Health Care – Insurance 101

 

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Balancing Risk for Health Insurance

Given the recurring debate over a private market vs. a single (government) payer for health insurance, I thought it might be helpful to review a few basics of the insurance business. What follows borrows from an essay by Frank J. Lysy, a retired economist at the World Bank.

What is insurance?

Well, duh … an insurance policy is a contractual agreement in which you (the insured) make regular payments. In return, you get the insurer’s promise to protect you against claims associated with events explicitly enumerated in the policy.

As with all contracts, you do need to read the fine print.

How does insurance work?  

An insurance company has to manage premium income so that it has enough cash to pay claims as they come due. While an insurer cannot predict the claims profile of a single policyholder, a “pool” of policyholders typically has identifiable claim characteristics based on things such as age (drivers under 25), location (urban vs. rural), or health factors (smoker vs. non-smoker).

If the pool reflects a statistically “normal” population, the insurer can estimate expected claims with a high degree of confidence, and set a premium rate that will generate funds sufficient to cover those claims. If, however, the pool does not reflect the population as a whole, the insurer will find it difficult to match the actual level of claims and the premium income.

Ensuring that premium income generates enough income to cover future claims is the primary management task for an insurance company, whether it’s in the auto, homeowner or health care business.  However, it is a particularly daunting challenging for health insurance.

The Health Insurance Company’s Perspective – Adverse Selection

You, the policyholder, typically know more about your health situation than your insurance company.  If you have a family history of heart disease or cancer, you’ll probably want health insurance. By contrast, if your budget is strained or you are a healthy young adult, you may opt to forego health insurance.

Another problem is “free riders” that buy health insurance only when they expect to have a significant medical expense (e.g., a planned knee replacement).  As recently seen with the “Special Enrollment Periods” (SEP’s) under the Accountable Care Act (ACA), the pool of individuals who enrolled during an SEP had significantly higher-than-average health care costs; many let their policy lapse once their medical bills were paid.

This adverse selection means the pool will have a higher-than-normal percentage of individuals with higher-than-average claims. In this situation, a premium rate that would cover claims for a statistically normal pool of individuals will not be adequate to cover actual claims. To compensate, the insurance company can raise rates in the next premium period. Unfortunately, the now higher rate may lead some policyholders—typically those at low risk of medical expenses—to drop their insurance, causing the pool to develop an even more adverse profile.

Your PerspectiveBiased Selection

Health insurance companies, of necessity, try to bring the pool closer to a normal profile by enrolling policyholders who have lower-than-average claims.

For years, they accomplished this by denying coverage if you had a pre-existing medical condition. With the ACA, that’s no longer an option. But they can still build in criteria (check that fine print!) that allow them to deny claims you thought were covered, or to impose higher co-pays on certain types of expenses. For example, you might find that your surgeon’s fee is covered but the anesthesiologist’s fee is not. Or that drugs with a reasonable co-pay are “reclassified” into a tier with a substantially higher co-pay.

These unexpected costs can be financially devastating.  A Harvard Medical School study found that 62% of personal bankruptcies in 2007 in the U.S. were caused by medical problems; 78% of those filing for medical bankruptcy had health  insurance at the start of their illness.

Another angle to encourage people with higher-than-average medical expenses to enroll in a different company’s health plan. A classic example is adding the cost of gym membership to the insurance premium. This can deter anyone not interested belonging to a gym, but appeals to someone who is already paying for it.  This strategy improves the profile of the pool because people who go to gyms are generally healthier than the overall population.

What About The Individual Mandate in the ACA?

These two problems—adverse selection and biased selection—explain why the ACA requires every American to have health insurance. If everyone is insured, there are no free riders.  You can’t game the insurance company by waiting to purchase insurance until you know your medical expenses will be high. And if everyone has to have health insurance, insurers can be more confident of having a normal claims profile. Their incentive to discourage higher-than-average claimants is offset by the larger pool of lower-than-average claimants.

