Why health insurance?

The challenge of health care in any society is to ensure that every single citizen can afford to access a decent health care, atleast when experiencing unbearable pain and suffering or facing a life-threatening diseases. Apart from the moral arguement (letting a man die when he could have been saved has an element of moral repugnance associated with it) there is also the more mundane and practical issue of equity - provision of affordable and universal health care. It is widely acknowledged that the most efficient and cost-effective manner of providing for such health care is through a system of health insurance.

However, health insurance, like any other insurance market, suffers from several market failures. Thanks to the problem of information asymmetry, buyers are likely to camouflage their health risks (moral hazard) while sellers have the incentive to screen out those with the highest health risks (adverse selection). And to top it all, in order to avoid being caught on the wrong side of a compensation suit, doctors prescribe the full spectrum of diagnostic tests and even medicines (defensive medicine) with no regard for its cost.

It therefore demands that governments intervene more directly in health care markets, or else make the concious choice that we have no problem in leaving people to suffer and die when there exists the strong possibility to prevent such pains. This is especially true in light of the rapid increases in health care costs and advances in technology that has made it possible to detect diseases and save lives. It is one of the supreme ironies that the dramatic improvements in health care technologies that have made it possible to reduce suffereing and save more lives may also have ended up making health care unaffordable to an increasing number of people and generating numerous distortions in incentives among the various stakeholders.

An excellent illustration of the dichotomous nature of the impact of technological advances on health care is heart-attack care. On the one hand, the spectacular "evolution of heart attack treatment over the past three decades" has dramatically increased the probability of survival for victims. On the flip-side, costs have risen exponentially far out of proportion to its documented benefits and there has been a trend towards aggressive over-treatment by inserting stents and performing agioplasties and bypass surgeries and in more invasive treatments for prostate cancer.

In his seminal paper on the Economics of the medical care market, Kenneth Arrow had argued with great clarity that markets don't work in medical care. He points to the non-economic influences on this market - professional commitments (of doctors) to provide a service and to engage in services that aren't self-serving; standards of caring decided by non-economic actors etc. In a recent interview he had opined that the problems have been exacerbated by the erosion of professional standards and commitment at the altar of mammon and the market.

Paul Krugman argues in this nice post that health care cannot be sold just like any other service, especially in view of the uncertainty surrounding the need for such care (Kenneth Arrrow described health care as a "random event"), the incentive for insurers to deny as many claims as possible and avoid those in need of such care, and the difficulty in quantifying the type and amount of care needed. While acknolwedging the superiority of a universal, single-payer system, Krugman though feels that a more appropriate immediate and medium term goal for the US would be a universal system with private insurers competing with a government run non-profit insurance provider (the "public option"). Kathleen Sebelius makes this excellent case in favor of universal health care.

Mark Thoma points to two reasons - market failure and equity - for governments to intervene in the health care markets. Market efficiency dictates that governments intervene to the extent of putting in place mechanisms that remedy failures and restore the markets ability to function properly - "ensure that people have the information they need to make informed decisions about their care, that there aren't incentives that cause doctors to order too much or too little of some type of care or test, that monopoly power is checked" etc. Thoma though feels that equity is reason enough to justify government intervention and market failure only lends added weight to this reasoning. He writes,

"So those opposed to government involvement in health care markets have to first argue that there is no market failure significant enough to justify intervention, a tough argument in and of itself, and also argue that people who, for example, go without insurance or cannot afford the basic care they need deserve no compassion whatsoever from society more generally. That's an argument I could never make even for those who could have paid for insurance but chose to take a chance they wouldn't need care, let alone for those who cannot afford it under any circumstances."

Paul Krugman draws attention to the Dutch health insurance system as an excellent example of a middle-way between the single-payer (government paying) system and a market driven health insurance system. The Dutch system prescribes a basic set of treatments which are pre-defined in the insurance cover, premiums are fixed at a flat rate irrespective of the risk and age profile, and risk management among funds is done using a commonly managed risk pool. The features of the Dutch system are

1. Long-term treatments, especially those which involve (semi-)permanent hospitalization, and also disability costs such as wheelchairs, are covered by a a state-run mandatory insurance.
2. For all regular (short-term) medical treatment, there is a system of obligatory health insurance, with private health insurance companies who are obliged to provide a package with a defined set of insured treatments.
3. An extra government allowance is given to those with insufficient income to cover their costs.
4. People are free to purchase additional packages from the insurance companies to cover additional treatments such as dental procedures and physiotherapy.
5. Premiums are set at a flat rate for all purchasers regardless of health status or age.
6. Risk variances between funds due to the different risks presented by individual policy holders are compensated through risk equalization and a common risk pool which makes it more attractive for insurers to attract risky clients.
7. Funding for all short term health care is 50% from employers, and 45% from the insured person and 5% by the government. Children until age 18 are covered for free. Those on low incomes receive compensation to help them pay their insurance.

Another excellent example of cost-effective and universal health care is the German model. The basic features include all individuals are insured for a basic package of health care benefits; individual’s contribution to the financing of health care is tailored closely to the individual’s ability to pay; the individual’s premium is not a per-capita levy, as in the United States, but is purely income-based; the insurance costs of those employed are financed by a payroll tax while unemployment insurance pays the premiums for unemployed individuals, and pension funds share with the elderly in financing their premiums, which are set below actuarial costs for the elderly; and premiums for children are covered by government out of general revenues.

The health insurance premiums paid by Germans are collected in a national, government-run central fund that effectively performs the risk-pooling function for the entire system. This fund redistributes the collected premiums to some 200 independent, nongovernmental, competing, nonprofit "sickness funds" among which Germans can choose. These sickness funds act as purchasing agents on behalf of the central fund and patients and premiums are paid based on the individual's actuarial risk calculated using over 80 variables by the administrators of the sickness fund.

Tailpiece

The health care debate in the US appears to be nearing its climax. The House Committee on Energy and Commerce has cleared a draft health care reform Bill that addresses both the vital elements of the reforms - insurance market reforms and the expansion of coverage with subsidies. The Bill contains a "public option plan" that would compete with private insurers and create health insurance exchanges, where people could shop for insurance and compare policies.

It also seeks to rein in private insurance companies by banning underwriting practices that prevent millions from obtaining affordable insurance; insurers would have to accept all applicants and cannot charge higher premiums because of a person’s medical history or current illness; and all insurers would have to offer a minimum package of benefits, to be defined by the federal government. Further, nearly all Americans would be required to have insurance and federal subsidies would be provided to help make insurance affordable for people with modest incomes, by expanding the eligibility and scope of Medicaid.

Update 1
NYT has this primer on the health care reform debate in the US.



Update 1
William Dow, Arin Dube, and Carrie Hoverman Colla point to the experience of San Francisco (which along with Massachusetts are the only near-universal health care program states in the United States) to show that mandatory employer-health-spending requirement (either buying private insurance or paying to an account or buying the public option) and a public option plan have had no adverse impact on economic growth and businesses.

Uwe Reinhardt defines the overarching goal of health reform thus, "to put in place a reformed health insurance system that can offer Americans the same reliable, permanent, portable and life-cycle health insurance enjoyed by, say, Germans or Canadians or the people of Japan and Taiwan".

Update 2
Uwe Reinhardt explains the need for community rating (whatever premium an insurer quotes must be the same for all members in that insurer’s risk pool, generally age group) and guaranteed issue (means the insurer must serve all applicants willing to pay that insurer’s community-rated premium) to keep health insurance costs affordable and why both requires making health insurance mandatory. See also his discussion of Bachus Plan here. Read about the German model here.