Three Things Not to Confuse About Health Insurance “Reform”

If the raging debate on health care reveals anything it’s that people and politicians alike are confused about the role of health insurance. This is because they have mixed up three very different ideas into a messy notion that is emotionally appealing but unsuitable for any coherent policy.

First, in real insurance a group of people expect that misfortune will befall a certain fraction of them but they cannot predict which ones.  Because they are risk-averse, each is willing to pay a premium somewhat higher than is required to mitigate the expected risk.  This margin pays for the plan’s operations, as well as dividends if the plan is also capitalized by external investors who cannot submit claims to the plan (i.e. shareholders).

Second, people have the idea of collective purchasing power, in which “employers get better premiums for health insurance because they have more leverage than individuals.”  In that case, our employers should also buy our cars, houses, groceries, clothing, and everything else.  Indeed, hardware stores and grain dealers form co-operatives for this purpose.  However, this has nothing to do with risk.  The members of the cooperatives also give up choice, which is why individuals seldom choose to band together to buy goods and services. We would all have to accept what the board of directors chose for us.

Third, people have the idea that the rich should pay more than the poor for health care.  In fact, a few rich people already pay for most of the entitlements of the middle class and the rest.  This is likely the primary reason for the popularity of Medicare, 40 percent of which is funded by general federal tax revenues, i.e. the progressive income tax.  Even the Medicare payroll tax, which funds 43 percent of Medicare, approximates a flat-rate income tax. 

All this has nothing to do with insurance.  People who pay taxes towards food stamps or public housing would be horrified at having to claim the “benefits” for themselves. Most importantly, all three of these issues must be dealt with separately in order to form a coherent public policy.

The government can tax the rich to subsidize the poor without insurance or enforcing “one size fits all” collective purchasing of medical care; people can form groups to buy health goods and services collectively without insurance or subsidies; and the government can police insurers’ solvency and good-faith payment of claims without either of the other two.

Indeed, our failure to untangle these three very different challenges may be the “root cause” of our politicians’ inability to address “health-insurance reform” intelligently. When regulation of health insurance is designed by populist impulse, rather than principles that will improve peoples’ welfare, the results are disastrous.

For example, surveys show that about 80 percent of Americans would prefer that the government require health insurers to offer coverage without taking account of pre-existing conditions.  But, surely, very few Americans would answer affirmatively questions such as:

• Should property insurers offer coverage without taking into account whether landlords have installed proper fire-protection equipment?
• Should life insurers offer coverage without taking into account whether individuals smoke, are overweight, or participate in dangerous sports?
• Should automobile manufacturers offer warranties (a type of insurance) without taking into account whether drivers adhere to regularly scheduled maintenance?

Similarly, folks describe health insurance in terms whose absurdity would be immediately apparent if used for other types of insurance.  For example, “health insurance pools risk by combining the healthy and the sick, the young and the old.”  Nobody believes that auto insurance pools risk by combining drivers who have not had accidents with those who have already crashed their cars.  Indeed, I doubt anyone would be foolish enough to buy auto insurance if one penny of his premium was paid out to someone who had an accident even yesterday. 

Auto insurance pools risk by combining drivers who have not yet had accidents, but fear that they might in the future.  Similarly, neither a 30-year-old nor a 60-year old would expect to pay the same premium as the other for the same life insurance, or have the same likelihood of dying within 10 years of buying the policy.  Nor would many people argue that each person has a “right” to auto or health insurance.

Such notions, unfortunately, now dominate the debate, and the result is confusion. We will only address health insurance reform intelligently when we put aside populist myths and design policies based on sound economic principles that will actually improve people’s welfare.

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John R. Graham is Director of Health Care Studies at the Pacific Research Institute.