Code Red: Two Economists Examine the U.S. Healthcare System

September 14, 2010

The Health Insurance Purchase Mandate: Peeking Into Pandora’s Box?

Filed under: Health insurance,Health Reform,Tax deduction,Uninsured — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 8:58 am

Governors from most twenty mostly red states are suing to block the implementation of health reform. I have no idea whether they will win on the legal merits. But when it comes to the economics of the issue, they are on the wrong side. But even as my head says that the mandate is a good thing, my heart tells me otherwise.

Mandating the purchase of a good or service should be anathema to any card-carrying economist. But healthcare is unlike other goods and services in one critical way. No one will sell you food or clothing or anything else that you cannot pay for. But if you need surgery to save your life, someone will operate on you. Healthcare providers are trained to “treat now, bill later.” And while providers pursue (and sometimes harass) the uninsured for payment, the lion’s share of their costs end up as bad debt or charity write-offs. So the uninsured get their care while the rest of us pay for it. An insurance mandate is supposed to prevent such free riding. It is as if we are saying, “We can’t stop ourselves from taking care of everyone who needs medical care, so we will force everyone to pay their fair share.”

This concern about free riding is how we got health insurance in the first place. During the Great Depression, many patients couldn’t pay their bills. So hospitals and doctors encouraged individuals to prepay for their share of the community’s medical costs in exchange for guaranteed access. Even then, many remained uninsured and some had trouble getting medical care. By the 1950s, the new Hill-Burton program subsidized nonprofit hospitals in exchange for guarantees that they would take in the uninsured. A building spree of taxpayer funded county hospitals and community health centers further bolstered the safety net.

This safety net worked quite well for a long time. Thanks in part to tax subsidies, most Americans purchased insurance. Health insurers generously reimbursed private providers and the government had little trouble raising the money to subsidize county hospitals and community care centers, so there was enough money to care for the uninsured. The uninsured might not have had immediate access or seen the best providers, but few died on the streets. But this safety net has grown torn and tattered amidst a perfect storm of economic forces. Providers are either competing away their profits or using market power to build up empires to deter future competition. Either way, they have lost their appetite for serving the uninsured. Counties are cash poor due to the skyrocketing costs of running their hospitals and clinics. And all of this is occurring even as the percentage of uninsured is reaching new highs.

For the better part of the past half century the U.S. healthcare system could accommodate the free riders, but not anymore. So what are we to do? Let the uninsured die on the streets? (I call this the “Dickensian” proposal.) Eliminate market competition so that providers can make enough money to restore the safety net? (If we do this, we might as well embrace the “Canadian” proposal.) Force providers to increase their charity care and bad debt burden? (Although many nonprofit hospitals do not do enough to justify their tax exemptions, this won’t go very far.) Seen in this light, the insurance mandate makes a lot of sense to a lot of people. The uninsured impose a wealth externality on everyone else. Why not use the classic economic solution to externalities and “tax” the unwanted behavior?

But take off the economist’s glasses and the slippery slope comes into view. I am not concerned about mandates, per se. Purchase mandates are hardly exceptional. Children must get vaccinations. Car buyers must pay for airbags. Homeowners must have smoke detectors. Heretofore, most of these mandates have something to do with health and public safety and in many cases, there are genuine health externalities to justify the mandates. But in the last few years, policy makers are increasingly justifying mandates with wealth externalities. Force motorcycle riders to wear helmets because the cost of their head injuries drives up insurance premiums for everyone. By similar logic, tax cigarettes and banish sugary soft drinks from our schools. Why stop there? We can mandate (and monitor?) twice-weekly turns on the treadmill and, God forbid, ban deep dish pizza, char-dogs, and all the other delicacies that make life in Chicago worth living. Health insurance creates a Pandora’s Box of wealth externalities. Perhaps it is best to keep the lid on tightly.

24 Comments

  1. I, too, am a bit torn about this issue. However, for basic health insurance, there are also health and public safety implications, which dominate the concern for the ‘slippery slope’. If people would like to see the Dickensian solution, live a few months in Lima, Delhi or any city in a country where poverty and the lack of public services is obvious. The slippery slope argument sounds more like a political artifact — we can use it for any government intervention.

