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Friday, October 17, 2008

McCain's market-based health insurance plan

McCain's plan to solve the problem of rising health care costs and the growing ranks of the uninsured:
  • Allow people to buy health insurance across state lines, opening competition for health insurance plans nationwide on an individual basis
  • Give a tax credit ($2500 to individuals, $5000 to families) that will provide the money to purchase a basic plan
  • Recoup these costs by making employer-sponsored healthcare benefits taxable
On the surface, the raw economics seem to be in McCain's favor. Competition lowers the price for the consumer, and in this respect it makes sense to allow the end consumer - the patient, you and me - to buy from whom we choose, knowing the entire cost of our healthcare. And perhaps this means that employee-sponsored health care plans will bite the dust, but in the name of the market they should, shouldn't they?

The problem is that insurance is inherently a form of socialism, and the bulk of healthy consumers punch below their weight when it comes to healthcare costs. The sickest 1% of our citizens account for 27% of our healthcare costs, the sickest 5% account for 38%, and so on - you see where this is going. It's a stable statistic. This is why we have insurance - the bulk of healthy people willingly transfer their wealth to the currently sick people, in exchange for the good of being prepared for the possibility of becoming sick. Scratch and scratch. Insurance agencies stay one step ahead in this game by signing up a whole bunch of healthy people. Their model is simple: revenue is provided by healthy insurees who pay in more than they take out, while overhead and unhealthy insurees constitute the expenditures. It's exactly the same idea that Cap One is taking to the bank: identify and sign the least costly consumers, and they will more than compensate for the more risky consumers. The more healthy buyers the bigger their margin.

The complication insurers want to avoid is called adverse selection: it can be summed up as "the only people who buy insurance are those who benefit from it." In the case of health insurance, this would mean that the only people who buy insurance are the sick. You can see how this instantly turns the entire balance sheet red. Adverse selection occurs when the insured (or the lessee) holds some power over their insurer (or lessor.) For health insurance, this typically results from an asymetry of information, IE, the potential insured withholds information about health issues that make him more risky, such as pre-existing conditions or cigarette smoking. So, insurance companies control that risk-benefit ratio with medical underwriting (the infamous pre-coverage health exam by which so many people are given higher rates or denied coverage) and then adjusting premiums for risk.

If McCain's plan is enacted and works as designed, the bulk of consumers will buy cheaper insurance than they already have. The design of the plan is to incentivize Americans to ditch their expensive employer-sponsored plan for the cheaper, primary care-intensive ounce of prevention. In fact, they might be forced to - the average cost of insurance for an American family is around $12,000, of which $8,000 is usually paid by imployer. $9,000 (the sum of what families already pay plus their tax credit) will get you a pretty decent plan that would be adequate for most healthy families, and with greater care coordination and preventative care, this will probably be okay for healthy Americans. However, in doing so they will have self-formed a gigantic low-cost risk pool. Credit card companies are known for risk pooling: they form groups of lessees with similar credit ratings and buy and sell them as aggregates. This allows the company to manage these accounts much as one might manage a portfolio of stocks. But imagine if, say, CapOne was forced to sell off all its financially-savvy lessees and accept only the most high-risk. They'd go bankrupt because their margin would go to nil. This is exactly the situation that will occur if every healthy American is allowed to go buy the cheapest adequate individual plan out there - they will self-pool in cheaper plans and no longer will contribute to the pool providing for the sickest citizens.

In other words, if the McCain plan works as designed, it will induce adverse selection. Because an insurance company's margin is the direct product of the ratio of healthy and sick insurees, they would have to adjust for this market realignment or face bankruptcy.

Only now, the insurance company can not do anything about adverse selection, because adverse selection is built into the system. McCain's health plan is designed to prevent insurance companies from artificially adjusting their risk pool (as a credit card company might) so they have to compete in a price market for insurees, IE, they have to drop their price. This would be financially untenable. A company providing for the care of a large pool of high-risk individuals would have to lower their premiums to competitive market prices just to retain the low-risk individuals that form their revenue base. But the cost to the company for the high-risk individuals remains high: their cost to the company is directly determined by their cost of care, a number determined not by market forces, but by the medical infrastructure. In a market where low-risk individuals are able to drive down the price of insurance by self-pooling, the high-cost individuals essentially represent a dramatically increased overhead that is robust to market forces. The result is that, at lower prices, this company would need to expand their low-risk pool to maintain the margin at a lower premium-per-person. But in order to expand their low-risk pool, they must become more competitive in the market, IE, lower prices. This would require more customers, requiring lower prices, etc. ad nauseum. The process is analagous to inflation. Smaller non-catastrophic insurance providers that do not insure large numbers of high-risk patients (such as United Concordia) would be able to bleed the big guys of their revenue base.

