Trying to clarify some issues for people…

I made the mistake, apparently, of trying to explain why allowing the sale of health insurance across state lines in the United States isn’t likely to fix the US healthcare mess.  I have never, ever met someone quite as ignorant as this guy, quite honestly.  I mean, this man just doesn’t get it.  Doesn’t understand that insurance markets do not operate like garden variety markets for good and services.  So I decided to try, via Twitter, to give the guy a crash course in insurance and basic healthcare economics.

So I started out by trying to explain the concept of adverse selection.   In simplistic terms, adverse selection is a market failure that comes from the way pricing works in insurance works.  A decision to buy insurance weighs one’s perception of the potential cost of the insured risk against the cost of the insurance.  Insurers set their prices based on statistical models on covering their potential losses .  They try very hard to determine how much of a risk any particular insured peril is.  Consider, then, a market for insurance – a community.  Insurers will have an idea of how much on average their healthcare will cost in any given year, and base their premiums on that sort of a model (I’m grievously simplifying, but just to illustrate the concept!)

Now, suppose in our market, some people smoke and some don’t.  The cost for care for those that smoke will likely be higher.  What could happen is that the price of the insurance will reflect this, and those people who don’t smoke might therefore assess the value of the insurance not to be worth the cost.  They might then decide not to buy insurance – or what could happen is another entrant to the market might show up, and offer insurance just to those non-smoking people for a lower cost.  For our original insurer, they have a problem – their average cost is going to rise because the best risks are no longer in their risk pool.  This can cause a vicious circle whereby only the higher risks remain in the pool and costs soar.

Something similar to this is what caused the end of the community rating system that was originally used by the Blue Cross/Blue Shield system in the United States – new entrants cherrypicked out the best risks and drove costs up. 

So, what’s this got to do with the cross state line idea?  Well, let me try to explain.

The savings would most likely come from differences in what’s required to be covered in various states in the the US.  Different states mandate different conditions be covered in different jurisdictions.  Ultimately, you’ll get cheaper insurance, because you’ll get covered for less.  The buyer essentially gets exactly what they pay for, after all.

Remember what I said about cherrypicking?  Well, suppose you’re in a state with relatively lax mandates.  You can offer very cheap coverage to young, healthy people for the simple reason that you don’t have to cover much and the risk to you as an insurer is low.  Your clients are generally healthy and you can fairly accurately model their risks for the relatively few perils you cover.  That’s great for young, healthy people who don’t see a need to carry much insurance.  However, if you’re older, or sicker, or considered a higher risk, you’ll see your costs likely soar, because those healthy folks are being poached out of the overall risk pool.  That’s a lot of people who’ll see their costs rise, potentially.

What about those savings?  Well, consider that in 2005 the US Congressional Budget Office studied that.  What’d they find?  Well, here’s the study: http://www.cbo.gov/doc.cfm?index=6639&type=0  Take a look at the fifth paragraph.  Here’s what it says:

“In general, health insurance that includes coverage of mandated benefits will cost more than it would if those benefits were not required. In aggregate, this estimate assumes that if only those benefit mandates imposed by the states with the lowest-cost mandates were in effect in all states, the price of individual health insurance would be reduced by about 5 percent, on average.”

Five percent.   That’s it.  Five percent.  Some magic bullet that is.

There’s another great argument for why it won’t work.  I’d go on about it, but it’s done better on another blog: http://healthpolicyandmarket.blogspot.com/2009/12/selling-health-insurance-across-state.html  Summarizing, insurers get their cost efficiencies from the networks they establish in their markets.  Without those networks, there’s not likely to be much cost advantage.  I’ve got no personal experience with this “in-network” nonsense, every single healthcare provider in Canada is my network, at least as far as my provincial medical insurance goes.  So you might by that cheap cheap policy from another state, but where will you be able to get the service?

Basically, I’m not going to write a dissertation on the subject, but I could.  The aim of this posting is to highlight the fact that insurance markets aren’t so simple as to suggest that this approach will actually address the problem.  The reader needs to go and do their own research, and maybe if I get the inclination I’ll flesh out more of this.

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2 comments so far

  1. John on

    I agree with you that sale across state lines by itself won’t have a massive difference, but I don’t buy the CBO’s estimate of 5%, it’s just not logical. I agree there’d be some adverse selection, but if people were allowed to pick their health insurance coverage like they pick their car insurance coverage, you would get enough healthy people buying catastrophic coverage that should offset some of the losses taken on the sicker people.

    At the end of the day, if you get into more accidents, you pay more for car insurance. If you get sicker, you’re going to have to pay more for health insurance. I don’t see how that’s a bad thing.

    All that said, my point is that if insurance would stop covering things with a known risk of 100% (annual checkups, blood work, etc..), combined with the sale across state lines and laxed minimum coverage laws (aka give people choice), you would see the costs of care and of insurance decrease. And it would decrease far more than 5%

    • warriorbanker on

      I can’t really comment on the CBO’s methodology, I don’t know how they derived the figures, but generally speaking to the best of my understanding, they use fairly sound study methods. Interestingly, the study dates from a few years ago, one wonders what the impact would be like now, if cost levels vary more given the rate at which insurance costs seem to have soared.

      The degree of adverse selection is difficult to measure. Invariably, some healthy people will find that more comprehensive insurance is still important to them, and demand elasticity would be somewhat favourable – I think health insurance demand is relatively inelastic overall, though the sheer number of people who haven’t got adequate coverage in the US never fails to stagger me.

      Interesting that you mentioned car insurance – one of the more ridiculous arguments I’ve seen is about “compulsion” to buy insurance. Car insurance is required by law, after all – and while the counter-argument is that one can choose not to own a car and thus not be required to buy insurance, that’s pretty rare.

      I’m similarly concerned about your second paragraph. While that makes some sense, the problem is that if that happens too much, people will essentially be priced out of the insurance market, and without a prohibition on discrimination for pre-existing conditions, they could wind up unable to shop around for insurance. That’s probably the best argument for some manner or public option, though I read a great article about the GOP’s love of high risk pools and why that will not necessarily fix anything.

      Choice, in broad terms, isn’t a bad thing – but the reality is that too many people will likely choose to go cheap on their coverage to the point that the problem of going broke for getting sick will not be alleviated.

      The problem’s complicated, that’s for sure, and it will take more sophisticated minds than mine to sort it out.


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