    Comment by pll — September 16, 2010 @ 8:17 am

    • There are some lines that we governments do not cross (though it is getting harder to find them.) Regulating health behaviors in the absence of public health concerns has been one of them. I would hope we can keep that bright line intact. But perhaps that ship has sailed.

      Comment by dranove — September 16, 2010 @ 8:34 am

  2. What if the response to the externalities was not banning soft drinks or candy or cigarettes but a tax on the producers and/or consumers that approximated the costs of obesity, diabetes etc.Ensure that those taxes are used to treat those with the problems rather than going into general revenue and paying for roads and animal control. Would that be a better approach from an economist’s perspective?

    Comment by Alan — September 16, 2010 @ 9:43 pm

    • The effect of a subsidy is the same as the effect of a tax. And so are the concerns. Do we subsidize treadmill makers? Subsidize organic farmers? Do we want the government deciding how we should live, all in the name of holding down medical costs?

      Of course, we do allow insurers to base premiums on health status. Why do I feel better when this is done in the private sector?

      Comment by dranove — September 16, 2010 @ 9:49 pm

  3. You wrote “So the uninsured get their care while the rest of us pay for it.”

    I question whether or not you’ve put much thought into the topics of healthcare and insurance.

    Insurance is a form of charity, is it not? We don’t seek insurance for ordinary everyday coverage. In most cases paying out-of-pocket for routine care would be a far more cost effective strategy. And those of us with sizable deductibles are practically paying out of pocket for routine care anyway.

    So why do we seek insurance? For life-altering and catastrophic events. We live in an imperfect world. Accidents happen. Disease happens. We break our hips, arms and legs. We develop cancer, tumors, blockages and clots. We have heart attacks, kidney failure and lung disease. Injuries occur at work, during commutes or on vacation. Regardless how or when it might happen, it happens.

    I find it interesting (and shameful) that insured citizens tend to look unfavorably at the uninsured as a social burden when, in fact, both groups receive subsidies that can easily exceed their “contributions” to the system. The only difference between the insured and the uninsured (and between the insured themselves) is the amount of financial contribution they make toward their own care. You can label the contribution one’s “fair share” but there’s nothing fair about it. Ask a self-employed small business owner if s/he thinks it’s fair that s/he pays substantially more than a typical W2 employee, and for less coverage. As a disease-free non-smoker under 40 I’ve paid ~$1350/month for Anthem family coverage with a $500/pp deductibles.

    One look at the cost of most major medical procedures or the cost of long-term care and it becomes crystal clear that individual insurance premiums barely make a dent. To a great extent, we’re all “free riding” the system. Here are few representative costs:

    PTCA Non-Invasive Coronary Angioplasty $50-100k
    Simple Pneumonia and Pleurisy $10-40k
    Gall Bladder Removal (open) $50-100k
    $198/day for a semi-private room in a nursing home. or $72,270/year
    $3,131/month for care in an Assisted Living Facility (for a one-bedroom unit, or $37,572/year)
    $21/hour for a Home Health Aid or about $18,000/year for a visit from a home health aide 3 times a week

    So I ask you, who do we think pays the balance of our medical bills if they exceed our total contributions into the system? Other people, through their premiums and taxes. Some pay more than others. Insurance banks on most contributors remaining healthy enough to subsidize the care of others. Insurance is nothing more than a subsidy, a charity whether it’s managed privately or publicly.

    The ONLY people who get the short end of the stick are those who manage to get through life relatively unscathed, whose total cost of care (for themselves and their families) never exceeds their financial contributions into the system. It’s not like they’re going to get a refund of their unused premiums.

    Given the current trends here in the States, I’d guess a very smaller number of citizens belong to that group.

    What irritates me the most is the unintended hypocrisy and ignorance of your statement. If the insured feel as if they “pay for the care of others” and are ignorant to the fact that their own care is (or may eventually be) subsidized, perhaps then we should make insurance more democractic. Perhaps policy holders should get to vote on who receives subsidies for medical costs not covered by their own premiums. After all, why should others foot the balance of your medical bills or mine without any say in the matter?

