Purging Healthcare of Unnatural Acts

In tribute to Uwe we are re-running this instant classic from THCB’s archives. Originally published on Jan 31, 2017.

Everyone knows (or should know) that forcing a commercial health insurer to write for an individual a health insurance policy at a premium that falls short of the insurer’s best ex ante estimate of the cost of health care that individual will require is to force that insurer into what economists might call an unnatural act.

Remarkably, countries that rely on competing private health insurers to operate their universal, national health insurance systems all do just that. They allow each insurer to set the premium for a government-mandated , comprehensive benefit package, but require that each insurer “community-rate” that premium by charging the company’s individual customers that same premium, regardless of their health status and even age (with the exception of children).

American economists wonder why these countries do that, given that in the economist’s eyes community-rated health insurance premiums are “inefficient,” as economists define that term in their intra-professional dictionary. 

The Affordable Care Act of 2010 (ACA, otherwise known as “ObamaCare”) also mandates private insurers to quote community-rated premiums on the electronic market places created by the ACA, allowing adjustments only for age and whether or not an applicant smokes. But within age bands and smoker-status, insurers must charge the same premium to individual applicants regardless of their health status.

As fellow economist Mark V. Pauly points out in an illuminating two-part interview with Saurabh Jha, M.D., published earlier on this blog, aside from the “inefficiency” of that policy, it has some untoward but eminently predictable consequences. It happens when healthier people disobey the mandate to purchase insurance, leaving the risk pools of those insured in the ACA market places with sicker and sicker individuals, thus driving up the community-rated premiums. As Pauly points out at length, a weakly enforced mandate on individuals to be insured can become the Achilles heel of community rating.   

Every actuary or economist who instructs students on this point probably therefore opines that, ideally, for the sake of economic “efficiency” and to overcome the untoward side effects of community-rated premiums, one would like to allow insurers to peg the premium charged an individual applicant on the best actuarial estimates of likely future outlays for that individual, that is, to charge individuals so-called “actuarially fair” premiums and publicly subsidize those applicants faced with very high premiums. The word “fair” here signifies that chronically healthy individuals are not asked to cross-subsidize chronically sick people through the premiums they pay, which many Americans consider fair. General taxpayers pay those subsidies.

Alas, thinking about the administrative steps needed to translate our profession’s normative dicta into workable operations in the trenches has never been our profession’s strong suit. Not surprisingly, then, not much is said about that crucial step in the Jha-Pauly interview. But we can muse about what life in those trenches might turn out to be. After all, we do have some idea of how a market for individually purchased health insurance that is based on risk rated (actuarially fair) premiums works, because that is how the pre-ACA market for individual and small-group policies worked in this country.

As Pauly acknowledges, the administrative costs of such a system are high. It is so because every applicant must submit to the insurer a very detailed description of his or her health status and those submissions must then be converted into customized, risk-rated premiums. That information, of course, could be conveniently harvested by hackers.

Pauly cites some estimates of the administrative costs of risk-rating in individual insurance markets; but they strike me as low.  A clearer picture can be had from the horse’s mouth, so to speak, namely the Council for Affordable Health Insurance which represents insurance carriers active in the individual and small group market.  On the third page of a letter dated May 7, 2010, addressed to the National Association of Insurance Commissioners (NAIC), the Council noted inter alia that pre-ACA

“The NAIC standards for individual market loss ratios vary between 55%-65%, depending on the type of plan. In fact, most guaranteed renewable plan loss ratios are set by the states at 60% or less.”

What the Council calls “market loss ratios” is otherwise known as the “medical loss ratio” (MLR). It represents the fraction of the premium that insurers lose on procuring actual health care for their insured. The remaining fraction (1- the MLR) goes for marketing, administration and the insurer’s profits. Thus an MLR of “60% or less” implies that 40% or more of the premium does not buy health care, but goes for marketing, administration and profits. It takes a certain fortitude on the part of private health insurers to acknowledge that huge spillage into overhead so openly.

It is hard to imagine that any other country would tolerate so large a leakage of the premium into overhead. While economists would nevertheless call such a market “efficient,” as the profession defines that term, there is no reason why non-economists should take the economists word for it. Indeed, it can be doubted that non-economists would apply that felicitous term to any health insurance system that burns up to 40% or even more of the premium the insured pay just on marketing, administration and profit efficient, if the insured were aware of it. 

We also know from the pre-ACA days that millions of Americans then were denied insurance coverage outright by private insurance over preexisting conditions. Eliminating that problem by mandating “guaranteed issue” was one of the major goals of the ACA. Estimates of the percentage of applicants denied coverage in pre-ACA days vary. Some estimates put the number at 1 out of 7 (i.e., 14%). Other sources quote much higher figures. In an Issue Brief, the Kaiser Family Foundation provides a table with numbers, by state, of “declinable conditions.” It is worth citing here at length from Jonathan Cohn’s “ObamaCare’s New Paperwork Is Simpler than Private Insurers”:

“If you want to know which conditions attract scrutiny, you can consult a Blue Cross Michigan underwriting guide. The list of “unacceptable medical conditions,” which you’ll find on page 23, starts out like this: “Abnormal pap (unless there have been 2 subsequent normal ones), Addison’s disease, Adrenal gland disorders, AIDS, ARC (AIDS related complex), HIV+, Alcohol abuse or alcoholism (unless 12+ years since recovery), Amyotrophic lateral sclerosis (ALS), Alzheimer’s disease, Aneurysm, Angina pectoris, Aplastic anemia, Arteriosclerotic heart disease, Atrial fibrillation or flutter, Ascites, Autism and Aspergers syndrome, Autoimmune diseases.” Highlights later in the alphabet include Cancer, Congenital Disorders, Heart Murmurs, Lupus, Parkinson’s Disease, and, of course, Pregnancy.”

