchers examining America's badly hampered individual healthinsurance markets nevertheless have found considerable evidencethat unregulated markets provide consumers with reliable long-termprotection from the cost of illness. For example, University ofPennsylvania economist Mark Pauly and colleagues find:

  • "Actual premiums paid for individual insurance are much lessthan proportional to risk, and risk levels have a small effect onobtaining coverage."5
  • "Premiums do rise with risk, but the increase in premiums isonly about 15 percent of the increase in risk. Premiums forindividual insurance vary widely, but that variation is not verystrongly related to the level of risk."6
  • "Guaranteed renewable" policies, which are intended to protectagainst premium increases if the enrollee becomes sick, "appear tobe effective in providing protection against reclassification risksin individual health insurance markets."7 The vast majority of insuranceproducts (75 percent) provided guaranteed renewability before theywere required to do so by government.8
  • High-cost individuals who are covered by small employers arenearly twice as likely to end up uninsured as high-cost individualscovered in the individual market.9
  • "On average, guaranteed renewability works in practice as itshould in theory and provides a substantial amount of protectionagainst high premiums to those high-risk individuals who boughtinsurance before their risk levels changed. The implication isthat, although there are some anecdotes about individual insurerstrying to avoid covering people who become high risk (for example,by canceling coverage for a whole class of purchasers), the data onactual premium-risk relationships strongly suggest that suchattempts to limit risk pooling are the exception rather than therule."10

Similarly, RAND economist Susan Marquis and colleagues find thatthe individual market protects enrollees with expensive conditionsand that risk-based premiums are not as harsh as critics imply:

  • "Purchasers derive value from having the range of choices thatthe individual market offers."11
  • In the individual market, "a large number of people with healthproblems do obtain coverage."12
  • "We also find that there is substantial pooling in theindividual market and that it increases over time because peoplewho become sick can continue coverage without newunderwriting."13
  • Regarding enrollees who purchase insurance and later becomesick, "in practice they are not placed in a new underwritingclass."14
  • "Our analysis confirms earlier studies' findings that there isconsiderable risk pooling in the individual market and that highrisks are not charged premiums that fully reflect their higherrisk."15

Recent experience in California shows that insurance companieswill sometimes rescind coverage when enrollees provide inaccurateinformation about pre-existing conditions - and perhaps even whenenrollees have not done so. California insurers have sincereinstated coverage for many enrollees, often under the threat ofbreach-of-contract suits. As one California attorney told TheWashington Post, "These cases are very, very good in front ofa jury…I wish I could tell you the amount of money theythrow at us just to make it go away and keep quiet."16

That episode demonstrates that government enforcement ofinsurance contracts can prevent individuals from defraudingstrangers and prevent insurers from breaching their commitments tocare for the sick; that media scrutiny is an important marketmechanism; and that both types of consumer protection can spurinsurers to change their behavior. All told, free markets provideconsiderably better health coverage than critics suggest.

Should Markets Provide Universal Coverage?

Critics are correct that markets will not provide healthinsurance to everyone. Voluntary insurance pools often will notcover medical conditions that are known to exist at the time anindividual enrolls.

Health insurance markets are completely justified in notcovering pre-existing conditions - and it is crucial thatgovernment not force them to do so. Were government to forceinsurers to cover pre-existing conditions, few would purchaseinsurance until they had an expensive medical condition, and thepool would unravel. Thus, there is a very good reason why marketswill not deliver universal coverage.

That still leaves a problem. Risk-based premiums will encouragemost people to purchase insurance before they become ill. Yet therewill always be some people who either did not join a pool whilethey were still healthy or never had the opportunity because theyare indigent or because their high-cost condition has been withthem since birth.

Assuming they cannot afford medical care, individuals withexpensive pre-existing conditions require subsidies, whichis not to say they need insurance. Insurance is merely oneway - and a very expensive way - of subsidizing pre-existingconditions. More than other types of subsidies, insurance resemblesa blank check. In general, strangers do not voluntarily give blankchecks to other strangers, again with good reason: strangers aredifficult to monitor, and the beneficiaries (encouraged by theirhealth care providers) may take more than they need. Other ways ofsubsidizing the needy include limited amounts of cash, vouchers, orin-kind subsidies from providers, private charities, or government.Compared with the alternatives, the added costs of subsidizingpre-existing conditions with insurance outweigh the addedbenefits.