    It is incorrect to state that “the uninsured impose a wealth externality on everyone else”. Rather, it is “people whose medical costs exceed their financial contributions who impose a wealth externality on everyone else.” And in that context, we have quite a dilemma on our hands.

    SOURCES:

    http://www.nlm.nih.gov/services/procedcosts.html
    http://www.longtermcare.gov/LTC/Main_Site/Paying_LTC/Costs_Of_Care/Costs_Of_Care.aspx
    It seems the only people that have a legitimate claim to anything at all are the insured whose use of

    Comment by josephmartins — September 21, 2010 @ 12:30 pm

    • Is auto insurance a charity? Homeowner’s insurance? Of course not. Neither is health insurance. The insurance product is rather easy to describe. I pay $X up front and in the event something rather horrible happens, I don’t have to pay $10X (or whatever) later on. People value such wealth security and firms that are well equipped to bear the risk are able to prosper by providing it. (Unfortunately, sometimes these firms prosper in less noble ways.)

      When individuals buy insurance, they understand that sometimes they cross-subsidize others and sometimes others cross-subsidize them. (Well, perhaps those who have not put much thought into the topics of healthcare and insurance don’t understand this. 😉 ) But let’s not confuse the after-the-fact cross-subsidization that is, by definition, part of insurance, with before the fact free riding. This isn’t semantics. Those who buy insurance are not, at the time of purchase, exploiting anyone else.

      If someone pays $0 for insurance, then the cross-subsidization is all one way. These individuals are exploiting others, free riding on the rest of us. Not everyone can afford insurance, of course, and society has a commitment to subsidize many things for those in need. But many of the uninsured can afford insurance, or at least make a substantial contribution towards the cost. Surely it is not asking too much for everyone to pay their fair share.

      Comment by dranove — September 21, 2010 @ 1:31 pm

  4. I am not disagreeing with the notion that everyone should make a contribution. I agree with that. However, you continue to use the term “fair share” and I suspect that you have no idea what you mean by fair share. Have you paid $1350 per month for your insurance as I have? Perhaps I feel you are not paying your “fair share”.

    Homeowners and auto insurance are forms of charity. Perhaps not charity by definition, but absolutely charity in practice. You and others simply don’t wish to see insurance that way because it is a rather unappealing notion isn’t it? Clearly you feel that because you make what amounts to a token monthly payment you are entitled to coverage that far exceeds your total contributions. What is that if not charity?

    Charity (noun) – something given to a person or persons in need. While I am sure you did not need to read the definition, I copied it here for others to consider.

    If the costs due to damages/injuries exceed your contributions and your ability to cover the balance are you not then “in need”? Are you going to approach a bank for a loan to cover the balance? Are you going to dip into retirement? Of course not. You’re going to tell me that your monthly premium payment entitles you to be covered at the expense of others much the same way that your tax contribution entitles you to the expensive services of first responders.

    Those of us who buy insurance absolutely do exploit others from the very first day our policies become active. Perhaps not intentionally, but we do. Should a new policy holder get into a debilitating accident and sustain permanent damage and ongoing medical costs, who do you think covers the costs? Do you really believe that a couple months or years contribution toward insurance premiums meaningfully differentiates someone from the uninsured?

    Should you kill someone with your automobile, whether accidental or not, or should your home sustain damage due to your actions or not, the tens of thousands to potentially millions of dollars required to make things right aren’t going to come from your bank account or your family’s estate David. Those funds come from the contributions of others. That’s the nature of insurance, public or private.

    My point is quite clear. You’ve painted the issue as black and white: insured and uninsured. It’s not. It’s a continuum from those who pay little if anything for coverage, to those who pay a substantial amount. From those who have been fortunate not to have illnesses, injuries, accidents and natural disasters to those who have been less fortunate.

    We are not paying for the uninsured alone. We are paying for each other.

    Comment by josephmartins — September 21, 2010 @ 2:37 pm

    • I think you do not understand the basics of pooling risks, insurance and pricing of risk. Homeowners and auto insurance are most definitely not charity.

      Comment by pll — September 21, 2010 @ 4:34 pm

    • Hard to know how to respond to someone who views someone who receives a payout from their auto insurance as a charity case. I’ll just ignore that bit.

