The proper role of insurance in healthcare

After reading the two part healthcare articles by L. Randall Wray over at Economic Perspectives from Kansas City, I found that my squishy brains was churning with thoughts regarding his argument that we are utilizing insurance too much in the provision of healthcare. What is the proper role of insurance in healthcare?

1. Healthcare and Insurance

The issue can be elucidated by taking two analytical steps. First, pretend that healthcare services are classical or "typical" services and posit what properties they have that differentiate them from the norm. From these properties comes the justification to treat healthcare services as being different from other services. Of course, the degree of regulation that a person expects to exist for the economy in general can muddle this analysis, and it is likely that many important properties of healthcare services will actually be present in other classes of service. The second step is then to determine how well insurance provide various functions of healthcare.

In the past I have asserted that the healthcare problem is a public contracting problem. This is true because healthcare services are much like services provided by private contractors to the government. Public contract services are paid for by a public agency but provided by private entities. Often, these companies are one of a few firms that can fill the contract, and so the contracting agency may have few options. Similarly with healthcare. For people who actually receive healthcare through the government or paid for by the government, their healthcare really is a public contract. Although healthcare is not always paid for by the government in the United States, the public pays into health insurance pools which are then administered by insurance companies. A person is often limited in his/her healthcare options by where he/she works. Even where healthcare is purchased on the market by private citizens, few have the understanding or sophistication to see how the policy will actually play out for them, and so competitive regulation is absent and the decision is essentially arbitrary. For people who develop medical conditions and are unable to switch providers, these folks are locked into a public contract situation where their insurer can often make arbitrary changes to the contract. In public-private contracting, the government, and therefore the public, is in danger of being harmed by companies that use manipulative business and accounting techniques to undermine the level of service that they provide for their own profit. Similarly, a person or group of people entering an agreement with an insurance company are in danger of being harmed by the fine print of their contract, negotiations made by their employer on their behalf, and "pre-existing conditions". In order to ensure that private entities are providing efficient and quality services, the key questions and the place that most of the work must be done is in the oversight of the private contractors.

But healthcare through an insurance model is really a question of double contracting. First, insurance companies enter into contracts with the general public. Then, these companies turn around and enter into contracts with health service providers. For government provided healthcare, there are services provided through the Veterans Administration or Military, where the government actually provides the service, and there are services like medicaid that contract with healthcare providers, just as insurance companies do.

But healthcare is not really a uniform service. It is often tacitly assumed that people have no real preference beyond "the best quality available" in choosing their healthcare service provider. This, however, isn't true. Some people will prefer a more friendly doctor or one with a more professional demeanor. Some people believe in alternative medicines. One healthcare economist has compared this to people's taste in restaurants, though this may be a stretch. People primarily want consistency and accuracy from their doctors. Data compiled in hospital mortality rates clearly show that some surgical teams are much better than others. The public is not allowed to know which hospital they are more likely to die at, or which doctors are most likely to misdiagnose their condition at the clinic. Faith is placed in the doctors that they are all trying their best, and that is enough for even the most free-market voices in the public debate on the issue.

It is not clear that the public would do the right thing with hospital quality of care information, were it aggregated by a nonprofit or government agency and made available to them, but a good argument can be made that it would. At the very least, it might cause services at better rated hospitals to be bid up in price, and services at not-so-good hospitals to fall in price. Very rarely, this would create a situation where those who couldn't afford to go to the nicer hospital instead go to the alternative hospital and experience a reduced health outcome or even death as a result. This is only a very small harm. Hospitals, however, would experience a much stronger incentive to provide quality care, because the prestige of the institution and its management would be at stake. Here there would actually be a rarity in business: an accepted philosophy for what a quality service actually is combined with public concern sufficient to motivate action. It might happen that hospitals that serve poorer communities would suffer an even greater reduction in health outcomes than what currently exists, but how do we separate our new knowledge from the effect of knowing? There is also a deeper, philosophic argument for why this information should be available. Public disclosure is a necessity in free societies.

