Saturday, May 6, 2017

A Modest Proposal for Improving Health Insurance and Care

by Levi Russell

I want to start off by saying I'm not an expert in health insurance or healthcare economics. That said, I've read my fair share of analysis on the subject and understand how the math of insurance works. In the current debates over the ACA vs the AHCA, "high-risk pools," redistribution, and (largely academic) discussions over the inability of insurers to accurately price risk due to regulations, I thought I'd sketch out what I think is a basic free-market healthcare "system." Please note that I often about the mistake of committing the Nirvana Fallacy, so none of what you read below should be interpreted as a claim that "markets are perfect" or any other silly Utopian view. I think there's a lot that can be done to simply improve on current policy. Here I discuss how I would like to see that happen.

Health Insurance

The way I see it, the primary problem with the current health insurance system is that it isn't actually insurance. It's a third-party payer system in which people pre-pay primarily for routine care. These plans have low deductibles, co-pays, and high "premiums." Again, a large percentage of one's "premiums" aren't really premiums.

These generous "insurance" plans are a product of decades-old payroll tax policy. Employees are taxed on their earnings, but are not taxed on so-called "fringe benefits." Employers, competing for the best talent, provided more and more generous fringe benefits rather than increase taxable wages. This led to the current comprehensive health insurance plans prevalent today and created the perverse third-party-payer incentives that have driven up the cost of insurance and care.

Due to concentration in the (massively regulated) medical care industry, hospitals are able to dramatically inflate the cost of care, which pushes up premiums. Insurance companies, also a highly concentrated industry partly thanks to the ACA, have very little incentive to negotiate for lower prices resulting in a bizarre circumstance in which paying out of pocket for routine care is cheaper than using comprehensive care "insurance."

Given these problems, what can we conclude about policy changes that could improve insurance?

1. Stop favoring "fringe benefits" with payroll tax policy. This will allow for a divorce of employment from health insurance, partly solving the pre-existing condition issue.

2. Stop forcing insurers to ignore basic health factors in pricing insurance and to cover pre-existing conditions. This has led to more concentration and certainly hasn't helped drive premiums down overall. However we handle redistributive aspects of health care, we certainly need a functioning price system.

3. Remove caps on contributions to health savings accounts. Provide subsidies to low-income people in the form of tax credits so they can afford catastrophic plans and can contribute to their health savings accounts (HSAs). This will allow parents to ensure that their children have insurance for horribly tragic terminal conditions long before they are born. This would also go a long way to solving the pre-existing conditions problem.

4. Provide something like Medicaid/Medicare for the (I suspect relatively small number of) people who would fall through the cracks if the changes in 1, 2, and 3 above were made.

For more of my thoughts on HSAs, including an example, see this FH post.

UPDATE - Joshua Hendrickson at Ole Miss pointed me toward this article on health insurance by John Cochrane at U Chicago. I recommend checking it out.

Health Care Costs

It stands to reason that one primary cause of high insurance costs is that the care itself is expensive. All sorts of laws restrict the ability of consumers to find primary care at affordable rates: certificate of need laws (which put the power to increase the quantity of medical care facilities up to a state-level board consisting of hospital administrators; discussed here and here on FH), scope of practice laws (which restrict the ability of nurses and nurse practitioners to provide routine care, thus decreasing the supply of care and increasing costs), restrictions on direct primary care (a fee-based service that connects doctors and patients directly without the use of "comprehensive care insurance"), and a whole host of other things I'm probably missing.

In my mind, whatever happens at the federal level, we will continue to see states move away from their restrictive laws and increasingly allow doctors and patients to make decisions about health care on their own. As this article notes, monthly fees for all-inclusive primary care through a "direct primary care" physician can be as low as $25 per person thanks to the reduction in bureaucratic paperwork. This podcast interview has more information. Thanks to innovative medical entrepreneurs, there's even a surgery center in Oklahoma that posts all-inclusive prices for all the procedures they perform on their website. I assume I don't need to tell you that their prices are far below what a typical hospital would charge an insurance company for the same procedures. Imagine that; the price system works to provide care at low costs when it is not chained down by bureaucracy.