      I can’t pretend to offer a generally acceptable definition of “fair share.” But I think we can agree that someone making, say, $60,000 who does not pay anything for health insurance and then does not pay their medical bills is not paying a fair share. With that common ground, we can see the economic justification for some sort of subsidized purchase mandate.

      And by the way, I have paid $1350 per month for insurance. My brother has paid a lot more than that.

      Comment by dranove — September 22, 2010 @ 1:13 pm

    • JosephMartins might consider a course in option pricing/derivatives. People buy derivatives to hedge the risk of a possible adverse event that may occur at some point within the contract period. Buyers of insurance of any sort are enterring into a contract to hedge their risk, they are not charity patrons or recipients. The price of that contract will approximate the risk of loss plus a small profit that will be competed away in a free market to a level that justifies the risk on the capital required.

      Comment by Tom Kamp — October 8, 2010 @ 12:41 pm

  5. We’re splitting hairs David. I have the feeling we could go back and forth with examples all day long. Obviously you and I have set aside countless details and massively oversimplified the discussion.

    I believe at the end of the day it’s about two things: contribution and consumption. Independent of whether an individual is insured or not, the individual can be viewed as a NET contributor or NET consumer. If your consumption of health care services exceeds your total financial contribution toward those services, you’re a NET consumer regardless if you have insurance or not.

    My frustration lies in the fact that many policy holders express that they are “paying for others” (a comment usually directed at the uninsured) as if they may never be on the receiving end financially in their own time of need. They see themselves as subsidizing the health care of the uninsured, when, in fact, their own health care is privately subsidized as well.

    Those who find the notion of paying for others distasteful, and who do not wish to contribute to a system that pays for others fail to understand that “paying for others” is the foundation upon which insurance is built. If it were not for the insurance industry’s redistribution of pooled assets, catastrophic health care services would be available only to those who could actually afford the costs out of pocket–a very small percentage of Americans.

    Comment by josephmartins — September 23, 2010 @ 10:10 am

  6. It is very easy to say everyone is required to purchase insurance. My main concern still lies in the fact that insurance companies will not sell insurance to those they deem “high-risk”. During a recent 4-month bout of unemmployment, my husband lost his employer provided health insurance. The Cobra premium was 4 times what we had been paying and would have consumed a full 50% of his monthly unemployment checks. I attempted to buy insurance on the open market. ALL of the major carriers DENIED us coverage! They would not sell us coverage at ANY COST because of my husband’s hypertension. Hypertension is a fairly common malady and is treatable and controllable with prescriptions. My experience leads me to wonder what other bogus reasons insurance companies use to put people into high-risk pools and deny underwriting policies.
    I do not see how this legislation can be enforced if the private insurance industry is not required to underwrite EVERYONE. If everyone has to pay in, then the flip side should be true; insurers should have to cover everyone.

    Most uninsured don’t buy insurance because they are denied underwriting by insurance companies or the cost to buy a policy is prohibitively high (not because they are lazy, losers trying to get a free ride). Example: as Joseph Martins writes in his comments above, his family premium is $1350 per month. I guess he can pay that amount on his salary, but I don’t even make that much money per month; How can I possibly pay more than I make working full-time? Should I live on the streets, homeless in order to pay for health insurance? The cost structure doesn’t work. The argument about what is someone’s “fair share” must be settled. Just as student loan repayments are now capped at %10 of one’s income, health insurance premiums should have a similar cap. If we can take the uncertainty out of cost, then uninsured would be more apt to seek insurance (assuming they can qualify for underwriting).

    Comment by Janet Cornell — October 5, 2010 @ 6:38 pm

    • Janet,

      Your husband’s situation is all too common. We are all potential victims of “reclassification risk” — having our insurance premium class increase because of a new health problem. Unfortunately, the market gives us no way to protect against this risk, so you and others see your premiums skyrocket, if you can get insurance at all. The new insurance exchanges will cap the maximum premiums and this may be an option for your husband. Economists have been exploring ways for people to buy insurance against reclassification, so that even if you become ill, your premiums stay the same. I am not sure why policy makers and industry have turned a deaf ear to this vital protection.