Enter the insurance company. The insurance company will not insure patient care. Though it does have the sophistication and means to determine, to some degree, the quality of service provided by each medical provider, even while keeping the general public from knowing. However, they only have a limited interest in preserving patient health, insofar as preserving the health of the patient will maximize the future difference between premiums collected and costs of services paid out. This makes them unlikely to act on such knowledge. The insurance company also has no interest in limiting costs that it can pass directly to patients. As an actuarial institution, the insurer has an incentive to limit payouts on the patient's behalf, passing as many costs to the patient as possible. The insurer that is unable to do this will instead seek to negotiate for lower costs of service from the provider, but the items of negotiation do not necessarily correspond to the profit margin of the service, and hence can lead to strange gamesmanship between providers and insurers that undermines quality of service. In short, it would be difficult, if not impossible, to create a system where insurance companies act on behalf of their patients. The relationship is naturally one of adversarial negotiation. The insurance company is really meant to address the financial aspect of the situation, specifically providing large short term payments that individuals cannot afford.

One can expect the average individual to pay much more to insurance companies than he receives in benefits. Theoretically, this is the only way such companies can exist, as they must pay for their own employees as well as turn a profit for their investors with an income stream that is only premiums. In practice, however, insurers negotiate steep discounts on service costs from health providers. Therefore, insurance can lead to reduced costs for the average consumer. This is at least partially a result of information availability to consumers, specifically the nondisclosure of provider quality. This factor seems to be a source of abuse as well, as insurers do not necessarily act as agents of their policy holders. To complicate matters, these contracts are not subject to uniform standards of disclosure. Even so, the insurer maintains some level of negotiating leverage with health providers by being able to route its policy holders toward less expensive hospitals. It is not quality of care that matters so much as price, but the downward pressure this exerts on healthcare costs is probably significant.

Here it is worth noting that the presence of strategically placed regulations and oversight requirements can be very powerful in forcing insurance companies into the proper negotiations with providers instead of allowing them to gouge consumers. This seems to be a significant part of the current Democrats' healthcare reform strategy. As is usual in politics, the people who proposed a solution were criticized harshly and in ways that had little to do with the facts. Where insurance is providing services it reasonably should, the addition of sensible regulations will lead to a very efficient outcome that can be called a "solution". In cases where insurance really has no business, this change is not really going to solve problems so much as suppress bad outcomes, requiring constant regulatory adjustment and fixes to cover loopholes and tricks, and a high degree of efficiency will not be achieved.

It is also worth asking, if only for theoretical reasons, what criteria a person can use to select an insurance company. Often times a person will pick insurer based on cost alone. In other situations the individual will know that they are more likely to use one or another service, and pick an insurer that has good coverage of that particular health service. Distance also becomes a factor, and sometimes people will ask their friends about quality as well. All of these are valid criteria, and so long as free markets work in general, there is no reason to believe that individuals cannot pick insurance plans that work for them, so long as there is some minimal quality of contract that insurers provide, i.e. so long as the government pursues reasonable regulation of the insurance business practices.

2. Where health insurance works

The types of health service paid for by insurance companies are nicely described by Professor Wray, and I will briefly summarize them, then assess whether they are best provided by insurance companies, the government, or individuals.

Insurance companies cover random, catastrophic health events. These include physical accidents and injuries caused by others, outbreaks of disease, and some other non-chronic conditions. As long as these health events conform to solid actuarial standards, and there are proper government regulations to constitute a "second best equilibrium" where insurers compete for quality of service and financially incentivize people against risky behavior, this type of healthcare is well provided by the insurers. These catastrophic events will, of course, visit individuals more or less frequently and at greater or lesser cost along demographic factors which a person does not have control over - age, gender, geographic location, occupation, specific health conditions, etc. Here, regulations requiring insurers to offer the same rates to all these different demographics would only lead insurers to compete to control the "choicest" demographics. In fact, they will do this anyway, but much less desperately. To a certain degree, risky behavior cannot be separated from the demographics, because insurers are limited in the information that they can obtain. If the question is one of equality, there is no reason that the burden of equalization should fall on the insurance company (For instance, if the cost of being female is just higher in our society than it is for being male, a subsidy could be used to ensure that women are not made poorer than men on average as a result). Health insurance works in this case, and it is very similar to what one sees in car insurance or any other type of insurance.

