Friday, November 15, 2013

Unavoidable Realities of Insurance: Health Care Edition

Insurance markets are unavoidably unpopular, because of a basic fact and an unpalatable implication.

Here's the basic fact about all insurance markets: What gets paid out must equal what gets paid in. Or to put it another way, what is paid in by the average person in premiums must be pretty much equal (with some minor differences noted below) to what is received by the average person in benefits.

And here's the unpalatable implication: Some people will receive much more from insurance payments than they pay in. They might buy life insurance and die young, or buy car insurance and suffer a severe accident, or buy health insurance and face a costly period of hospitalization. But in turn, because of the basic fact that the average person can't receive more more in benefits than the average person pays in premiums, there will inevitably be many people--probably a majority of insurance buyers--who will receive much less in insurance benefits than they pay in.

For example, I'm a direct purchaser of insurance for my home, car , and (term) life, as well as an indirect purchaser of health and dental insurance through my employer. The best possible outcome for me is that I would pay premiums year after year, all my adult life, and never receive more than minimal insurance benefits. After all, receiving significant payments from an insurance company would mean that my family had experienced damage to our home, or a car accident, or sickness, injury, or death.

Any market where the good outcome experienced by a majority of buyers is to make payments all your life in exchange for little or no benefit is going to be continually unpopular.

A lot of energy goes into trying to ignore or deny either the basic fact about insurance markets or the unpalatable implication. The expansions of what health insurance policies must cover that are required by the Affordable Care and Patient Protection Act offer a vivid example. The rules expanding what a typical health insurance plan must cover mean that the average person will need to pay higher premiums, because the benefits being paid out of the health insurance system need to equal what is paid in. Moreover, some people are going to draw on these additional coverage provisions much more than others, so many of those who are unlikely to draw upon such policies will find an even bigger gap between what they are paying in insurance and the insurance benefits they personally receive. Indeed, many of these all-pay, little-benefit households--and many people have a pretty good idea whether they fall into this category--are being required under the new law to pay for others to receive a level of health insurance coverage that they had not previously chosen to receive for themselves.

There will always be a political dynamic to promise that the majority should receive more for their insurance, but that no one should need to pay more on their premiums. For example, the original Medicare legislation back in 1966 required that premiums paid by the elderly should cover 50% of the costs of Part B. But Medicare spending went up, premiums didn't, and in 1997 a law needed to be passed to assure that premiums paid by the elderly would cover 25% of the costs of Part B.

Another way to quarrel with the basic fact about insurance is to point out that private insurance companies spend money on administrative costs and on profits. In addition, insurance companies earn revenue from investing reserves. One can argue that insurance companies could be more efficient, or their profits could be more regulated, and that in these ways benefits might be increased somewhat without paying more in premiums. I'm all for encouraging greater efficiency, and I think the government has been slow in pushing the private sector to coordinate on formats for electronic medical records and billing. But the National Association of Insurance Commissioners reports that in 2012, insurance companies spent 85.7% of the premiums they received, while 11.8% was paid in administrative expenses, and the other 2.7% was profit margin. In other words, the overwhelming amount of money paid into health insurance in premiums is indeed paid out to health care providers. The existence of private-sector insurance companies may bend the basic fact that what is paid out in insurance benefits must equal what is paid in, but it does not sever the connection.

Just to be clear, neither the fundamental fact about insurance nor the unpalatable implication goes away with a government-run or a single-payer insurance system. Whether it's Medicare or Medicaid or private sector health insurance or government-run exchanges, it still  holds true that benefits must be paid for. It's tempting, of course, to assert that the U.S. government could run a nonprofit health care system in a efficient and cost-effective manner that reduced administrative costs, but even if this assert is true, as noted a moment ago the additional revenue from greater administrative efficiency is a modest share of total health care spending. Also, given events in recent weeks, that assertion that the U.S. government could run an efficient and cost-effective health insurance system must be open to considerable dispute. There's a reason why, in a country as large and diverse as the United States, insurance regulation has typically been done at the state level rather than the federal level. Even with a government-run or single-payer system, it still holds true that because some people will experience very high costs, the typical person will pay into the health insurance system more than they ever get out--and should be perversely grateful to be lucky in this way.

I have for years favored having the government spend more to subsidize health insurance for those 50 million or so Americans who have lacked it. My preference has been to fund these subsidies by placing limits on the tax exemption given for employee compensation paid in the form of employer-paid health insurance. (For some estimates from the Congressional Budget Office of how such limits could raise $46-$101 billion per year in extra tax revenue when phased in 10 years from now, see Option 15 in Chapter Five of this recent CBO report.)

However, the Affordable Care and Patient Protection Act goes well beyond providing assistance to those without insurance. It has been promoted with set of promises that everyone in both the individual and employer-provided insurance market can have the same or more insurance coverage while everyone pays the same or lower private-sector insurance premiums--and while future increases in government health care spending are lower than than they otherwise would have been. In seeking to carry out these promises in defiance of the basic economics of insurance markets, the law will necessarily disrupt the health care arrangements for a sizable share of the 200 million or so Americans who already have private health insurance.