As Milton Friedman said, there are no panaceas. Health insurance and health care will never be free and some people will have a tough time taking care of their medical bills. This is true regardless of the institutional structure; the world isn't perfect. However, I think the points discussed above would improve outcomes across the spectrum, especially for those in the bottom two income quintiles. Reduce restrictions on health care providers, allow doctors and patients to interact directly without excessive red tape, level the playing field for HSAs and catastrophic insurance plans (i.e. actual insurance), and provide cash assistance or some other means of helping those who fall through the cracks. As a result, we'll get lower costs, more choice, and far less deadweight loss. What are your thoughts?


  1. Here's my prescription: Medicare for all financed by a VAT. So-called "free market economics" simply will not work. Access to health care is a fundamental human right, and is so recognized by every other advanced industrial nation.

    1. tm3823,

      Thanks for your comment. If we're going to have a productive discussion, though, you're going to have to make an effort to rebut some of the points in the post rather than simply repeating political platitudes.


  2. As an unabashed advocate of free markets, I love your suggestions. This system would solve a lot of problems. I believe that it is especially important to decouple health insurance from employment. Limiting employment freedom because of concerns over health insurance is a big drag on the economy. However, the concern of some people over how pre-existing conditions will be handled in the interim between the system that currently exists and the development of a healthy free market system is very real. There seems to be an inherent unfairness to bankrupting people who happen to lose the genetic lottery because they or one of their family members currently has MS, Type 1 diabetes, a bad heart, etc. It seems to me that the biggest challenge with health care reform is the transition period. Free markets take time to mature in order to serve the entire market, but, someone who needs a pacemaker can't afford to wait. It seems unrealistic that our society will agree to a system that allows people to lose everything because they are unlucky enough to have a disease that is expensive to treat.

    P.S. I realize that your list at the end of the 1st paragraph under "Health Care Costs" was not intended to be exhaustive, so, I'm sure you would have included reform of the FDA as a necessity to bring down the cost of pharmaceuticals and medical devices had you continued with your list.

    1. Anonymous,

      Thanks for your comment.

      "It seems unrealistic that our society will agree to a system that allows people to lose everything because they are unlucky enough to have a disease that is expensive to treat."

      I agree. What we need are lower healthcare costs for those with and without these terrible diseases. With that additional cash freed up, we'll all be more able to donate to hospitals like the one that took care of Kimmel's kid. That hospital takes in nearly 1/4 of a billion a year in donations. Maybe this seems a little pie-in-the-sky, but fundraising isn't rocket science.

      You're right about the FDA. I almost added something there, but I didn't want to have to get into Friedman/Peltzman on optimal time to market.

    2. I agree that lower healthcare costs will mitigate the financial effects of the terrible disease, my concern is that there is no viable path to get from the system we have now to the system you suggest. The cynical side of me tends to believe that this is why so many countries eventually end up with universal health care, whether single payer or some variation. No one can seem to figure out how to transition back to a market based system once you start treating health insurance as a payment mechanism and not as actual insurance.

    3. Anonymous,

      I agree that there isn't currently a *politically-acceptable* way to get from what we have to a better system. That's why we have to continuously make the case that gov't solutions are often ineffective, despite fancy titles like "universal health care."

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  4. Good free market advice.
    But there's a structural failure we must fix first - Gresham's Law.
    The worst politicos drive out the good.
    Politicos thrive on redistribution, and create ever more devious ways to hide it. Tax & spend. High nominal rates w/unequal deductions. Slices; payroll, personal income, corporate income, real estate, sales etc. Unfunded mandates. Minimum wage (we all vote for welfare but only employers fund it...). And fake insurance; young cost 2k, old cost 12k, but EVERYONE pays 7k average.
    UNTIL we expose and block shell games, reforms won't work.
    Robert Arvanitis

    1. Agreed, Robert. We have to continue to shift the conversation. It's really the only way to create sustainable change.

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