Insurance companies cover routine care. Here, the individual will express the greatest preference for variety of care. Some individuals are best served through home visits. Others seek alternative medicines. Still others will not be bothered to take any steps toward routine care whatsoever. Though the majority may still come to regular check-ups with traditional doctors, individuals will express a variety of preferences in this regard. In this market, it really doesn't make sense for insurance companies to be involved. What is really needed is consumer advocate groups who can rate care providers along the lines of price, quality of service, sanitary standards, etc. Insurance companies cannot be trusted to do this consistently, as they are not agents of their policy holders and don't really care about quality of service. However, in this situation, insurers who provide catastrophic coverage can look to personal health records and give lower premiums to those who show evidence of actively working to preserve their own health. Because of its low price, routine care is not well provided by insurers, and the price-negotiating effect is less likely to reduce costs for consumers. If the goal is to make it affordable for all people to receive routine care, subsidies should be introduced to make it affordable for everyone, or perhaps the issue of poverty should simply be addressed separately.

Insurance companies cover the cost of chronic conditions. Here, the unlucky insurer ends up trapped in a situation where they are paying large sums of money for a long and indeterminate period. The money is spent on expensive medical techniques, drugs, and hospital stays that would be much more expensive if paid out of pocket. This is probably the porkiest part of the entire system. Here, the power of insurance companies to negotiate prices down is probably the strongest, but also where the greatest tension arises between insured and insurer. Here is where people are denied coverage because of preexisting conditions, where fine print costs families their savings, where secret deals fleece the consumer, and where the vast majority of healthcare costs are incurred. The problem with this is that here there is no actuarial element - a person has a condition and there is no risk against which the person is insured. Here, a person needs a health advocate who gets people together in groups and negotiates with the healthcare provider on their behalf. This really shouldn't be an insurance company.

To summarize: Health Insurance should cover only actuarially appropriate health risks and should not be used to pay for routine checkups or long term care.

3. Solutions

The issues that most critically need to be addressed are the costs associated with chronic conditions, the transition from catastrophic event to chronic payment, workplace-funded healthcare, general regulation, and standards of disclosure. These are really issues in healthcare and not insurance. Where insurance should not be involved, the structure of a system that does not utilize it is sketched out.

A. Chronic conditions

Because of the great disparity in costs associated with the cost of chronic conditions, the way that this aspect of the healthcare problem is managed will essentially determine the success of the entire system. There are really three groups of chronic conditions: those associated with old age, those associated with poor health choices, and those that the individual is not at fault for.

Chronic conditions associated with old age for the most part fall under medicare in our current system, so I won't dwell on these issues much longer, except to say that medicare should probably phase in sooner for most people. The effects of aging become pretty clear by the time someone is 55. From now on, my discussion will focus on chronic conditions caused by poor health choices and events outside of a person's control.

Medicaid and other programs that provide medical services to the poorest of the poor should also be expanded to provide these services in a complete and consistent manner. Unless a person is in such a group, there is no reason to expect their healthcare to be free, and so everyone else will have to pay, even if only a little bit.

In order to control costs and ensure quality of service, people with chronic conditions need a union, not an insurer. A "Health Union" would be an organization that geniunely represents the interests of its members. Those who don't have chronic conditions don't have a reason to pay dues or be members, and they shouldn't. Those who do have chronic conditions would pay to hire a collective bargaining team to lower costs for them. Unions, as fundamentally democratic and not-for-profit entities, have the potential to maximize both the cost savings and the quality of care for their members, and they won't hesitate to fight for their members in court. If conservatives get all pissed off about the term "health union", they could be called "health advocacy associations" or even "HMO"s.