      Comment by dranove — October 5, 2010 @ 6:53 pm

  7. David

    I understand why economists may favor insurance for the reclassification risk bu insurance to protect against the risks related to insurance? Does every citizen need to have a PhD in Finance and be able to do risk arbitrage on themselves and their families?

    What is the drain on personal productivity, to say nothing of personal finances as a result of this? How many hours should one be expected to spend on the process of getting and maintaining insurance, as opposed to maintaining or improving one’s health? Will employers be expected to offer such protection? I can’t imagine the time and money drain on my small employer, with 6 employees, 4 of whom have, and/or have family members with serious health problems.

    Comment by Alan — October 5, 2010 @ 8:20 pm

    • Blame my lousy explanation. The idea is no more complicated than this. You buy insurance at a fixed price when you are healthy and young and the premium doesn’t change just because you get sick. The premium for the young person does need to be raised because the policy has built in protection for when the insured is no longer young and healthy.

      Those are the essentials that any consumer would need to know, but there is a lot of actuarial science behind the scene that would give anyone pause. Even the most ardent economist will tell you that this or any similar scheme will not fully measure up. Which is not to say that government funded insurance has no warts.

      Comment by dranove — October 5, 2010 @ 9:08 pm

      • David

        Thanks for the clarification. I now understand how it might work. It is similar to the rate guarantee I signed up for when I got my daughter an individual policy earlier this year.

        Much easier to understand than insurance on insurance.

        Alan

        Comment by Alan — October 6, 2010 @ 9:47 am

      • Sorry for my initial convoluted explanation. My economist colleagues will applaud my purity but everyone else will scratch their heads.

        DD

        Comment by dranove — October 6, 2010 @ 10:35 am

  8. Let me suggest the interstate highway system as another metaphor that might be useful. It was/is a hugely expensive project to build and to continually re-build and maintain, like the health care system. It is easy to see the benefits to everyone in the country resulting from the increased efficiencies it offers. Most of these benefits are shared by all of us even if we do not drive, even if we just think about all the things that are shipped to us each day. The average person’s usage might not match perfectly to their costs in taxes, but if they have an accident then the emergency service they receive pays them back. In fact, they even derive a big benefit from the emergency vehicles for someone else who crashed because the wreckage is quickly removed to allow benefits to return to others who did not crash.

    In the same way, if health care was provided to the general public and financed globally along with emergency care for “health crashes”, it would provide value to the entire society. One main difference now is that we do not make this service available for the average person at a low everyday cost basis. As you stated before the problem is that Americans will not let someone die on the streets (at least in large numbers) without providing emergency care. So metaphorically, we give the expensive fire trucks, ambulances and police, but not the cheap roads.

    Of course, you could argue that incremental usage of the roads, once built, does not add meaningful marginal costs like it does in health care. I would argue that this is not so obvious as it might seem. Extensively used roads really do require a lot of extra cost to keep going and the costs to society of potholes, construction delays, etc are not insignificant. Sure it costs way less than health care, but maybe not in relationship to the benefit it gives (i.e health care costs more, but health is more valuable than transportation) We just accept the costs of the interstate system without much thought so they do not seem so large. Furthermore, if we eliminated the hidden taxes of insurance administration and profits in the existing for-profit system we have now, the incremental costs for health care usage would drop a lot and the consumer benefits would amost certainly increase. Real research and analysis could offer estimates here.

    One could also argue that our government could never administer health care as well as the insurance companies, but that is not really obvious either. The insurance costs in our system now must add 100’s of billions of dollars per year to the cost, yet provide no benefit to sick people. We trust the government to handle the roads and the emergency vehicles. I do not hear people complaining that their share of the interstate tax load is more than their neighbors. I think that is because we just accept the need for good transportation. If we just accepted the need for a healthy society in the same way, we could provide it.

    I was a student of yours in 1994 or so and I have since moved out of health care into other industries, but I think about this stuff as a voter. I’d love to hear if you think this makes any sense.

    Thanks.

    Comment by Dan Sullivan — October 8, 2010 @ 8:47 am

    • I agree with your point about the administrative costs of a private system. But it is not private versus public per se that makes a difference. Private insurers administer Medicare on behalf of the government and keep admin costs very low. But they don’t have to advertise or do medical underwriting. One is justified in asking whether the costs of these market activities are justified by having market-based insurance.

