Monday, May 8, 2017

Insure Before the Die is Cast, Not After

Discussions of health policy drive me crazy because people get the basics wrong. Even the framing of the problem is usually wrong.

Most people think the problem is something like this: “In the game of life, this man rolled snake-eyes. He now has a massive medical bill. Now I need to get you and you and you and (32 additional you’s who didn't roll snake-eyes) to pay for his bill.” This is wrong. You don’t go looking for someone to pay for your bills after you’ve already incurred them. That’s not insurance. The real problem is more like this: “Okay, we’re all going to roll two 6-sided dice. If it comes up snake-eyes, you’re going to have big medical bills. But it’ll be okay, because we’re all agreeing to cover your expenses.”

Na├»vely you might think “Same thing. Insurance is just getting a large population to pay for the few with catastrophic expenses.” But it’s not the same, because in the second example you don't know who's sick yet. If people are shopping around for insurance after they’ve already rolled snake-eyes, nobody is going to want to insure them. There is this huge adverse selection problem, because (uniquely to health insurance) people are dragging their existing liabilities around with them.

Insurers can never quite get the pricing right in the "insure after the die is cast" market. They have to estimate their mix of sick and healthy patients for the next year. This is impossible to do, because the healthy are always going to shop around for a better rate and the sick are always going to try to snag any policy they can get. Health insurance isn't supposed to be "Hey, I just found out I have cancer. Will you give me a policy so you can pay my medical bills?" It's supposed to be, "None of us know who's going to get cancer in the next ten years. Let's lock in a term policy so that when one of us gets the bad news, the others will cover him." To be insurable, traditionally a risk has to be "fortuitous from the point of view of the insured." ("Fortuitous" here means "happening by chance." It doesn't mean "lucky" or "fortunate" the way it's used in common speech.) A known upcoming medical treatment does not qualify under this definition. I'm not just pedantically spewing industry parlance here. There are real world consequences for deviating from the "insurable risks are fortuitous" rule. Risks that aren't insurable under the traditional definition are subject to the extreme adverse selection problem described above. You get the insurance death spiral. You can try to force everyone into a risk pool with mandatory insurance laws, but the penalties have to be pretty big to get them to actually join (and we would have to actually enforce them!).

With risk pricing and coverage exclusions, we'd have a functioning market. Someone who knows they will have an expensive surgery next year will still be able to get a policy. "Shoulder surgery, you say? Sure, I'll write you a policy that will cover you for everything else, but I won't cover the surgery you are already planning. You'll only be covered for new problems that we don't know about yet." Or, "You get sick whenever your dice come up snake-eyes or box-cars? Sure, I'll write you a policy, but you'll pay twice the premium as everyone else." In this world, more insurers would be willing to actually write health insurance policies in the private market (more than the three or so we have today). Premiums would be affordable, because insurers wouldn't be playing a game of "beat the death spiral." 

Inevitably when I'm trying to make this argument I get asked, "Well, what do you do for people who aren't covered the moment their dice come up snake-eyes?" And this is a hard problem. Uncovered liabilities are always hard problems. Some mix of community action, charity, government assistance, and good old fashioned "eat the cost yourself." It's a sticky problem, but it's hardly a problem that's unique to healthcare. I might respond by saying, "You'd see more people buying insurance if premiums were affordable. Follow my prescription of allowing coverage exclusions and risk-pricing and that will be the case." An important first step is to make health insurance affordable and available for some customers. In today's individual market almost nobody is willing to issue a health insurance policy, and those who are willing assume insurance shoppers are extremely high risks. Paraphrasing Deng Xiaoping, let some people get insurance first. 

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