The Bottom Line

My point is that, from a purely financial perspective, it doesn’t much matter whether the system for health insurance is based on a marketplace of private companies (the ACA) or a single payer (Medicare)—as long as there is universal participation. Phrased differently, neither the private health insurance market nor the single payer system will be viable in the long run without something approximating universal coverage.

There is little doubt that the ACA needs to be fixed to reduce the problems of adverse or biased selection. But when you hear a politician telling you that everything would be fine if only all health insurance was private or if we only had a single payer system, take it with a grain of salt.  You’re probably hearing an argument based on philosophy, ideology, or politics…not basic principles of economics or finance.

A Market Model for Health Care

 

medical_heartOn January 6th, the House and Senate passed a bill to repeal major parts of the Affordable Care Act (ACA).  While several Republicans have proposed “market-based” alternatives to the ACA, none of them had sufficient support to be a feasible replacement for the ACA. Unsurprisingly, Obama vetoed the bill.

How do those proposals differ from the ACA? One, for example, would replace the ACA subsidies with tax deductibility of individual health care insurance premiums. Another would replace subsidies for insurance premiums with age-based refundable tax credits.

Is either proposal better than the ACA? And why? Would either actually alter the quality of health care (for good or ill), or will it just change how we pay for it? Would either slow the explosive growth in insurance premiums and the health care costs they pay for? Would either proposal affect your health care—or just those insured under the ACA?

If your head is spinning, you’re in good company. Few of us understand the finer points of either the ACA or the “market-based” alternatives. But a key difference is whether you see health care as a private or a public good. Market based models assume that health care is a private good and that people purchase it in pretty much the same way they buy cars.

Stanford economist Kenneth Arrow argued that this analogy doesn’t really work.

First of all, buying a car is usually a discretionary decision. Except in rare instances, you don’t have to buy a car today, and even if you do, you still have a host of makes and models to choose from. You can test drive several models to see which one you like best. You can read consumer reports and check with your friends to see how different cars perform and compare the quality of support from different dealers.

Not so with medical care. Apart from preventive care (e.g., vaccinations), routine screenings, and discretionary things like plastic surgery, the need for medical care tends to be unpredictable in both timing and treatment. While you can choose a family physician based on recommendations from friends, you can’t “test drive” the relationship until such time as you are actually sick. And once you are sick, your ability to explore treatment protocols, hospitals and/or specialists beyond what your doctor recommends is limited, in no small measure because, when you are sick, you probably don’t have the time and energy to do so.  In an emergency — a heart attack, a broken hip, or an automobile accident—you may have no choice at all as to the hospital or the doctor.

Another issue is price. You can compare prices for different cars, or for the same car from different dealers.  You can try to negotiate, and sometimes succeed.  You can buy the cheapest car, or you can pay more to have a more reliable dealer. You can add optional features. If you’ve done your homework, you know the cost of the car before you sign on the dotted line.

That’s not how health care works. Do you know what your doctor charges for different medical services? Would it make a difference if you did? When you are faced with excruciating pain in your gut or your chest, you’re not going to start shopping for the lowest cost physician.

The situation gets even more complicated if you’re hospitalized … you may know what your doctor will charge for, say, repair of a broken hip, but you will probably not know the cost of other hospital services—anesthesia, lab work, x-rays, physical therapy, and the inevitable “misc. charges”—until long after the event. If your insurance company refuses to cover a particular service or an “out-of-network” doctor, you, of course, are stuck with the bill.

A third leg of this stool is medical expertise. You can study up about the differences in quality and performance for cars that interest you. But how do you study up on a disease you don’t know you’re going to get or an accident you don’t expect to have. And once you’re sick, you rarely have the luxury of time to become an expert on a complex disease, particularly if you have no medical background. Think about the lengthy and small print inserts that come with your prescription medicines—do you ever read them? Do you actually know what they mean?

My final observation is that inherent in the market model is the notion of profitability—of pricing the service to cover not only direct and indirect costs, but also to provide a return to the owner of the service. In the absence of some degree of regulation, owners of most medical services can charge whatever the market will bear.

