Carrots are good for your health (insurance)

The Supreme Court is expected to deliver its decision this week on the PPACA (“Obamacare”) so while we wait with baited breath I thought I might offer an alternate approach to achieving the goals of the “Shared Responsibility Payment” (“the mandate”), which is the core issue of the court’s upcoming decision. The mandate is structured as a disincentive (“stick”) against not buying health insurance. Constitutional issues notwithstanding, the mandate is just about the worst method to achieve that goal. The penalty by 2016 would be a mere $695/year or 2.5% of household income (whichever is greater). Considering that an individual policy costs anywhere from $3-$6k/year it is more costly to pay the fine than to buy insurance only for those who earn more than $180k/year (3.7% of taxpayers ). In other words, the mandate incentivizes 96% of taxpayers to drop their insurance in order to realize a financial gain. If the Supreme Court does not overturn the PPACA on constitutional grounds then, they should overturn it on sheer stupidity grounds.

Although libertarians are opposed to any government intervention in any market, IF it seems a foregone conclusion that our overlords will simply not stop until they’ve “done” something about healthcare then I suppose it is my duty to point out how to properly incentivize behavior. Incentives (“carrots”) work much better than disincentives (“sticks”). My solution uses our existing legal framework: contracts and government enforcement thereof.

Referees don’t make the rules, they just enforce them.

Health insurance should operate like life insurance. With life insurance you purchase a policy for X number of years. In so doing you enter into a contractual relationship with the insurer whereby you promise to pay them $X dollars per year for Y years and they promise to not cancel the policy regardless of changes to your health. If they break that contractual promise, then the government steps in and forces them to live up to their end of the bargain (lawsuit).

So in the case of health insurance there should be a “term-health policy” whereby you contract with the insurer for X number of years (typically one’s expected lifetime) and the insurer provides you a price structure that is guaranteed for the life of the policy. The “carrot” here is that the longer the term, the better the rate, so rates would be much lower than they are today. Pretty simple: you promise to pay for a long time, they give you a low rate and promise to not cancel. If either party breaks their promise then the government steps in and enforces the terms of the contract.

So, how would this work in practice? Consider the following: If you cancel a policy there would be penalties, however (and here is the key) if you later want to reinstate coverage you would be required to bring your premium payments current by paying all the premiums you would have otherwise paid during the lapse in coverage OR you could obtain a brand new policy with premiums that reflect your current health status and shorter term period, so they would be exponentially higher.* This “discount-incentive/payback-disincentive” system eliminates the free rider problem because (a) in general people prefer to pay less now rather than more later and (b) you gain nothing by not carrying insurance and only trying to get it when sick. By removing government regulation we would see market driven solutions like this one, where the only limit is human imagination rather than bureaucratic fiat. Insurers should be permitted to figure out the best way to incentivize people to maintain their polices IF they must be straddled with the legal requirement that they may not deny coverage.** Those insurers that figure out the best methods will be copied thus improving compliance over time. However insurance companies often seem as inept as the government (bureaucracy is the same everywhere!) so I thought they could use a nudge in the right direction.

We, free individuals in a free market, should make the rules amongst ourselves (contracts) – it is government’s job only to enforce, not make, those rules. Referees don’t make the rules, they just enforce them.

* If an insurer went out of business the law could specify that as long as you had a policy in place it could be transferred to a new insurer irrespective of your current health condition. A more free market approach however would be to take out insurance against the insolvency of your own health insurer, so if they do go out of business your policy would provide you a lump sum payment to establish a new policy elsewhere. In such a system the insolvency premium would reflect the relative risk of your health insurer, i.e. a new upstart carrier might offer really low rates but carry a high risk premium and thus the cost of the health premium + insolvency premium might be the same as a more established carrier. Because those insurers insuring against insolvency have a vested interest in not paying claims they will be the ones to “regulate” the solvency of the health insurers through auditing and such. The insurers would permit this regulation because they will know that few people would buy their health policies if no other carriers will issue insolvency policies that cover them.

**In order to transition to this new system, we should dismantle Medicare (which currently covers wealthy old people) and Medicaid and use those funds to establish a new temporary program that would subsidize the premiums of the unhealthy AND destitute, i.e. those that truly need help as opposed to those whom the premium might merely be inconvenient or difficult. In the long run the “pre-existing condition” issue would go away as the market would incentivize parents to purchase life-term health insurance for their children at birth (these policies would be so inexpensive even the “poor” could afford them). The parents would pay the premiums until age 18 at which point the child would “inherit” the policy with an excellent rate. They would have a huge incentive to never cancel as “lifer” policies would be the ones with the lowest overall cost since they have the longest guaranteed term. 

