Universal Health Insurance

Many State Governments as well as the Union Government in India have recently initiated programs offerring health insurance for farmers and other poor people. In this context, here have been voices calling for the Government to diversify its health insurance options by roping in private insurers. They argue that these private insurers, including the foreign insurance multinationals who have entered after the liberalisation of the insurance market, can offer cheap and good quality health insurance for farmers and the poor.

However, experiences from across the world, and in particular from the USA, shows that we should be wary of such prescriptions. It is now widely acknowledged internationally that till we come up with something better, Governments are the most efficient providers of any universal health insurance program. At best,certain services can be outsourced to private insurers. But then we in India are used to a time lag in accepting and rejecting trends. We tend to adopt practices and policies only as they start going out of acceptance in the west. (Remember how in the early nineties, the Government adopted the then discredited Laffer Curve theory, which argued that indirect tax revenues could always be increased by lowering the marginal tax rates). The same could be happening with this advocacy for private health insurance.

The need for Health Insurance assumes importance in light of the astonishing advances in medical technology. While these advances have undoubtedly saved many lives, these newer operations and surgeries, involving sophisticated instruments and procedures are very expensive. Experience from across the globe indicate that instead of reducing costs, technological advances have actually led to a steep rise in medical costs. It is therefore important to cover individuals, especially the poorer sections, with some form of insurance so as to hedge their health risks.

But insurance markets have certain very peculiar characteristics. It is plagued by the famous "adverse selection" problem, first conceptualized by the 2001 Economics Nobel Prize laureates George Akerloff and Joseph Stiglitz. Adverse selection arises from the inability of the market to recognise "lemons". A lemon refers to a defective item put up for sale. The presence of lemons throws up interesting possibilities in certain markets like those for used cars and insurance. Both these markets suffer from what economists call "assymmetric information" related problems. The sellers in these markets - used car owners and insurance claimants - have more information about the commodity on sale, than the buyers. For example in a used car market, in the absence of full information about the quality of the car, the buyer will be unwilling to pay the full price for even a good condition car. Similarly, sellers of good cars will be hesitant to put up their cars for sale since even good cars are likely to trade only at a discount. This dual effect is likely to see the market being occupied more by lemons than good quality products, thereby further deepening the information assymmetry problem.

A solution to this stalemate is setting up effective signalling mechanisms whereby the better quality product, whether used cars or individual insurance applicants, can differentiate themselves. But this is easier said than done and herein lies the problem with insurance market. The healthier individuals may be unwilling to pay the higher premiums charged by the insurance companies, who will therefore be left with the less healthier applicants. This in turn makes the insurance companies either hike up the premiums or put in place mechanisms to screen the medical histories of individuals. They try to screen out the lemons and keep only the healthy individuals. But this screening exercise is no mean task, requiring multiple levels of testing and monitoring. A bureaucracy then develops.

Private insurers spend significant resources screening out lemons. Is is estimated that in the US, these bureaucratic transaction costs account for upto 20% of the insurance costs for private insurers. In contrast the Government insurance programs like Medicare and Medicaid spend a mere 2% of the cost on administration, leaving the remaining 98% to be spent on medical care.

Further, rigorous screening procedures defeat the very purpose of providing insurance. It ensures that all those urgently and most necessarily in need of insurance are kept out of the insurance net. It reduces insurance sector to a mere profit making industry, with the provision of providing insurance being only incidental. We thus have an industry which seeks to provide health insurance ending up insuring all the healthiest and least needy customers for insurance, while eliminating all those most needing that insurance!

In view of the adverse selection problem and the need to have efficiency in delivery, it may be appropriate for any health insurance system to have the following three characteristics. One, any health insurance should be universal for the particular category proposed for. Second, people should buy insurance from the Government. Third, the actual delivery of medical service can be outsourced to multiple private health insurers.

By making health insurance universal and by getting government to sell insurance, we eliminate the costs incurred in fighting adverse selection. This will go a long way in bringing down the transaction costs. The core objective of providing health services can be outsourced to the private insurers, who will compete in Government run "Health Markets" (Senator John Edwards, Democratic Party Presidential nomination contender, has proposed something similar in the US) to sell insurance bouquets. The private insurers will sell insurance in these Health Markets to the Government, which in turn will sell it to the individuals. To be competitive in this market, the private insurers will have to reduce their overheads, and strike bargains with drug companies and medical service providers for reducing service cost. Here larger insurance providers like Government have an advantage in that they have significant bargaining leverage.

The insurance premiums will obviously have to be fixed taking into account the medical histories of individuals and will be calibrated in proportion to the market cost of delivering those services. Wherever the individual is unable to afford the premium, the Government can subsidise the individual to the extent required. The subsidy can be directly paid to the private insurance supplier. The element of subsidy, which in any case would be required, will therefore be beter targetted and utilized.

Health Insurance has generated a great amount of debate in the US since the nineties and is one of the most serious public finance concerns of the Federal Government. The Congressional Budget Office have repeatedly come up with figures explaining the serious budgetary implications associated with steeply rising health care costs. The contender for Democratic Party nomination for the US Presidential elections, John Edwards has outlined a similar plan, which envisages significant role for the Government.

As we have seen, insurance sector is an example of market inefficiency arising from assymmetric information. This requires Government intervention to bridge the information gap and reduce the attendant transaction costs. But the delivery of actual insurance service can be efficiently delivered by private insurers.

The experience in health insurance from across the world and in particular from the US, is a strong reminder to us about the continuing importance of government role and the deficiencies of the private sector in atleast certain markets. It reiterates the limitations of the market in delivering certain services, and the need for Government interventions during such market failures.