Exclusions for pre-existing conditions do not indicate a lack ofcompassion by insurance companies or consumers. They are theconsumers' way of telling us that consumers do not want tosubsidize people with pre-existing conditions throughinsurance. They do not preclude other options for subsidizingthe needy, both public and private.17

Does Compulsion Improve the Picture?

Introducing compulsion into the mix disrupts the market processand thereby reduces the ability of consumers to meet each others'needs. Congress is currently considering the introduction of threeprincipal forms of compulsion into health insurance markets:imposing price controls on health insurance premiums; making healthinsurance compulsory for most or all U.S. residents; and compellingtaxpayers to fund, at a minimum, the start-up costs of a newgovernment-run health insurance scheme.

Price Controls

Compelling insurers to charge all consumers the same premium isa form of price control. According to National Economic Councilchairman Larry Summers, "Price and exchange controls inevitablycreate harmful economic distortions. Both the distortions and theeconomic damage get worse with time."18

In a free market, insurers innovate and compete to providehigh-quality health insurance to everyone at the lowest possibleprice. If Congress demands that insurers sell $50,000 policies and$5,000 policies for $10,000, however, insurers will compete toattract only those customers that represent a $5,000 profit and toavoid customers that represent a $40,000 loss.

Congress cannot police the thousands of subtle ways thatinsurers would respond to price controls by courting the healthyand avoiding the sick. Health economist Alain Enthoven notes: "Agood way to avoid enrolling diabetics is to have noendocrinologists on staff in the county. A good way to avoid cancerpatients is to have a poor oncology department."19

Price controls punish insurers who provide quality coverage tothe sick. In 2008, an Aetna plan in the price-controlled FederalEmployees Health Benefits Program dropped coverage for the12-hour-a-day nursing care on which spinal muscular dystrophypatients like 11-year-old Shelby Rogers depend. An Aetna spokesmanexplained the company dropped the benefit because other insurers donot offer it, which caused the $50,000 patients to gravitate toAetna's plan.20

In the end, price controls will eliminate the plans that sickpeople find most attractive. President Obama's economic advisorDavid Cutler finds that the price controls in Harvard University'shealth insurance exchange reduced choice by eliminatingcomprehensive insurance.21

Compulsory Health Insurance

The $5,000 of profit that insurers would receive from low-costpatients is in fact a $5,000 tax on the healthy. To prevent thehealthy from avoiding that tax, President Obama and others proposeto make health insurance compulsory for most or all Americans,either through an "individual mandate," an "employer mandate," orboth.22

The Massachusetts experience demonstrates that at a nationallevel, compulsory health insurance would effectively prohibitlow-cost health plans and force tens of millions of already insuredAmericans to purchase more expensive coverage.

Massachusetts belies the claim that making making healthinsurance compulsory will bring down health care costs. Federal,state, and private-sector health care spending have all increasedunder compulsory health insurance. Private health insurancepremiums are growing 21 percent to 46 percent faster than thenational average.23 A report funded by the BlueCross BlueShieldFoundation of Massachusetts indicates that overall public andprivate spending on health insurance has grown 66 percent fasterthan it would have otherwise.24

In 2009, Massachusetts' compulsory health insurance schemecovered previously uninsured families of four at a cost of at least$20,000, which is 50 percent greater than the nationwide averagecost of employer-sponsored family coverage.25 That estimate should beconsidered conservative, because it does not include the cost ofthe additional coverage that Massachusetts requires already insuredresidents to purchase. It is even more exorbitant considering that86 percent of uninsured Massachusetts adults were in "good, verygood, or excellent" health26 and therefore should have cost less to insurethan the average person.

Summers writes, "If policymakers fail to recognize the costs ofmandated benefits because they do not appear in the governmentbudget, then mandated benefit programs could lead to excessivespending on social programs."27.

Finally, compelling Americans to purchase private insurancewould give incumbent insurers a guaranteed customer base and wouldprotect incumbent insurers from competition by standardizingproduct design.

Government Programs

Congress is also contemplating a new government health insuranceprogram as an option for some or all U.S. residents under the ageof 65. For my thoughts on those proposals, I refer the committee tothe attached study I recently authored for the CatoInstitute.28

To the argument I make in that study, I would merely add: It canbe difficult to make private insurers to keep their commitments toprovide care to the sick. Yet making government honor itscommitments to the sick may be more difficult, because governmentwields the sole, legal, and unilateral power to breach itscommitments without compensating those it harms.29

Conclusion

Whatever our disagreements about government health insuranceprograms, however, I hope we can agree that private insurers do notdeserve the sort of massive bailout represented by proposals tomake private health insurance compulsory.

