How Could the Private Sector Do This to Us? (More Observations on Why Health Insurance Stinks)

In my last post, I nominated my candidate for the Biggest Problem with Health Insurance, which is that in most cases it’s not insurance at all but rather a pre-paid medical services plan. This has had at least four extremely unfortunate consequences.

  1. Because most plans now cover not just catastrophic expenses but also routine and even elective expenses, almost all health care transactions are marked up 30 to 50 percent to cover the “insurance” company’s administrative expenses.
  2. Because health care services are almost entirely pre-paid, people have a tendency to think of them as cost-free and use them far more often than they would if price mattered to the patient.
  3. Because we persist in calling this arrangement “insurance,” we delude ourselves into thinking that drawing the uninsured into the risk pool will somehow lower per capita costs.
  4. Because the whole system runs almost entirely on the principle of cost-shifting rather than risk-spreading, people are now basically addicted to Other People’s Money.

In addition, another very serious problem arises from the fact that so many people receive their health care as a condition of employment.  This causes people to worry that losing their job will cause them to lose their access to health care.  And the worry is most acute for those who already have a chronic disease or other health condition that may be uninsurable under a new plan sponsored by a new employer.

Partisans on both sides of the current health care “reform” debate agree that the status quo is unacceptable.  Partisans on both sides also tend to agree that the status quo is more or less the result of private enterprise.  The debate is about the extent to which today’s free-market failures can or should be corrected by more government intervention.  The history of private health insurance, however, seems to me to cast serious doubt on the premise of free-market failure.

What Does Health Care Have to Do with Employment, Anyway?

The association of health “insurance” with full-time employment is so widespread that it’s easy to overlook its weirdness.  As is often the case, history provides the explanation that logic cannot.

In perhaps the most authoritative exploration of this history, David Blumenthal traces the rise of employer-sponsored health insurance to FDR’s decision not to press for national health insurance as part of the Social Security Act in 1935.  Blumenthal, “Employer-Sponsored Health Insurance in the United States — Origins and Implications,” New England Journal of Medicine (July 6, 2006), at 83.  [I am not linking to the Blumenthal article because a NEJM subscription is required, but I recommend it highly.]  Private insurance emerged in the 1930s to fill the gap left by Roosevelt’s decision.

But how did private insurance become employer-sponsored?  That happened mostly in the 1940s, when FDR’s wage and price controls forbade employers from raising wages to attract workers during the wartime economy.  Unable to raise wages, employers began adding benefits (which they were allowed to do), including health insurance.  Somewhat paradoxically, the part of the government paying attention to the labor movement ruled in 1945 and 1949 that health benefits could not be reduced in the middle of a labor contract, and that such benefits should be considered part of the wage package during collective bargaining with unions.  The federal government thus created a policy framework that could ratchet up health benefits when the labor market was tight, while at the same time making it very hard for employers to make them less generous.  That was probably enough to make the employment-health insurance connection permanent.  According to Blumenthal, “Between 1940 and 1950, the number of persons enrolled in private health plans increased from 20.6 million to 142.3 million . . . .  By 1948, when President Harry S. Truman decided to advocate again for national health insurance, private health insurance was an established fact of life that not only had diminished the apparent need for government action but also had spawned a strong, new insurance industy with a stake in the status quo.”

Why Have Employers Bought Such Stinky Policies?

The next critical event occurred in 1954, when the IRS declared that health insurance premiums paid by employers should not be taxed as income to the workers.  The importance of this decision was brought home to me quite recently as our law firm considered what to do about our outrageous renewal premium.

Let’s suppose we can buy each employee either a $6,000-per-year policy that covers everything, or a $1,000-per-year policy that covers all hospitalization and all budget-busting expenses but requires the employee to pay out of pocket (from the $5,000 savings that we give him) for routine expenses.  The latter policy is better if the employee will spend less than $5,000 on routine care, right?

Wrong.  Because of that $5,000, state and federal taxes will eat up nearly $2,500 if and only if we give it to the employee instead of to the insurer.  It’s taxable to the employee if we save the money, but tax-free if we buy “insurance” with it.  So even though we all know the cheaper policy will actually help rein in health spending by making the employee a more careful consumer, it’s still a bad deal for the employee unless it cuts his health spending in half. Thus, from 1954 on, the tax-efficient way to structure health “insurance” has been to pre-pay everything on the employer’s nickel.