You can see this feature of a “market model” with drug prices over the past couple of years. If you google Valeant Pharmaceuticals, you will learn that this Canadian company has been steadily acquiring the rights to older drugs, many of which were relatively low cost generics. In February 2015, Valeant acquired the rights to two generic heart drugs for which there are no ready substitutes. The very same day, it increased the price of one from $215.46 to $1,346.62, an increase of 525 percent.  They increased the other by a mere 212 percent from $257.80 to $805.61.

A company spokeswoman justified the increase by saying that Valeant’s “duty is to [its] shareholders and to maximize the value” of its products.  Clearly, maintaining the health of the patient was not part of its duty. Taking advantage of someone’s misfortune clearly was.

Most people would agree that our current system, a mix of regulated and market models isn’t working very well. Most observers of the health care market agree that the ACA got quite a few things wrong, and needs to be fixed. But fixing the ACA is not the same as scrapping it for a market model.

While I don’t pretend to know what the “right” health care system looks like, I’m not yet convinced that a pure market model—with no government intervention at all— is where we need to go.

What do you think?

Health Care: Private or Public?

 

article-1108763-02FA1BC4000005DC-843_468x323Most of my friends instinctively think of health care as a “private” matter, if only because so many health-related problems deal with the most intimate aspects of life. You want the right to choose your own doctor and to select the kind of medical care you need, when you need it. In this sense, it’s like buying a car … you want to choose the make and model that suits you best.

But many people also see health care as a “public” concern, much as education, sewage treatment, public parks, and fire departments are public concerns.

What makes health care a public concern?

One answer is that the benefits of individual good health accrue to the society as a whole. Healthier individuals make better students and more productive workers, which results in a higher standard of living for everyone over time. Widespread immunization reduces the probability of contracting infectious diseases that can be debilitating or deadly. Public programs to curtail smoking, drinking and drug abuse reduce the risks of second-hand smoke and accidents caused by incapacitated drivers. Preventative health care (e.g., an annual check-up or a flu shot) helps people to live better and longer.

Another is that health care, like education or sewage treatment, requires an upfront investment—in hospitals and clinics as well as diagnostic and treatment equipment—that is often too large for any one individual or corporation to make, given the uncertain period to generate a reasonable return.

A third is that the demand for much of our health care is relatively insensitive to price. It’s a pretty simple concept if you think about, say, end-of-summer or Black Friday sales when crowds line up to purchase cars, TVs, and computers that they wouldn’t buy—and maybe couldn’t afford—at the pre-sale price.

You can’t do that with health care. If your budget is tight, you may forego discretionary items like getting your teeth cleaned or getting a tummy tuck. But when your kid has a broken leg or your spouse has a heart attack, you don’t stop to ask how much it will cost to set the bone or have surgery to put in a stent. You get it taken care and worry about the cost later. Unlike on Black Friday, the health care services you purchase are based on your medical condition, while the price you pay is determined by a doctor, hospital or drug company without regard for your financial circumstances at the time.

The consequences for the public

This is a “public” issue because those who are most price sensitive to health care — perhaps because they do not have adequate (or any) insurance — tend to forego those discretionary items that have broader social consequences. Their kids don’t get glasses or regular dental care, so they have problems concentrating at school, which affects their learning capacity and often creates disruptive situations in the classroom. Adults — our teachers, our co-workers, our employees—don’t get the preventive care, including drugs and therapy, that would  prevent more serious and costly illness at a later time.

It is a public issue because the uninsured—regardless of age and overall health—are still at risk of serious accidents or illness. All too many people—again, people in our community that we rely for services and support—suffer or die from medical issues that could have been prevented or cured if they had had the benefits of appropriate medical care.

It is a public issues because the uninsured or under-insured often labor under enormous debt as a result of medical bills; indeed, medical debt has been estimated to be the number one cause of consumer bankruptcies in 2013.

