mor on health

Health Bill Hacks Wildly at True Problem, and Misses

While Senate is out to play for recess, the rest of the country waits on their brilliant solutions to surface in the fall. Obama wants health care reform that reduces costs, covers more Americans, and makes doctors accountable to their patients. Sounds like a great plan.

I only find one problem with it: there is no plan.

A few bipartisan congressional committees have been arguing over different ideas for the past few weeks. A couple of proposals have been knocked around, and it looks as though we are in store for some sort of public health insurance plan designed to compete with those evil private companies that drive up prices to exploit the American public. (My brutality is entirely sarcastic.)

Basic, Adam Smith-style, economics show us why a publicly provided insurance plan will not achieve these goals without dire sacrifices. However, taken out of context, it can also show us why they think it will work.

Let’s begin with the latter, the logic behind the public plan: A public insurance policy or series of regional nonprofit cooperatives (the two primary health reform proposals) are designed to compete with private insurance providers. The lower prices of these subsidized entities will attract customers to switch from private providers and attract the uninsured to jump on board. The competition will pressure private providers to reduce prices to try and keep their customers. Such is the beauty of competition.

Now the problems with that logic: In a perfectly competitive world, prices are driven down to the actual costs of doing business. This is because firms undercut each other until profits are minimal. As a result, private insurers naturally have vast incentives to reduce costs and waste, as they are profit maximizing, competitive firms. If their prices were artificially high, competitors would have opportunity to charge less and take customers. This is a basic market system.

However, we do not live in the perfect world. Firms can get around this by conspiring with competitors to charge an agreed-upon, higher price. Even if this was legal, short-run incentives to cheat typically cause these cartels to fail (think OPEC). If the U.S. government thinks that collusion is taking place in the health care insurance industry they should look into anti-trust action, rather than jumping in the with their own firm(s) to stir the pot.

We need to examine the reasons why costs are so high in the private sector before thinking about hijacking the industry with a subsidized public entity. (Not to mention that the government does not have a very good track record with efficient operations: postal service, department of motor vehicles, social security, etc.)

Costs are high for a much less controversial reason: asymmetric information. Meaning, we know more about our health, and likelihood to use the policy, than does the insurance companies. So if you are extremely healthy, and will not cost the insurance company very much, you should not pay very much. And, conversely, if you are unhealthy (or paranoid), you should pay more for your constant doctor visits and prescriptions.

Unfortunately, insurance companies cannot clearly tell how healthy its customers are. To cover these risks they are forced to charge somewhere in the middle. Healthy people are charged more than they are eager to pay (some choose to opt out), while unhealthy people are charged too little. As you can imagine, operating costs in the insurance company are driven up because its customers are primarily unhealthy; prices follow accordingly. Soon enough, premiums and deductibles are so high that it is barely insurance at all, and you are better off paying out of pocket. If it were not for the terrifying risk of being caught sick without a method of payment, the market would crumble altogether.

Hence, the problem is not in private companies exploiting the public for vast profits. The problem is inherent in this type of insurance system. Generally, insurance is supposed to be something you never hope to use, like car insurance. And we purchase it for some peace of mind. Health insurance, on the other hand, has turned into a sort of ambiguous savings account. We all contribute as little as possible to the communal pot and draw down as much as possible.

A public insurance system does not address this problem of asymmetry, and would also be plagued with high operating costs. The only way to reduce the prices is to run at a loss (which government firms can do) relying on subsidies to stay afloat. Money to fund subsidies must come from somewhere—your pocket, pockets of the wealthy, your employer’s, your kid’s…who knows? Congress will figure that out in the fall.

Around 60% of Americans are provided healthcare benefits through their employers. Congress hopes to elect incentives (or mandates) to motivate more companies to provide this benefit. Providing healthcare imposes huge costs on firms, resulting higher prices for their customers, reduced wages for employees, and/or fewer employees altogether. To make the matter worse, firms – not the customers – are choosing the health insurance providers. And as our beautiful and prosperous market system has demonstrated for hundreds of years, the consumer always makes the most efficient choice in spending their money. Your employer has as much business in purchasing your healthcare than it does in purchasing your food and housing.

Democrats argue that the proposed reforms, although not ideal, are better than doing nothing. I would have to agree on some levels. However, better options are out there. Rather than making feeble attempts at optimizing a system that clearly doesn’t work, we should focus on real reform by changing the way Americans purchase healthcare.