Home > Uncategorized > Insurance Vs. Welfare

Insurance Vs. Welfare

Insurance is a way of spreading risk among many individuals so that if a negative event strikes one of them, the cost will be shared by all.  Setting up a mechanism to accomplish this is a difficult task which requires a lot of resources.  Because having a way to spread risk benefits all parties (ex ante), the creation of such a mechanism creates the potential for enough profit to call forth the necessary resources.

Welfare is a way of using the government to take wealth from some people and transfer it to others.   The government is required to accomplish welfare (this is different from charity) because, unlike insurance, it takes from people without giving them anything of equal or greater value in return.  This means that the threat of physical violence (imprisonment, seizure of property etc.) must be used to make people participate.

The ultimate goal of progressives with regard to healthcare is to transform it from a system of insurance into a system of welfare.  This has been going on for decades.  They are not about to accomplish it but they are about to take an important step.  To put this step in context, we must go back and look at the previous steps and what their effects have been on the health insurance market.

For an extensive summary of health insurance regulations see Kofman and Pollitz.  Let me just say in summary that government tells insurance companies what they have to cover, what they can charge, who they have to cover, and even who they have to actively market their policies to.  In addition they have created barriers between states (and in some places within states) to shelter companies from competition.  To call the current state of healthcare in this country a failure of the free market is an absolute absurdity.  To the extent that it is a failure, it is a failure of the partially government directed market.  A market that is only a little free will not function well.  What’s more, it will fail in specific predictable ways.  I suspect that the progressives know what these ways are and are causing them on purpose so that they can steer it more and more toward complete government control.  I might be wrong about this (it is admittedly dangerous to guess at people’s motivations), but if I am then they are just fools.  This would be less troubling but certainly not not troubling…

I will start by describing how a functioning insurance market would work.  A bunch of people who all face some chance of getting sick buy insurance.  Only some of them will get sick and the insurance company will pay them more than they paid in and the ones who don’t get sick will lose their premiums.  Some will be better off in the end for having purchased it and some will be worse off in the end but they buy in because they don’t know which one they will be and they don’t want to bear the risk.  Insurers will compete for customers and this will drive the price down to that level which compensates the insurer for taking on the risk plus whatever profit is required to call forth the resources necessary to run an insurance company  (note that the profit margin for insurance companies is low relative to other industries.  Hillary’s claim that insurance companies’ profits were “the biggest in the history of the world” were apparently motivated by the fact that it is the biggest industry in the history of the world).   If someone has a higher risk of illness they will cost more (in expected terms) to insurers.  Healthier people will cost less.   This will mean that if an insurance company can tell better than others who is healthy and who isn’t, they will be able to make more profit.  Because of this they will compete to get the healthier clients.  They will come up with the most efficient ways of identifying the risk associated with each person and charge lower premiums to more healthy people.   To the extent that people can affect their level of health they will have an incentive to do so.  A person can see that if they smoke, their insurance premium will be higher by X dollars.  X will represent the actual expected additional cost to society of them choosing to smoke.  Then they will choose whether it is in their own interest to smoke and pay X or not smoke and save it.   The only government institution required to make this function is the institution of contract law.  The insurer and insuree sign a contract saying that if the insuree gets sick the insurer will pay.  If insurers are really signing these contracts and then just refusing to pay (as many on the left have been claiming) then the courts should litigate the contract and punish the insurer accordingly.  This requires no additional legislation.

If everyone has perfect information, this market will be efficient.  There are two potential problems that may arise otherwise.  The first is known as adverse selection.   If insurers cannot tell who is healthy and who is not, they will have to lump them together and charge them the same premium.  In this case they will only compete the price down to the average of the cost of a healthy person and the cost of an unhealthy person (weighted by their relative proportions in the population).  If this price is sufficiently cheap that everyone stays in the market, there is no problem in the sense of efficiency, it just results in the healthy people subsidizing the unhealthy (this takes on a welfare-like aspect but it is still voluntary so no government required).  The problem arises when some of the healthy people are not risk averse enough to pay the cost of subsidizing the unhealthy in order to get insurance.  They will choose to bear the risk themselves and drop out of the insurance market.  This will make the (weighted) average cost of insuring a person of unknown health increase and insurance premiums will increase along with it.  This will cause more healthy people to drop out which will cause premiums to go up more etc.  In other words you will see “skyrocketing” insurance premiums and growing ranks of the uninsured.  More on that later.

The second problem is known as moral hazard.  This derives from the insurance company’s inability to observe peoples’ behavior after the contract is signed.  If the insurance company can tell whether or not someone smokes, then they can charge them a higher premium as mentioned above.  If the person says they don’t smoke, the contract can be written so that their benefits are null and void if they smoke.  Then if they get lung cancer and it turns out they were smoking, the insurer is off the hook.   This will create the incentive for the person to refrain from smoking.  If, however, the insurer cannot tell whether or not the client has been smoking (or cannot prove it to a court), then this will not be possible.  In this case the insurer will have to assume that some proportion (possibly all) of their customers will engage in the risky activity and price their policies accordingly.  This will be inefficient because more risky behavior will go on when people know they are not bearing the risk than would if they were (or had to pay a higher premium for the privilege). 

