Wednesday, November 16, 2016

How to Cover Pre-Existing Conditions

The concept of a “pre-existing condition” misses the point. As a property and casualty actuary, every time I hear it I think, "If acquiring a 'pre-existing condition' is financially devastating, then why don't insurance policies pay out at the time of the diagnosis? Why do health insurers play this silly game of treating sick people like hot potatoes?" We should allow health insurers price for the individual risk. Below I'll explain how an insurance market can operate this way and still solve the pre-existing condition problem.

There are two senses in which a condition can be “pre-existing” and I think that they get conflated in standard discussions. The first sense is the one in which the damage has already happened. A huge expense has been incurred, and we’re just arguing about who’s going to pay for it. The second sense is the one in which no “event” has occurred, no “damage” requiring treatment has been done, but the expected future cost of all insurance claims has gone up because new information has come to light. In this second sense of a pre-existing condition, there are no existing medical bills to pay off, but you can expect some expensive bills in the future.

Insurance is supposed to pay for catastrophic personal expenses, the kind that it’s not feasible to budget for. The loss of a home or medical treatments that will cost tens of thousands of dollars, for example. For insurance to work, people have to be covered by an insurance policy at the time of the loss. It would make no sense for me to waltz into my local insurance agent the day after I crash my car and say, “I’m going to need a policy that will pay for some extensive body work.” Or, “I just maimed a guy before getting slapped with a DUI. Please give me an insurance policy so I can pay for his medical bills.” Insurance companies worry about this, so they usually make sure that they aren’t taking on such a liability. My second hypothetical, with the DUI guy maiming another motorist and getting a new insurance policy to cover it, would never actually happen. But the first one, the guy needing body work, might. In the property and casualty world, insurers look for pre-existing damage to cars and homes to make sure they aren’t taking on a liability on day one. They may tell the customer to fix the damage, or only issue coverage with some kind of deductible or coverage exclusion. Insurers also worry about the second sense of a “pre-existing condition,” the characteristics of a property or property owner that make it more likely that a claim will occur. If the insurer finds out about Mr. DUI above, not only will they not cover the damage already done, they will charge him more than the average risk because people with DUIs tend to be horrible risks. He may well pay ten times as much for his policy than an otherwise identical person with no DUIs.

So let’s get that straight first of all. “Pre-existing” can mean “I’m trying to get someone to pay for a liability that already exists” or “I have no outstanding liabilities, but my probability of a future claim is significantly higher than normal.” People should state clearly which one of these they are talking about.

Okay, but here’s the tricky part, where the two actually do bleed into each other. Suppose that a medical diagnosis makes your insurance premiums cost ten times as much as before, such that they become completely unaffordable. You’re not asking someone to assume the liability for a surgery that you’re already planning to schedule, but you are expecting some expensive medical bills in the future that you can’t really afford out-of-pocket. Such a huge hike in insurance premium might be just as devastating to your personal finances as a $100,000 bill for a surgery. There are several ways to cover this kind of pre-existing condition.

1)      The insurance payout happens when the diagnosis comes back, not when the medical bills come in. Suppose a diagnosis for diabetes for someone in your demographic has an expected cost of $100,000 over the remainder of your lifetime; in this case your insurer pays you $100,000. Honor served. The payment can be a one-shot or a structured payment, like an annuity or something.
2)      Guaranteed renewal. The insurer provides a renewal guarantee, such that they can’t simply drop a bad risk after new information comes to light. This can be an automatic provision, or it can be an endorsement the insured has to purchase. If it’s an optional provision, there are adverse selection issues, where only people who think they will become sick purchase the “guaranteed renewal” provision and healthy people save some money by skipping it. But if it’s mandatory, insurance might end up being so expensive that healthy people skip out on insurance altogether and you’re left with a bunch of sick people in the same insurance pool and no healthy people to subsidize them. It’s a tough call.
3)      Insurance covers future premium increases for new conditions and diagnoses. This solution is very much like 2), but more transferable. On getting a diagnosis of diabetes, I get either a big payout equal to my expected future insurance premiums or a promise to pay such future premiums. I can take this to another insurer, who will write me at a very high premium. But that high premium isn’t financially crippling. It’s something I was insured against! (This is economist John Cochran's idea.)
4)      Longer Coverage Periods. In this solution, neither the insured nor the insurer can cancel the policy, and the policy term is very long. As in, a decade or more. So you don't risk getting dropped every year because your health status changed. You're "locked in" for a long time. The premium is roughly fixed, perhaps with an annual adjustment for inflation and predictable changes (like your age increasing, which on average has a predictable effect on your healthcare costs). It may be difficult to enforce the non-cancellation provision on an insured who *really* doesn’t want to pay their bills. I suspect that there is no political will to enforce these provisions, and non-payers will be seen by courts and politicians as sympathetic victims. But if implemented this would solve the pre-existing condition problem. At the beginning of the policy period, the insurer simply factors in the expected cost of my getting diabetes. Most policyholders won’t get diabetes, but a few will, and there are enough premium-paying insureds to cover that expense.

All of these solutions have problems. Insurers are wary of long policy terms, premium guarantees, and renewal guarantees. Insurers like to have as many levers to pull as possible to manage their risk portfolios. If they go insolvent because they are too constrained in their risk-management strategies, that means a lot of policyholders won’t have the financial security they were initially promised.  The adverse selection problem looms large: people who suspect they are sick, even if they don’t have a diagnosis yet, will be more likely to seek insurance. They will be more likely to seek out insurance with these kinds of policy provisions. There is also a moral hazard problem: being insured against a bad outcome can make people more careless. For example, if I am insured against all future premium increases, I might not be very cost-conscious when shopping for a new policy, and just as importantly the insurer selling me the policy might *know* I’m not cost-conscious and inflate the price. Item 1) has the problem that the initial payout might not be high enough, or it might be *too* high for most insureds so as to be an unnecessary expense for the average policy holder. Needless to say, the exact policy language needs to be refined such that insured and insurers find the terms acceptable. Neither party really wants terms that are either too generous (which will inflate premiums and invite fraud) or too stingy (which will leave some insureds with uncovered medical bills). There’s a classic trade-off here.

Given all this, it’s possible for a private insurance market to cover pre-existing conditions, so long as the patient has insurance at the time of the diagnosis for such a condition. If the patient *doesn’t* have insurance at the time of the diagnosis, that’s a different kind of problem. In that case, not enough money was set aside to insure that expense. Arguing about who should pay after the fact is kind of missing the point. Assuming we’re talking about people who are planning to be insured and stay insured for their adult lives, pre-existing conditions are a solvable problem. The diagnosis itself is the insurable event, so the insurer at the time of the diagnosis should be liable for all costs related to that condition. Ensuring that everyone is insured all the time against the possibility of acquiring a “pre-existing condition” is a different problem entirely. It needs to be recognized as such and discussed in different terms, because the policy implications are very different. 

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