What would happen to those denied coverage by insurance companies in the scheme envisaged by Pauly? Would they be assigned to a high risk pool?

Unfortunately, while we do know a lot about the modus operandi of a classic, medically-underwritten (risk rated) market for individually purchased health insurance, there is no experience in the U.S. on how to link such a market to the system of public subsidies that Pauly calls for in the Jha-Pauly interview. How exactly would this work?

Relevant variables here presumably would be, on the one hand, the insured’s “disposable income” and, on the other, the risk-rated health-insurance premiums quoted that individual by competing insurers. “Disposable income” would have to be carefully defined for this purpose. Is it just available money income after taxes and transfers? Or should it be the latter figure minus required outlays for other necessities, such as food, housing, clothing, fuel for transportation to and from work, etc.? Besides that question, a series of others come to mind, to wit:

  1. For what benefit package would the premiums be quoted? Who would specify that package? What might be excluded from the package? Would there be lifetime limits on coverage or annual limits on specific services (e.g., prescription drugs)?
  2. What would happen if the specified benefit package underlying the public subsidy were shallow and the insured got severely ill, facing unaffordable medical bills for clinically beneficial products (e.g., drugs) and services not covered by the policy? Who would pay those bills? Would the cost of such care be shifted to paying patients through higher prices? Or would the insured simply be denied those clinically beneficial products and services, at the risk of avoidable, premature death or chronic illness?
  3. Would premiums be reset annually, in light of changes in the insured’s changing health status?
  4. Could an insurer cancel a policy ex post if the applicant had inadvertently or deliberately concealed a particular medical condition from the insurer when applying for coverage?
  5. What would be the risk-based premium on which any subsidy would be based? Would it be the lowest one quoted in the relevant market area? And what would that area be?
  6. Would the insured’s out-of-pocket cost for the coverage be linked to his or her disposable income, as it is under ObamaCare?
  7. Who would manage the market place in which individual policies are sold, or would the market return to pre-ACA operations, managed solely by an uncoordinated net of insurance brokers?
  8. Who would pay the brokers’ commissions, the insurance companies, setting up an evident conflict of interest, or the insured, as it should be.
  9. Would people denied coverage by insurers in this free market be enrolled in a high risk pool? If so, what would be its design parameters – the benefit package, the premium charged the individual, the magnitude of public subsidies, and so on?

Others undoubtedly can think of yet other questions; but let these suffice.

Probably because of the complexity of operating a risk-rated private health insurance system supported by public subsidies, few nations operating universal health insurance systems have adopted that approach. In fact, I cannot think of any.

Switzerland, Germany and the Netherlands, for example, all rely on a system of competing private health insurance carriers. Unlike the U.S., they do not have government-run health insurance programs at all. Competing private insurers can quote different premiums for the same, government-specified benefit package, which tends to be quite comprehensive. But unwilling to subject their citizens to the complexity and vagaries on risk-rated health insurance markets, these countries mandate that the premiums quoted by competing insurers be strictly community rated, even with respect to age. Somehow these countries have been able to make this work for decades, without the collapse of their health insurance markets. If we Americans were not as insular and proud as we are, we might explore how these countries manage to do that and learn from it.

We would discover that somehow these nations make the mandate to be insured stick to the point of garnishing the wages of individuals disobeying the mandate to be insured. Perhaps these nations also succeed in persuading young and healthy people that they, too, might fall very ill at some time in the future. One can then view community rating as the analog of a call option on a stock. In this case, it is a call option on a low premium in case one falls seriously ill, the price of the option being the overpayment relative to actuarial costs when healthy.

In the U.S., we consider it unacceptable for government to force individuals to purchase from a private vendor a product they do not wish to buy. To many Americans this makes sense – hence the strong opposition to the individual mandate to be insured – ironically much favored by Republicans during the 1990s but now decried by them. The mandate to be insured has been a major rallying point for those who oppose ObamaCare.

One way to overcome that problem might be to abandon the mandate altogether, but to offer individuals a deal they are less likely to refuse. In his “Averting a Health Care Backlash,” for example, Paul Starr as early as 2009 counseled the Obama Administration to let individuals opt out of the mandate to be insured, but to allow them back into ObamaCare only after 5 years. 

I would have been much rougher. In a blog post entitled “Rugged Individualism vs. Social Solidarity,” published in The New York Times, I proposed that individuals opting out of a system built on social solidarity, with community-rated premiums, should never be allowed to rejoin it later, aside from some very special circumstances. It would be a deal fewer people would refuse. Rugged individuals who turn their back on social solidarity can be asked tough it out on their own when misfortune strikes, rather than rediscovering in those calamitous moments the beneficence of the community. Unfortunately, too many of them follow the mantra “when the going gets tough, the tough run to the government,” as can be seen every time a hurricane wreaks havoc on some area or uninsured rugged individuals fall seriously ill or have a serious accidents, when they expect the best available health care, even if they cannot pay for it. A forgiving nation has always enabled this behavior.

Starr’s and my approach can be viewed as market approaches, albeit ones structured to contain a so-called “nudge” to obtain coverage.

Uwe Reinhardt is a professor of political economy at Princeton University.

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