Why Health Insurance Stinks, and Why the Most Comprehensive Health Insurance Stinks Most Comprehensively

The extensive public discussion of what we persist in calling “health care reform” has united us to a remarkable degree. Americans from all walks of life now overwhelmingly agree that the public debate on this issue has been wretched. Indeed, there is even widespread agreement on the cause of the wretchedness, namely the other side’s meretricious pandering and sloganeering. Both other sides.

This strikes me as a very durable bipartisan consensus, and I am reluctant to upset it. However, my main gripe about the public debate so far has nothing to do with “death panels” or town hall theatrics. My main gripe is that we are talking about our system of health care delivery (both current and proposed) as if it is a system of insurance. Health “insurance,” as we’ve come to know it, is not insurance. In fact, that’s the fundamental problem with it. And until we get that straight, I think we will continue to be confused about the likely effects of expanding its availability.

Insurance, properly understood, is a way of managing risk. For example, most people who own their homes pay a small amount to protect against an uncertain but potentially very serious loss, because they would be wiped out if fire or flood or some other disaster destroyed what is probably their most valuable single asset. The cost is quite low relative to the risk, because very few homes actually get destroyed by fire or flood or anything else in any given year. The risk spreading makes it a good deal, because it converts a risk you cannot afford into an expense you can afford.

In addition, real insurance can sometimes have the effect of reducing the chance that the insured risk will occur. For example, when insurance companies give people discounts for smoke alarms, smoke alarm usage tends to increase, and losses from fires tend to decrease. Good underwriting prices the risk accurately and encourages people to try harder to avoid losses.

Insurance is not magic, however. For one thing, it’s not free; insurance companies have to collect more in premiums than they actually pay out in claims, and they have to collect enough more that they can pay their employees and still show a profit for their shareholders. In addition, there are certain things that homeowner’s insurance does not cover. It usually doesn’t cover purely elective expenses, like the cost of installing new outdoor lighting or renovating a kitchen. It also doesn’t cover routine maintenance expenses, like the cost of painting the outside or trimming nearby trees or cleaning the gutters — notwithstanding the fact that these are very important things to do for the long-term preservation of the house.

And importantly, even if homeowner’s insurance did cover the cost of annual gutter cleaning, that really wouldn’t do anyone any good. For one thing, the cost is not significant enough to bother insuring; almost everyone can pay it, and anyone who can’t pay it has a financial problem that really isn’t related to the house. (And remember, because the insurance company does not involve itself free of charge, it is expensive to insure risks you can afford to bear.)

More importantly, there’s no real benefit to risk spreading on routine expenses. For any group of 100 homeowners, there is no benefit to taking 100 bills for gutter cleaning, adding them all into one giant pool, and splitting the cost 100 ways. (By “no benefit,” I mean of course that there’s no benefit to the homeowners. There’s a huge benefit to the gutter cleaners, and to the insurers, but not to the homeowners.) Even if only 95 or 90 homeowners bothered to get their gutters cleaned, by the time you add the insurance company’s costs of administration into the bargain, almost all the homeowners would have to pay a higher gutter-cleaning premium than it would have cost them to pay the gutter cleaner directly, without involving any insurance company.

This is, incidentally, why dental “insurance” stinks. Wearing my employer hat, I’ve looked at quite a few different plans over the years, and I’ve never seen a single one that was worth a damn. Unlike homeowner’s insurance, dental “insurance” is almost entirely about elective and routine expenses. This makes it essentially a payment plan rather than an insurance policy. It doesn’t spread risk, because we all incur about the same level of routine dental expenses. All it really does is put all the policyholders’ routine dental expenses in one giant pool and split the costs evenly. Since the insurance company has to charge more than it pays out, the policyholders as a group end up paying more for the insurance than they would have to pay the dentist in the first place. And since the “risks” covered are non-catastrophic (e.g., the cost of a check-up or a cleaning), no one with two neurons to synapse together would think dental insurance a good deal unless he can get the premium paid by someone else, like an employer. And an employer who wanted to cover his employees’ dental expenses as a way of attracting talented employees would be much better off skipping the insurance and paying the dental bills directly. Or more compactly, dental insurance may confer a benefit by shifting costs from one person to another, but not by spreading risk.

In my opinion, health insurance has become much too much like dental insurance and not nearly enough like homeowner’s insurance. Most health insurance plans do cover the risk of catastrophic injury or chronic illness, and I suspect that’s the most important reason people want health insurance. But they also cover elective procedures and routine maintenance, and in fact most plans cover routine checkups preferentially. But because insurance companies charge between $1.30 and $1.50 in premiums for every dollar of benefits, the effect of throwing this all into the pool is to raise costs substantially. And it’s this feature of health “insurance” that makes it so expensive and makes healthy young people want to opt out of it. This is the key flaw in the argument that expanding the pool to cover the uninsured will drive down costs. That might be true if we were actually spreading risk, but not if we’re only shifting costs around. Adding millions of young, healthy, and uninsured people to the pool should reduce the amount spent per person on Alzheimer’s therapies, coronary bypass surgeries, and prosthetic joints. But to the extent we are covering not just catastrophic and chronic health problems but also annual checkups and diagnostic tests, eyeglasses, and discounted prices at Jenny Craig or the local fitness club, we’re simply subsidizing greater consumption. We know how that story ends, whatever fables we are told during legislative debate.