3 thoughts on “Carrots are good for your health (insurance)

  1. Alan Johnston

    I enjoy reading your columns in the Morgan Co. Citizen.(and have emailed them saying so.) Your thoughtful analytical thinking on current topics gives me a new perspective on the issues. I try to read about the political landscape as much as i can. It is something that I believe being more informed will make me someone who can make a difference. I am a Republican leaning Libertarian in my political views.
    I studied electronics as an entry career that lasted about 29 years. About 7 years ago I chose to start my own business repairing electronics at home. In addition, my Dad’s age was becoming an issue with his Custom Cabinet shop so I as able to learn a new trade by helping him in my spare time.
    Now the electronics and cabinet work are very slow. Sensing this coming, I designed, manufacture and market bird house kits and kids toy kits and selling them on eBay and my website. This has provided a small income and I want to grow it to become something larger. I am not great at marketing and need help in doing so on a shoe string budget. If you would be interested in mentoring, I would be greatly appreciative. Thanks for your columns and your advice.

  2. Aubie W. Knight

    Greg –

    I applaud your free-market approach to the extremely complex problems facing today’s healthcare and health insurance system.

    However, there are some problems with our proposed solution. Here are a couple that I would like to point out.

    1) Insurance contracts have always been “unilateral”. The insured can cancel the contract anytime they would like (like with life insurance). Only the insurance company is bound to the contract. So your proposal would require a fundamental shift in how these contracts would work. The insurance industry would be skeptical about being able to collect if an insurance decided to stop paying premiums. Kind of like when someone stops paying one of those long-term gym memberships…..sure the gym can turn the person over to collections, but rarely are they actually going to get their money.

    2) The life long contract works well in life insurance due to the stability of the mortality tables. Life expectancy has been very stable and very predictable; two things that make insurance companies very happy and willing to participate in the market. Health care cost on the other hand have been very unstable an unpredictable (unpredictable in the sense of how quickly they are increase). There are many factors that contribute to this, but the one that I think is the biggest problem for your proposed solution is the fact that medical technology changes so rapidly. All of these new procedures and medications drive up the cost. There is no way for an insurance company to know what type of procedure or medication is beyond to horizon. From the actuaries stand point, there is no way to calculate the premium the insurance company can charge when you don’t even know what you will have to be paying for. Again, with life insurance it is very simple…….the insured dies and the insurance company pays. With healthcare, there will be new test and new drugs developed in the next few years that will costs tons of money that no one, including the insurance companies, can accurately predict. Without being able to predict the future cost, no insurance company would participate in this program.

    I enjoy reading your columns. Keep up the good work.

    Aubie Knight

    1. Greg Post author

      Thank you for your comments, they raise some valid issues. At first glance here are my thoughts:

      1) In the case of cancellation by the insured with life insurance: this is permitted I imagine because the cancellation does not bring any material harm to the other party in the contract (the insurer). Yes they will not be collecting premiums, but they are not incurring a direct current loss either, I mean, it’s not like they lose the income stream AND then they have to pay out the claim as well after you die… they are reducing their risk in some sense by allowing the cancellation, and I suspect it may even be a net benefit for them. For example I’m guessing most cancellations come from people taking out 20 or 30 year Term life policies. They are paid on for that part of a person’s life when they have children, once the children are out of the house people probably figure they can now save a few bucks as they don’t really NEED it any more and thus cancel their policy, i.e. they cancel it right around the time they are more statically likely to die. Now all cancellations aren’t all like this, but I would hazard to guess the lion’s share are like this and so in aggregate insurers permit this (or don’t penalize it) because it tends (in aggregate) to actually benefit them, i.e. the people most likely to be dying soon (based on actuarial tables) are the ones doing most of the canceling. Also, I’m guessing insurers are somewhat like banks with loans, there is only so much new business they can write based on their insured reserves, so when they lose an old customer, they can then convert that freed up reserve for a new younger customer who will continue to pay for a long time, not die, and then cancel. My guess is insurers would prefer everyone cancel their policies at some point… if they cancel them that means they aren’t dead! Theoretically with 100% cancellation (not concurrently) all they would do is collect premiums and never pay anything out 😉