The first step down the road to socialized medicine was to give tax incentives to employers for providing health benefits to employees.  This may have begun in 1974 with the Employee Retirement Income Security Act (ERISA) or it might have been going on before then, I’m actually not sure.  But at least since then there has been an incentive for employees to give health insurance as part of employee compensation.  Without the tax incentive there is essentially no major reason why it is beneficial for employees to be paid in kind with health insurance rather than with an increased wage that they could use to purchase health insurance for themselves if they wanted it.  In fact it would almost certainly be more efficient to pay them in cash for reasons described below.  But for some reason people decided that it was immoral for an employer to not give their employees insurance (I even heard Glen Beck endorse this view once).   The justification for this is usually some typically meaningless progressive assertion like “people need healthcare.”  But people need food.  We don’t demand that our employers include groceries in our paychecks.  What makes healthcare so special?   I wish I could say that I don’t know but I’m afraid  that I might…

So the tax code has been used to drive people into employer-provided insurance.   There are two main problems with this.  The first is that it pools people together.  Instead of each individual getting a policy that is custom-made for them (or potentially none at all), their employer gets a policy designed to cover his entire workforce.  This means that some employees are subsidizing other employees.   The more important problem, though is that the nature of insurance makes it dependent on contracting that spans very long time periods.   To see this, notice that an efficient insurance contract would include in the contract that the insurer could not drop the insuree after getting sick.  This is the whole point of insurance.  An insurance contract that allows the insurer to drop someone after they get sick is completely worthless.  It would never happen in a well-functioning market.  The reason it happens now is that people lose their jobs and their insurance is tied to their jobs.  If someone gets cancer while at one job (and under the insurance for that job) and then quits or gets fired, they can’t get health  insurance because they have to sign a new contract and now they have cancer.  This is because there is no risk left (at least with regard to the existing disease) so it is not a matter of insurance, it is a matter of making someone take on a known expense which is far greater than the amount of premiums collected.  Not surprisingly, insurers will not be very willing to do this.   But this problem wouldn’t exist if people were not pushed into employer-provided insurance plans.

In addition to this, the government has done much to force workers of different employers to pool together.  The Health Insurance Portability and Accountability Act (HIPAA), passed in 1996 after the failure of “Hillary care” and the subsequent retaking of congress by the Republicans, prohibits insurers from denying coverage to applicants based on health status.   According to Kofman and Pollitz, “Most states have enacted rating reforms in the small group market, prohibiting or restricting the ability of insurers to charge higher premiums based on health status or the risk of having future medical claims.”   This is imposing the adverse selection problem on insurers in order to force the healthy to subsidize the unhealthy.  Of course if the healthy don’t go along with it, you get skyrocketing premiums and growing ranks of the uninsured. 

If you still want insurance, you will also have to subsidize people who use services that you will never (in some cases could never) need.  According to Kofman and Pollitz

“One way to spread the cost of a medical condition or treatment among a broad population, making it less expensive for the group of people who need such coverage, is through a benefit mandate.  It is also a way to encourage people to seek certain care, e.g., preventive services, that otherwise may not be received.  In the absence of mandates, adding optional benefits to a policy can distort premiums if coverage is selected by people who need that benefit.” 

What they mean by “distorting premiums” is making them reflect the actual expected costs a person will impose, and by “care… that may otherwise not be received” they mean things that would not be worth it if people had to pay the actual cost of them.  As an example of this consider an insurer who is required to offer pregnancy benefits to everyone.  This will cause men and older women to subsidize women of child-bearing age.  This may cause the adverse selection problem as some of the subsidizers to exit the market (skyrocketing premiums and growing ranks of the uninsured).  I have heard pundits on occasion pointing out the absurdity of making men pay for insurance that covers pregnancy and they are correct.  The real problematic thing though, is forcing women who have no intention of getting pregnant to pay for it.  In a free insurance market, men would never get pregnancy coverage.  Even if you forced insurers to offer it to them they would just give it to them for free since it entails no additional cost.  The person who would suffer would be the woman who knew the chance of getting pregnant was very small but has no way of proving this fact.  She would have to pay more for the coverage that she otherwise wouldn’t buy.  Of course, in this case insurers are also prevented from charging different rates to men and women so they’re both screwed.  There is also a potential moral hazard problem.  It is unlikely (though not inconceivable) that people will get pregnant much more often when the insurance is imposed upon them, but examples could be found of behavior where this is more of an issue. 