But increased cost isn’t the only problem with this “kitchen sink” approach to what started out as an insurance policy. The more pernicious long-term effect is to make an extremely wide range of health service “free” (or substantially so) to everyone who has the “insurance.” Of course, it’s not free; it’s merely pre-paid. And once it’s pre-paid, one really might as well use it. Over time this drives costs up as demand for the services increases. In most situations, rising prices are cured by rising prices, because they serve to moderate demand or stimulate more supply. But with health “insurance,” the signal sent by those rising prices never makes it back to the patient who’s in charge of how much routine and elective care to consume, because the cost is paid by the insurance company rather than patient. It makes premiums go up, but heck, even the premium is probably paid by the patient’s employer.

Less tangibly, kitchen-sink health plans further expand our ever-more-expansive expectations of what “basic health care” entails, a fact that makes comparisons to other countries’ experience less relevant. In a recent Bloomberg podcast, Princeton’s Uwe Reinhardt, a leading authority on health care economics, tells the story of a Harvard Medical School professor whose mother in Florida told him she needed another MRI. The son replied skeptically, reminding her that she’d had an MRI only the month before. “Yeah,” said the woman, “but I felt so good afterwards.” There’s no such thing as a free colonoscopy, but on the whole we are shockingly stupid consumers of health care because we have no incentive to be smart about it.

So why do we pay too much for health care? I believe it is precisely because we “insure” it so prodigiously. The way to save money would be to use less and pay only for what we use, instead of buying too much on a pre-paid basis and then treating it like a public good. And yet in the very midst of all this profligacy, we are unhappy with the status quo. We have the alienating intervention of the insurance companies to deny reimbursement to patients or limit payments to doctors. We also have millions who are uninsured and millions more who live in fear of joining them. If we know the current system stinks, why doesn’t private enterprise come up with a better alternative? I’ll try to answer that question in my next post.

[This post is the first in a series of three, or arguably four.  You can read the others here, here, and here.]

2 Responses to “Why Health Insurance Stinks, and Why the Most Comprehensive Health Insurance Stinks Most Comprehensively”

  1. Nic Says:

    Mark, you have made some excellent points on the way that the insured population in the United States views insured benefits.

    In a previous life I was the insurance administrator for the student plan at a large university. The distinction between the way the insured view health insurance versus car insurance is striking. I have never heard anybody say, “I have not made any claims on my auto insurance ever, so I better go trash a car so that I get my money’s worth.” However I have heard people in my office plan on doing just that in health care, saying that they were going to “go see a shrink, just so I get something out of this”.

    At this same university, which did not have a student dental plan, I had a student come in to me and demand that we add a dental rider to the health insurance plan. I told the student that the university was exploring the option, but currently had only found an expensive option which would only work if it were mandatory for all plan members, and thus would push health insurance out of the reach of some students. He stated it should not be required, but optional, on a semester by semester basis. He would be willing to pay $100 per semester for this. I asked him why he wanted it. He replied that he had $2000 dollars worth of dental work that needed to be done. I told him that the extra $1900 was going to have to come from somewhere in order for the program to be financially sustainable, which was why enrollment would have to be mandatory and over the $100 he budgeted. Now, the interesting part about this, is that this student was an MBA student at a school that at that time was ranked number one in the country for finance. I told the student that if he and the other members of his MBA cohort were to develop a model in which dental insurance was financially sustainable, we would look at it, with an eye to implementation. He told me that financial sustainability was not his concern but mine.

    Unfortunately with healthcare, many Americans tend to treat it in a way that flies in the face of all economic principles, principles that they adhere to in other areas of their lives. When I purchase a car, I might be strapped for cash. I might purchase a small compact car, with enough power to get me from home to work dependably on a regular basis. When a powerful sports car wants to drag race me, and I lose, I understand that I did not pay for the power that the Porsche or the Ferrari has, and I deal.

    With health care, however, many people seem to want to pay for the Yugo when they are well, and get Porsche performance when they are sick. They become angry if they have to pay higher percentages for out-of-network doctors or if they have to get a referral, or that they cannot get an expensive drug until they have tried and failed a less expensive alternative.

    I believe that we need to work toward a system in which everyone has some protection against the catastrophic situations that can ruin a life. Realistically, that means that all insured may not have the same level of health services available to them, and those willing to pay premium rates will get more options. And even they may not get a plan that covers everything they want. That would be like paying admission at a store with the understanding that that once you paid admission you could take whatever inventory out that you wanted. Many in that situation would not stop loading their trucks until the store was empty.

  2. David Fitzgerald Says:

    Mark, excellent posts and looking forward to your next one. Perhaps my recent UK sojourn can again be instructive? As a UK taxpayer, my family and I were entitled to medical care through the NHS. In addition, I was enrolled through my employer in an international private health plan. Presumably, this extra benefit was added to our ex-pat plan so that Americans would not be dissuaded from accepting international assignments due to a real?perceived? drop off in quality of care.

    We found that the NHS did a really excellent job in providing basic services. ie. pediatric check ups, immunization, emergency room visits for slip and falls, etc… However, whenever something major came up (for example occupational therapy for my son due to a diagnosed sensory issue) we could rely on the gold plated coverage provided by my private plan.

    Would you think that some form of public/private arrangement like this could work in the United States? Basic care, even routine catastrophic care (similar to what the VA provides to veterans) could be offered to all through the public sector, while preserving an option for individuals or their employers (perhaps reviving the concept of a true fringe benefit) to purchase real insurance to pool risk for truly unusual or “gold plated” treatment?

    I’d be interested in your thoughts.

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