Thank you for holding this important hearing. I look forward todiscussing with the subcommittee how to provide secure healthinsurance to American consumers.


Notes:

1 The Cato Institute is a nonprofit, tax-exempt educational foundation under Section 501(c) 3 of the Internal Revenue Code. The mission of the Cato Institute is to increase the understanding of public policies based on the principles of limited government, free markets, individual liberty, and peace. In order to maintain its independence, the Cato Institute accepts no government funding. Cato receives approximately 82 percent of its funding from individuals, 10 percent from foundations, 1 percent from corporations, and the remainder the sale of publications. Cato's fiscal-year 2009 revenues were over $20 million. Cato has approximately 105 full-time employees, 75 adjunct scholars, and 23 fellows, plus interns.
2 See, for example, Michael F. Cannon, "Medicaid and SCHIP," Cato Handbook for Policymakers, 7th edition, chp. 13, p. 133, https://www.cato.org/pubs/handbook/hb111/hb111-13.pdf.
3 See Michael F. Cannon, "Medicare," Cato Handbook for Policymakers, 7th edition, chp. 12, p. 125, https://www.cato.org/pubs/handbook/hb111/hb111-12.pdf.
4 See Michael F. Cannon, "Large Health Savings Accounts: A Step toward Tax Neutrality for Health Care," Forum for Health Economics & Policy, Vol. 11, issue 2 (Health Care Reform), Article 3 (2008), http://www.bepress.com/fhep/11/2/3/.
5 Mark V. Pauly and Bradley Herring, "Risk Pooling and Regulation: Policy and Reality in Today's Individual Health Insurance Market," Health Affairs 26, no. 3 (May/June 2007): 770–79, http://content.healthaffairs.org/cgi/content/abstract/26/3/770.
6 Mark Pauly, Allison Percy, and Bradley Herring, "Individual Versus Job-Based Health Insurance: Weighing the Pros and Cons," Health Affairs, vol. 18, no. 6, December 1999, pp. 28-44, http://content.healthaffairs.org/cgi/reprint/18/6/28.pdf.
7 Bradley Herring and Mark V. Pauly, "Incentive-Compatible Guaranteed Renewable Health Insurance Premiums," Journal of Health Economics, vol. 25, no. 3, May 2006, pp. 395-417.
8 Mark Pauly and Bradley Herring, Pooling Health Insurance Risks (Washington: American Enterprise Institute, 1999), p. 18.
9 Mark V. Pauly and Robert D. Lieberthal, "How Risky Is Individual Health Insurance?" Health Affairs Web Exclusive, May 6, 2008, http://content.healthaffairs.org/cgi/reprint/hlthaff.27.3.w242v1.pdf.
10 Mark V. Pauly, "How Private Health Insurance Pools Risk," NBER Reporter Research Summary, Summer 2005, http://www.nber.org/reporter/summer05/pauly.html.
11 M. Susan Marquis et al., "Consumer Decision Making In The Individual Health Insurance Market," Health Affairs Web Exclusive, 25, no. 3 (May 2, 2006): w226-w234, http://content.healthaffairs.org/cgi/reprint/25/3/w226.pdf.
12 M. Susan Marquis et al., "Consumer Decision Making In The Individual Health Insurance Market," Health Affairs Web Exclusive, 25, no. 3 (May 2, 2006): w226-w234, http://content.healthaffairs.org/cgi/reprint/25/3/w226.pdf.
13 M. Susan Marquis et al., "Consumer Decision Making In The Individual Health Insurance Market," Health Affairs Web Exclusive, 25, no. 3 (May 2, 2006): w226-w234, http://content.healthaffairs.org/cgi/reprint/25/3/w226.pdf.
14 M. Susan Marquis et al., "Consumer Decision Making In The Individual Health Insurance Market," Health Affairs Web Exclusive, 25, no. 3 (May 2, 2006): w226-w234, http://content.healthaffairs.org/cgi/reprint/25/3/w226.pdf.
15 M. Susan Marquis et al., "Consumer Decision Making In The Individual Health Insurance Market," Health Affairs Web Exclusive, 25, no. 3 (May 2, 2006): w226-w234, http://content.healthaffairs.org/cgi/reprint/25/3/w226.pdf.
16 Karl Vick, "When Your Insurer Says You're No Longer Covered," Washington Post, September 8, 2009, http://www.washingtonpost.com/wp-dyn/content/article/2009/09/07/AR2009090702455.html.
