18 Aug 2006 Helping the Uninsurable: Tinkering vs. Radical Reform

From David Hogberg:

Over at The Health Care Blog, Matthew Holt has this to say about the collapse of PacAdvantage, a voluntary small business purchasing pool in California:

What happens to voluntary purchasing pools? Simple economics — they only get customers who can’t get a better deal in the underwritten insurance market and so they go into a death spiral where the people in them are too sick to be supported by the premiums they charge.

While the that explanation seems plausible, I’d like to see what state and federal regulations PacAdvantage had to comply with first (which, unfortunately, I don’t have time to do right now.) Often what are taken to be market failures turn out to be, on further inspection, caused by dumb bureaucratic rules.

Anyway, while Holt’s explanation of what happened may pan out, I can’t say the same for his solutions:

PacAdvantage is the type of organization that our friends in the “voluntary universal insurance” world (Cato, Galen et al) think is going to solve all of our problems, with no need for pesky mandates to buy insurance, or for community rating, or standardized benefits packages.

First, community rating and standardized benefit packages are very clumsy solutions to the problem of the difficult-to-insure. They are attempts to restructure the entire health insurance system for the benefit of the 1-2 percent of the population who are uninsurable. In short, using a nuclear weapon to swat a fly.

Community rating laws require health insurance companies to charge the same premium to everyone, regardless of characteristics like health status or age. However, health insurance companies will have to charge a premium high enough to enable them to cover the expenses of the sick and healthy alike. This results in the young and healthy being charged a higher premium than they would in a free market. Thus, many people who are young and healthy figure that the cost is not worth it and go without health insurance. This leads to the pool being composed of more people who are sicker, leading to the cost of the premium to rise — a phenomenon similar to the one Holt described as the reason PacAdvantage is folding.

Holt tries to get around this problem by calling for a mandate to buy insurance. The problem with that is the young are often just starting out in life and have very limited income. Such a mandate coupled with community rating means that we are imposing a very expensive burden on them. Chances are many will try to find ways of avoiding the mandate, turning otherwise honest citizens into criminals.

Standardized benefit packages also increase the cost of health insurance by requiring all health insurance plans to cover the same set of benefits. Naturally, health insurance companies boost their premiums to be able to pay for those benefits. However, if you are young and have a limited income, you might be better off with a cheaper policy — a “stripped down” policy that has a high deductible and covers primarily catastrophic costs. However, when standardized benefits are required under law, such an option is not available. The result is, again, that many young and healthy people decline insurance.

This arrangement is great if you are sick — say, a diabetic with considerable health problems. The standardized benefit package will likely cover diabetes, and the community rating all but guarantees that the premium you will pay is lower than what you would pay in a free market. However, as a way of solving the problem of the uninsurable, it is a lousy scheme. It results in more and more people going without insurance. In the last two decades some state governments have adopted community rating and almost all have passed various benefit mandates. It is not coincidental that during that time the number of people without insurance has risen precipitously.

Community rating and benefit mandates amount to radical reform — and like most radical reforms they have undesirable and unintended consequences. Far better to pass reforms that target the 1-2 percent who are genuinely uninsurable, and provide those people with government assistance in paying for health insurance.

In short, helping the uninsurable requires tinkering at the edges, not changing the entire system.