Out of Pocket Expense ChartLeaving aside the policy of one little law firm in 2009, has the 1954 decision really had such huge consequences?  In the words of health care analyst Sarah Palin, you betcha.  The chart shown to the left, taken from Blumenthal’s article, shows that out-of-pocket spending by consumers of health care in the United States fell from 48 percent of all health care costs in 1960 to just 15 percent in 2000. It’s almost enough to make a guy stop liking Ike.

Blumenthal also decries the effect of the 1974 Employee Retirement Income Security Act (“ERISA”), which allowed large employers to “self-insure” — that is, cover their employees’ health expenses directly — without being subject to “cost-enhancing state mandates to cover particular services (such as in vitro fertilization or mandated minimal mental health coverage).”  Blumenthal’s complaint is that this removed workers from the risk pool and made the state-mandated services more expensive, but it seems to me the real policy mistake is that there were cost-enhancing state mandates to cover particular services.

According to the National Association of Health Underwriters, more than 1,000 such mandates are now in existence, and the NAHU attributes up to 25% of current premiums to these (unfunded) mandates.  Sometimes they require coverage of particular procedures or diagnostic tools; sometimes they require that plans cover certain classes of alternative therapies, like acupuncture or massage therapy.  Thus, while some of today’s “reform” proponents rail against the evil insurance companies for coming between patients and their doctors, the reality is that state governments have been calling the tunes (without paying the piper) to a remarkable and regrettable degree.  If Blumenthal’s account is to be credited, these mandates were already considered onerous in 1974, and I doubt they have become less so in the intervening 35 years.

So how could the private sector do this to us?  Merely by responding rationally to the incentive structure created by a string of uncoordinated government interventions that have had disastrous unintended consequences.  Business executive David Goldhill, in an excellent article in The Atlantic, makes a nice point about the parallels between the housing bubble and the health care problem:

The housing bubble offers some important lessons for health-care policy. The claim that something—whether housing or health care—is an undersupplied social good is commonly used to justify government intervention, and policy makers have long striven to make housing more affordable. But by making housing investments eligible for special tax benefits and subsidized borrowing rates, the government has stimulated not only the construction of more houses but also the willingness of people to borrow and spend more on houses than they otherwise would have. The result is now tragically clear.

As with housing, directing so much of society’s resources to health care is stimulating the provision of vastly more care. Along the way, it’s also distorting demand, raising prices, and making us all poorer by crowding out other, possibly more beneficial, uses for the resources now air-dropped onto the island of health care. Why do we view health care as disconnected from everything else? Why do we spend so much on it? And why, ultimately, do we get such inconsistent results? Any discussion of the ills within the system must begin with a hard look at the tax-advantaged comprehensive-insurance industry at its center.

[The Goldhill article is so good that I’m subscribing to The Atlantic to reward it for printing such an excellent piece.  If I had read that article before I wrote the first part of this series,  I might just have posted Goldhill’s piece instead.  I really urge all Reasonable Minds to read it.]

So, in a nutshell, the major problems with health “insurance” today — its overly comprehensive scope, its high cost, and its dependence on employment — grew out of specific government policies with huge unintended consequences.  This means, at a minimum, that we ought not to base support for a government-centered reform effort on the facile supposition that “it can’t get any worse than what the insurance companies have given us.”  Indeed, I think we should draw the further conclusion that government interventions have already made this problem far worse than it needed to be, and even the most fervent supporters of greater government involvement should have the humblest of expectations about our ability to improve on the overall effect of so many billions of individual decisions.

Can the bell be unrung?  Can I say anything constructive about some possible future direction for health care?  Perhaps, but only in my next post.

[This post is the second in a series of three, or arguably four.  You can read the first post here, the third post here, and some hasty remarks on President Obama’s September 9, 2009 speech on health care here. ]

One Response to “How Could the Private Sector Do This to Us? (More Observations on Why Health Insurance Stinks)”

  1. Robert Blandford Says:

    Some may be interested in my bipartisan approach to health care. It can be found at:

    It has some features in common with the Wyden-Bennett bill but is more radical, involving government supplemented Health Funding Accounts and private guaranteed-renewable health policies from birth to death. These replace all other government health plans, including Medicare, Medicaid and SCHIP.

    The approach, by design, solves the inherent contradictions between pre-existing conditions, guaranteed issue, community rating, and market competition which have been on view in town hall meetings this August and which have frustrated politicians and citizens of both parties.

    It also has elements in common with David Goldhill’s recent article in the Atlantic “How American Health Care Killed my Father”.

    Goldhill and I have in common the facts that we are not health care professionals and were brought to the field by the real-life experiences of relatives.

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