17 See Michael F. Cannon, "Medicaid and SCHIP," Cato Handbook for Policymakers, 7th edition, chp. 13, p. 133, https://www.cato.org/pubs/handbook/hb111/hb111-13.pdf.
18 U.S. Department of the Treasury, "No Short-cuts to Development," remarks by Lawrence H. Summers Deputy Secretary of the Treasury To the IDB Conference on Development Thinking and Practice, September 4, 1996, http://www.ustreas.gov/press/releases/rr1247.htm.
19 Alain Enthoven, "The History and Principles of Managed Competition," Health Affairs 12, supplemental (1993): 35, http://content.healthaffairs.org/cgi/reprint/12/suppl_1/24.pdf.
20 Joe Davidson, "Caught by a Change in Health Care," The Washington Post, November 27, 2008, http://www.washingtonpost.com/wp-dyn/content/article/2008/11/26/AR2008112604131.html.
21 See Thomas C. Buchmueller, "Consumer Demand for Health Insurance," NBER Reporter, Summer 2006, http://www.nber.org/reporter/summer06/buchmueller.html.
22 In his recent address to Congress on health care reform, President Obama said, "And unless everybody does their part, many of the insurance reforms we seek - especially requiring insurance companies to cover pre-existing conditions - just can't be achieved. That's why under my plan, individuals will be required to carry basic health insurance." Transcript of Obama's Address to Congress, MSNBC.com, September 9, 2009, http://www.msnbc.msn.com/id/32765453/ns/politics-health_care_reform/.
23 Cathy Schoen, Jennifer L. Nicholslson, and Sheila D. Rustgi, "Paying the Price: How Health Insurance Premiums Are Eating Up Middle-Class Incomes," The Commonwealth Fund, August 2009, p. 8, http://www.commonwealthfund.org/~/media/Files/Publications/Data%20Brief/2009/Aug/1313_Schoen_paying_the_price_db_v3_resorted_tables.pdf; and author's calculations.
24 Robert Seifert and Paul Swoboda, "Shared Responsibility: Government, Business, and Individuals: Who Pays What for Health Reform?" Blue Cross Blue Shield of Massachusetts Foundation, March 2009, http://bluecrossfoundation.org/~/media/Files/Policy/Policy%20Publications/090406SharedResponsibilityFINAL.pdf.
25 Author's calculations based on Alan G. Raymond, "Massachusetts Health Reform: The Myth of Uncontrolled Costs," Massachusetts Taxpayers Foundation, May 2009, http://www.masstaxpayers.org/files/Health care-NT.pdf; personal correspondence with Massachusetts Taxpayers Foundation president Michael J. Widmer, July 20, 2009 (available on request); and Cathy Schoen, Jennifer L. Nicholslson, and Sheila D. Rustgi, "Paying the Price: How Health Insurance Premiums Are Eating Up Middle-Class Incomes," The Commonwealth Fund, August 2009, p. 8, http://www.commonwealthfund.org/~/media/Files/Publications/Data%20Brief/2009/Aug/1313_Schoen_paying_the_price_db_v3_resorted_tables.pdf.
26 Sharon K. Long, "On the Road to Universal Coverage: Impacts of Reform in Massachusetts at One Year," Health Affairs Web Exclusive, June 3, 2008, p. w281, http://content.healthaffairs.org/cgi/reprint/27/4/w270.pdf.
27 Lawrence Summers, "Some Simple Economics of Mandated Benefits," American Economic Review 79, no. 2 (May 1989): 177–83, http://www3.amherst.edu/~jwreyes/econ77reading/Summers.pdf.
28 See Michael F. Cannon, "Fannie Med? Why a 'Public Option' Is Hazardous to Your Health," Cato Institute Policy Analysis no. 642, July 27, 2009, https://www.cato.org/pubs/pas/pa642.pdf.
29 Flemming v. Nestor, 363 U.S. 603 (1960). See also U.S. Social Security Administration, "Supreme Court Case: Flemming vs. Nestor," http://www.ssa.gov/history/nestor.html. ("There has been a temptation throughout the [Social Security] program's history for some people to suppose that their FICA payroll taxes entitle them to a benefit in a legal, contractual sense…Under this reasoning, benefits under Social Security could probably only be increased, never decreased…Congress clearly had no such limitation in mind when crafting the law.")

Michael F. Cannon

Subcommittee on Domestic Policy
Committee on Oversight and Government Reform
United States House of Representatives