What happens then? The sick stick with what they've got because they have no incentive to change insurances - no company can offer them a premium significantly lower than the cost determined by the medical infrastructure. As their insurance company's margin decreases, their premium must increase if the company is to continue to provide for care and turn a profit. One might think that in an environment of increasing premiums, whoever raises premiums slowest "wins." But while insurance companies have an incentive to compete for low-risk individuals, they have no incentive to compete for high-risk individuals. This is because these people represent pure expenditure, and it is financially foolish to lower prices in order to increase expenditure. Without an employer to sponsor multiple employees as a bloc and thus force insurance companies to accept high-risk individuals as part of the pool, insurance companies should and would treat them as individuals. There may be an incentive to raise premiums only to the a level acceptable by the market, but as revenue-per-insuree decreases, there is certainly an incentive to minimize the expenditures due to high-risk individuals by raising their premiums.

You can see that the overall effect is everyone's insurance premiums will approach the actual direct cost of their healthcare (some asymptote designated by the cost of medical infrastructure.) For many Americans, this would be just fine because they don't get sick too often or too badly, and they'll catch a break. But for a significant portion of America, though, this would be devastating. It's $100 just to get your blood gases checked. What happens when you need a 5-day stay in the ICU? What happens when your croupy kid needs to be intubated? When someone needs IV tPA for a stroke? The costs are astronomical. Just apply the relevant facts: ~30% of the population receives ~90% of the total US healthcare expenditures, which came to $2.26 trillion in 2007. That's $22,198 per person, per year for 3 of 10 Americans. They would forfeit half an average year's pay. The cost of healthcare would be shifted from the population as a whole (as insurance is designed to work) to those who need it the most. McCain's"market of insurances" plan defeats the purpose of having health insurance at all.

This conclusion should have been obvious, right from the start. The demand for healthcare among those who really need it is inherently high and the supply (by virtue of the necessary expertise, infrastructure, research and safety precautions) is inherently low. In a situation of fixed supply and high demand, the most basic tenets of economics dictate that price will always be high. This is one example of why pure market economics can not solve the problems with health care. Price increases in direct proportion to your need, and people's very lives depend on healthcare. You can not afford to buy your life.

But what's really sticky is that very few people end up in the same risk pool they started in. The low-risk pool is composed primarily of the young and healthy, whereas the high-risk pool is mostly made up of the old and ill. As people age, their chance of being severely hurt or contracting some devastating disease goes up. Under a purely free-market system such as McCain's, their direct cost of healthcare (their insurance premium) will similarly increase as insurance companies risk-adjust their premiums in accordance with the demands of the market and the raw cost of our healthcare infrastructure. The end result is that when the truly expensive emergency or late-life care is needed, health insurance will not soften the blow. This plan takes all the non-insured and the adequately insured and incentivizes them to become under-insured.

The real problem with health care is not that insurance is expensive, insurance is expensive because there are problems with healthcare. We Americans face the old trilemma: effective, available, cheap - pick two. Infrastructure overhaul and cultural change would be a good start on this mammoth problem but probably wouldn't solve it entirely. It isn't encouraging that John McCain "Will Develop A Strategy For Meeting The Challenge Of A Population Needing Greater Long-Term Care For Make Benefit Glorious Nation of America," but I can't hold that against him. So he hasn't come up with a strategy for solving that problem, join the club John McCain, we call it America. But simply decreasing the cost of insurance isn't going to solve the underlying problems. It's like the gas prices I argued with my Dad about. He saw gas prices lose a buck, and said "Oh good, the market's working." In a sense, I agree that sure, when people are less willing to pay for gas, the price goes down to reflect the decrease in demand. It's good that we can adjust like that. But the current drop in gas prices merely reflects the fact that our economy is a wreck. It is not encouraging to see a 25% drop in gas prices in the span of a week - in fact, it's kind of ominous to see rats jumping ship. It's the same situation with health insurance: just because the cost of insurance goes down for the average American does not mean any real problem has been solved. It just reflects the fact that when people can't get much they settle for little, and those who can't settle pay out the nose. It's important to remember that we all run the risk of becoming the high-risk patient - all it takes is one drunk driver, one bad infection, one weird genetic condition and you could be totaled. Like the kids I took care of in the ICU last month.

I'm not saying that to be sentimental. I just want to point out that while the market would shelter healthy people like you and me, it would ravage those who absolutely require its services because that's the way a market works. Supply and demand. And that's fine for a lot of things. A great deal of problems are best solved by the market's coldly brutal efficiency. But not healthcare, and certainly not like this.


Katie said...

I like this post. Even though I don't understand a lot about healthcare and what you said, I understand more about what would happen if McCain implemented his healthcare. I think you should do this for Obama's healthcare plan, just to see the comparison. :) hope you are well!

Dargan said...

Great post. Thoroughly enjoyed reading it. I agree with Katie about an article on Obama's healthcare plain. Always enjoy your Auburn Football articles but it was nice to read about something a little more important.