      So with that said, how does this apply to cancellation of my proposed “term health insurance” policies. In this case there would be measurable harm to an insurer if such a policy was cancelled as the rate given was based upon a certain quantity of insurance being purchased (quantity as in # of years). So it’s just like any other quantity discount. If I agree to buy a ton of gravel and get a price for that quantity and then only buy 100 lbs at the low price, the seller will be harmed and will come after me. It would be as you say like with a gym membership, however those figures would be relatively small in comparison to such a policy, so I think that is why they are not pursued much, just isn’t worth it. But if you buy such a policy and stand to save hundreds of thousands of dollars over your lifetime due to the favorable rate for contracting for such a long period then I think the insurers are going to put in some stiff penalties, enough to make it worth their while but not so much as it would be impossible for most people to cough it up. It could work like airline tickets, you could get a really low rate but with a huge penalty for canceling, or you could pay a higher rate with only a smaller or no penalty for canceling. The beauty of this approach is that the sky is the limit! I’m sure there are approaches neither of us would never think of that someone could come up with and would work well.

      2) I agree, the actuarial tables would be a major challenge since health care costs are a rapidly moving target right now. But I think the biggest contributor to that is government interference in the market (subsidization) through Medicare and Medicaid. Unfortunately, in my opinion, health care costs will continue to sky rocket as long as those programs are around. Cost controls in those programs don’t work, they’ve been trying that for decades and health care market always figures out how to game the system no matter what they do: pay by patient, then give the patient more and longer care, pay by service: increase services and decrease patient time so they can do more services, put in hospital cost controls, hospitals cycle through patients faster, etc. Obviously the programs would have to be phased out due to current dependency, but long term that must be done. Things like electronic records are just a red herring and twiddling with details at the edges, they won’t have any material effect on costs. With respect to technology driving up costs…based on my understanding of economics and how technology works in other sectors of the market, I think it has a small impact, any new technology will be expensive, true, but in the long run costs are normally driven down (I think the iPhone has more computing power than all the computers NASA used to send men to the moon!). However in medical care technology costs don’t go down. Why? Because of government involvement in the market (I won’t rehash it here ,but I go into a lot of detail on how third party subsidization distorts the normal pricing feedback mechanism of the market here: ). MRI’s have been around for at least 2 decades now (it’s based on NMR technology which I used in my chemistry studies and NMR has been around since the 50’s). My point is that it is mature enough technology that price competition could easily drive costs down to where you could get an MRI in your doctor’s office for $250 instead of $2500. But there is no incentive or motivation to do that because the government is more than happy to pay prices well above that (through Medicare).

      Prices can be driven down and health care costs can be stabilized (thus making my proposed approach actuarially viable) if the following are done:
      a) Phase out all government health care subsidization (Medicare and Medicaid)
      b) health insurance moves back to an insurance model and away from a prepaid consumption model, this means high deductibles so the consumer is paying for routine care and only true emergencies are covered by insurance, the whole point of insurance is insure against catastrophic financial loss (home, auto, life) and it is no different with health. I think this would naturally occur in the market as prepaid consumption models (i.e. 0 deductible, 100% insurance coverage) plans would be absurdly expensive nobody would buy them.
      c) Get the government out of making the rules for health insurance (i.e. allow interstate competition, remove coverage mandates, etc) so insurers can compete and consumers can tailor plans to their desire.

      Personally I think the best type of policy is a high deductible/100% coverage with no copays, e.g. if your deductible is $5,000/year, then you pay every dollar of the first $5,000, the insurer pays nothing, then once you get over that deductible, you pay nothing and the insurer pays 100% of it. Ironically the market is actually responding through the price mechanism in an attempt to right itself… premiums have gotten so high in recent years that the only recourse is to move to policies with high deductibles (5-10k/year) which has the effect of making people more discriminating about their care and forcing them to pay for routine stuff… this should slow the rate of increase in health insurance, however Obamacare is going to mask any of that benefit by throwing even more mandates in there and driving up costs and wiping out any savings we might have otherwise seen… sadly this might make Obamacare look not as expensive as it is actually is (e.g. you think you’re doing ok because your policy only went up $100/year when absent Obamacare it would have only gone up $10 or maybe even gone down). The Fed does the same thing with inflation, we think 2-3% inflation is great, keeping prices stable, but absent the money creation from the Fed prices would steadily decline, making your dollar go further, effectively increasing your income, but we don’t see it and think everything is honky-dory.

      you really got me going here 😉 Thanks for your comments.

Comments are closed.