      As far as the Interstate Highway analogy goes, this is a public good, like a park. My consumption of the highway (or a park) does not preclude yours (up to the point of congestion, but that is a distraction to the main argument.) Building a highway also requires enormous coordination across regions. Decisions about the supply of public goods must be made collectively, or else there is little private incentive for producing them. Or if there is private incentive, the resulting product is likely to be a natural monopoly requiring rate regulation.

      Healthcare is a private good — if I get surgery, you don’t get the benefits. If I fill a bed, you can’t fill it too. Decisions about private goods can be made privately, without the need for government subsidy or coercion.

      The distinctions are not black and white. You may care whether I am healthy. Some providers have monopoly power. But the basic point is that incentives to produce healthcare seem alive and well in the private sector. Incentives to build highways in the private sector seem much more limited, which is why the government gets involved.

      Comment by dranove — October 8, 2010 @ 9:15 am

      • Thanks for your response. I think I understand your distinction between a public good vs a private good on an individual basis. Certainly, one person’s (out of 300 million) surgery provides little immediate benefit to someone else not in their family.

        But on a macro level it becomes fuzzy. Isn’t it of great benefit to live in a society where myself and all my neighbors can avoid the emotional, financial and productivity costs of worrying about health care as we do now? As a society, we expend tremenedous amounts of our skill and energy to address problems in health care that do not provide a good return in terms of improvement in our lives. This skill and energy might otherwise be directed toward solving other problems that would improve my life and yours more, individually and collectively.

        Thanks again for your thoughts.

        Comment by Dan Sullivan — October 8, 2010 @ 10:05 am

  9. I’m not so sure I see the distinction between public and private goods based on the comments above. Perhaps I’m getting hung up on the details of examples and analogies and losing sight of the points being made.

    When floods wiped out several streets and bridges in the small New Hampshire town I once lived in, the repairs provided no immediate perceivable benefit to residents of other States or even residents in the neighboring towns who rarely if ever use those roads and bridges. Yet, right or wrong, the funds to repair the damage came from State and Federal sources to which we have all contributed.

    On paper my use of the local roads and bridges may not physically preclude yours of the same, but one could argue that in a practical sense (in the context of the highway example provided by Dan) one’s own geographical location does prohibit or severely restrict one’s use of it. Such a scenario seems no different than surgery or bed that seemingly only benefits a patient and the patient’s immediate family.

    To put it a bit differently, as the probability (that you’ll benefit from something) approaches zero is it not indistinguishable from zero (that it is of no benefit to you)?

    Comment by josephmartins — October 8, 2010 @ 10:54 am

    • Joseph,

      Let’s forget the economics jargon. The difference between bridges and health insurance is pretty simple. If a private individual could somehow overcome the incredible coordination problem associated with building a bridge, it would then be a monopolist and able to extract huge profits. (There could be competing bridges but then we would need multiple connecting roads and it would be an utter mess.) In other words, the private sector would do a miserable job of providing bridges and roads. One might say the same about health insurance (I wouldn’t be so harsh but others would), but the complaints would have nothing to do with coordination problems or monopolies. The complaints would stem from the problem of adverse selection in insurance markets.

      There are many business models that leave one wondering if we couldn’t do better. But each may have a different underlying problem and may demand a different solution.

      Comment by dranove — October 8, 2010 @ 12:51 pm

      • Thank you David, I appreciate the clarification.

        Comment by josephmartins — October 8, 2010 @ 2:41 pm

  10. Dr. Dranove,

    Maybe I’m a different sort of person who enjoys sliding down slippery slopes, but I would enjoy a more extreme sin tax/virtue subsidy system. I couldn’t help but smile as I imagined a place where treadmill runs could earn me cash, where the fat guy outside CVS could not afford deep dish pizza and had to settle for beans, rice, and frozen vegetables, where the hyper kids on the El are now calm because they cannot buy sugary drinks anymore. I like this sort of a world, even if it means I must pay a little more to enjoy a beer and wings with your son and nephew on occasion!

    Comment by Justin — November 8, 2010 @ 12:39 am


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