The community pays for these health care costs one way or another. Sometimes it will be in dollars-and-cents (e.g., local businessmen hurt by customer bankruptcies or taxpayers who have to make up the shortfall in public hospital receipts). Other times, it will be through lost productivity in the work place or in our schools. Whichever way it happens, there is little doubt that your continued good health costs you substantially more than the amount you pay directly in premiums and deductibles for your own health care.

It is the balance between health care as a private or public good that lies behind much of the debate about our health care system. If you see health care as a public good, you will tend to favor a single payer nationalized health care system (as Europe and Canada have or the U.S. has with Medicare); if you see it as a private good, you may prefer the private payer system (as we have in the U.S.)

What do you think?

Health Care — A Curse or a Cure

 

images-1As recently as 200 years ago, if you stopped breathing, you were considered to have died, whatever the cause. There were few scientifically-based options to prevent or delay death.

A watershed moment in the history of health care came with the invention of the stethoscope in 1816 and the ability to register a heartbeat. But scientifically-based treatment protocols remained out of reach. For the next century, death continued to be, as it had been for much of western history, a part of “God’s plan” or—if you were of an atheistic or pagan persuasion—a matter of fate.

Until 1928, that is, when Alexander Fleming discovered penicillin. For perhaps the first time in history, man no longer had to rely on God or fate to determine the outcome of an injury or an infection. Over the last 90 years, our ability to triumph over illness has expanded exponentially.  Today, we can prevent most infectious diseases (even Ebola, it now seems), repair a faulty heart, excise a malignant tumor, or replace a failing kidney.

For much of the 20th century, medical advances focused on preventing “premature” death from infection or trauma. But these often seemingly miraculous discoveries had unintended consequences.  Most notably, our success in preventing or curing acute illness has led to steadily lengthening life spans, but also a greatly expanded population vulnerable to chronic—and costly—illnesses such as diabetes, COPD, cancer or Alzheimer’s.

Another unintended consequence is that the wonders of modern medicine are increasingly used to “manage” or delay conditions that were once considered normal signs of aging, e.g., sagging skin, declining fertility or loss of muscle tone.  Where is the boundary between preserving a healthy but age appropriate body and defying the natural process of aging? When does the effort to retard aging morph into an outright denial of the inevitability of death?

This urge to deny the inevitable has consequences to be discussed in a later blog, for long term trends in employment and education for our economy as a whole.  More immediately, it is reflected in the frequency with which high cost and often-intrusive medical interventions are employed to keep an aged body alive long after the will to live has gone and all-too-often in violation of the patient’s expressed wishes to be allowed to die.

As many people interpret the Hippocratic Oath (show the “utmost respect for human life”), doctors and hospitals feel they have an ethical obligation to treat your illness if they have the tools to do so. This prescription made perfect sense when there was little the medical profession could do to actually heal an illness or injury, when the role of health care professionals, like their clerical counterparts, was largely to give the patient comfort until God or the fates stepped in.

But what does “utmost respect” mean when science and technology allow the doctor to second-guess God or the fates … to decide, for example, that a failing heart is not a sign of God’s will, but a mechanical problem that should be “fixed” by implanting a pacemaker? Should a pacemaker be implanted in an otherwise healthy 35-year-old father of four? Most of us would instinctively say yes. Should one be implanted in an 85-year-old stroke victim whose mental capacity is permanently impaired? The answer is not so obvious.

These are not new questions, but they take on a new urgency as the baby boomers age. There are not enough health care resources—caregivers and care facilities as well as financial resources—to treat all the “ailments” of the over-65 crowd today, let alone the estimated 90 million elderly that will be clamoring for medical care by 2050.

The issue is not whether we should ration health care … we already do so, based primarily on ability to pay and/or seemingly arbitrary guidelines on what health insurance will cover.  The issue is how should we allocate limited resources in a way that is equitable and fair.

How should we, as a society, decide what kind of health care people should receive, and under what circumstances?  Should the decision be based on spiritual / religious precepts that are often ambiguous and controversial … or on a rational cost-benefit analysis that ignores the question of human dignity and the intrinsic value of life?  Who should make that decision?

What would you do?