So the problems commonly cited by those on the left who want healthcare reform (preexisting conditions, increasing insurance premiums and healthcare costs, and the uninsured) are all caused in predictable ways by existing government policy.   At this point we have to ask ourselves whether we believe that they are ignorant of these causes.  It certainly is possible.  These things aren’t exactly obvious.  They aren’t really that difficult to put together either though.  I’m sure I’m not the first to notice these things.  In fact Kofman and Pollitz often hint at the implications of these policies.  They talk of the tradeoffs made by policymakers “balancing higher premiums with the need to help finance certain illnesses.”  They (progressives) see the degree to which they can tie people together and make them subsidize each other as a benefit.  They recognize that there are costs of doing this (in this case due to the adverse selection and moral hazard created by such policies) and they try to balance the cost with the benefit.  But they never say that.  They blame all the costs on the remaining degree of freedom in the market and use it to justify more collectivism.   They do this because they know a secret.  The secret is that because of these problems, this kind of half-and-half capitalist/socialist system is not sustainable long-term.  It will have to either go back to freedom or go more and more in the direction of government control.  They believe it will go the latter way and unfortunately that has been the case historically. 

So with this hypothesis in mind let’s look at what is going on right now with healthcare.  The Democrats tried to pass a complete socialization of healthcare.  They couldn’t get enough democrats on board so they had to water it down to some version that would bring us closer and probably lead to full socialization in the future.  When Scott Brown was elected, they lost the ability to even do this with just Democrats.  They needed to get a couple Republicans on board.  The way they get people on board with bills that they don’t like is to offer them stuff.  They know in this case that they can’t get any republicans in this way because the public is so upset about it that it would be political suicide for any republican to sell out that way.  So they are going to ram it through with reconciliation but they know the public will be pissed and they need to try to tie the republicans to the bill somehow.  So they had a healthcare “summit” where they got the Republicans to name some things that they want.  Now they will give them some of those things (at least they will say that they are) and demand that the Republicans support their monstrosity of a bill because it has a couple things that they wanted.  Republicans won’t support it because the problem is all the stuff that is in the bill not a couple things that aren’t.  Then the Democrats will claim that the Republicans are just “playing politics” and “being obstructionist” to justify their use of reconciliation. 

Now I don’t know exactly what will be in this bill, it will be 2000 pages and I will never read it.  But I do know one thing that will definitely be in there.  This bill will make it illegal to deny anyone coverage for having a preexisting condition.  I know this for two reasons.  First they always mention this as something “we all agree on” whenever they are on tv.  And second it is the next step toward socialized healthcare.  The subsidization of employer-provided healthcare caused the preexisting condition problem.  Fixing the preexisting condition problem will cause another problem.  Once insurers have to take you after you get sick, there will be no incentive to get insurance.  You will just wait until you are sick and then sign up.   This means they will have to force everyone to buy insurance.  They have said this before when arguing that a “comprehensive approach” is required because the pieces won’t work separately.  This is true but the reality is that the public doesn’t want any of the pieces so they have hushed up about it.  They will pass the pieces they can and know that it won’t work without the other pieces so they will have to add them later.  Once this happens it will be full-blown welfare and not insurance.

In the nineties they had the presidency and both chambers of congress.  They assumed a mandate to pass their progressive agenda and they started by trying to reform the healthcare system which they had been screwing up since the seventies.  The public went nuts, the whole thing failed and the republicans took over congress.  Then they immediately passed HIPPA which created further problems so that the next time they got the Whitehouse and both chambers, they could cite those problems and try again.  Now they are losing again and they are doing the same thing.  They will take a little bit less than they wanted but it will move us a little bit closer. 

Once we all have to buy insurance and the government is setting the prices and the coverage it will be fully socialized medicine.   This will be true even if insurance companies are technically privately owned.  Once this happens there will be a massive moral hazard problem.  Currently we have to wear seatbelts because if we get injured in a car crash, the emergency room will have to treat us.  This makes our private reckless behavior a public concern.   Once we all have government-run healthcare, everything we do will be a public concern.  They will have a legitimate justification to keep us from smoking, drinking, eating junk food, going skydiving, riding motorcycles, anything that has an adverse effect on our health.  They will set the prices for everything.  Since people are getting it for free they will demand a lot.  If they set the prices too low, doctors won’t be willing to supply that much.  Then someone will have to decide how much care people get and who gets it.  These are the things that the real progressives want and they are taking us there progressively.

There is one tiny glimmer of hope in all of this.  If republicans (gulp!) take over congress again this year, the people really have to hold their feet to the fire to make them repeal this bill.  I think there is a chance of this happening but we have to do more.  We have to make them actually take steps back from the brink.   We have to demand that they take the opportunity while focused on healthcare to actually liberalize the market.   That means removing restrictions on interstate competition, tax incentives for employers and price controls.   We have to keep the pressure on though, not relax and think that everything is fine because republicans are in charge again.  And realistically we will have to stay engaged through two years of potential republican control of congress before we can get a president who would sign such reform.

Categories: Uncategorized
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