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.