If costs are still too high after bargaining, which they most certainly will be, these costs would need to be subsidized. The best way to structure this subsidy would be to preserve a portion of the individual incentive to shop for lower costs while covering the bulk of the expense from the supply side. Something like 60-99% of the cost of procedures would be paid by the subsidy. Individuals who cannot afford to purchase their medicine even under these conditions would ideally also qualify for medicaid. Where there are cases of individuals not being able to afford care, it is really a case for expanding medicaid, not a case for universal coverage.

Funding for subsidies related to poor health choices would come from taxes on products that contribute to those choices. This is already the standard for cigarettes and lung cancer. This philosophy should be expanded to include all products in the proportional degree of their contribution. For instance, soda contributes to type II diabetes, and therefore it and other sugar sources should be taxed appropriately. Motorcycles and Automobiles lead to traumatic brain injuries, and therefore they should pay a tax to help cover the cost of these injuries. Alcohol, of course, would be taxed heavily. Individuals should pay for their own health choices, but I can think of no other way to bring this about. Making individuals pay for their own chronic care only at the time of providing the health service is impossible. If these taxes are not levied, most people will not be paying the "real cost" of the products they consume. This is the most fair alternative I could think of, and it will reduce costs in the long term as well.

Funding for subsidies stemming from no fault on the part of the individual must come from the government. We have a long and compassionate tradition in this country of providing for people who have disabilities. We believe in a level playing field from which everyone has the same opportunities for success. If this creed is more than words, it must be put into action in a way that allows those with chronic conditions to live without crippling medical debts. This is a general fund issue, just as education, human services, and national defense are. Any one of us could wake up tomorrow and find that something has gone horribly wrong with our body. Just as the government protects us from Al-Quaida, it should protect us from the financial ruin associated with such a situation. If the cost is high, we should accept a higher deficit or raise taxes in whatever way is fair.

B. From catastrophic to chronic

The transition between catastrophic care and chronic care is worth addressing here because I have assigned one function - catastrophic health coverage - to insurers while reserving chronic care price negotiations to health unions and government agencies that set subsidies. Insurers will want to reclassify people as receiving chronic care at an early stage, while the legislatures crafting budgets will want to keep individuals in the catastrophic coverage stage as long as possible so that they can then reroute general fund dollars to their own pet programs.

There is no simple argument for when the transition should occur. Insurers may be able to set this threshold in a reasonable manner, preventing any formal legal definition from stipulating an exact time frame. There are reasonable bounds: post operative care should be covered as part of the definition of covering the cost of an operation; catastrophic coverage that pays for an emergency surgery to battle an invasive tumor should not be required to cover a person's chemotherapy for the rest of their life.

Whenever the transition happens, it will be crucial to prevent any disruption of care. For this reason, a person should receive both advanced notice and expert counseling that informs them of the financial effects of the transition and their options. Because chronic care is directly subsidized, even if disruptions do occur, a person who pays out of pocket rather than through a health union would not usually pay significantly more. When (s)he does pay significantly more, it is an incentive for both the individual to join the health union and the government to improve the transition, because the government would pay more in subsidy as well.

C. Workplace funded healthcare

Workplace funded healthcare is not so much of a horrible mistake as Professor Wray contends. Because workers spend a disproportionate part of their lives at work, and because occupational hazards can lead to many catastrophic events and chronic conditions, it is really a prudent public policy to make businesses financially responsible for the health of their workers. The problem is that businesses must pay for a huge variety of events that they aren't responsible for at all. Many businesses cover the entire family of the worker, even though the worker's family never sets foot on the factory floor.

There is a specific class of care that businesses should be responsible for. Though the majority of businesses these days aren't the dangerous factories of yore, safety hazards still exist at all businesses. When a person is injured on the job, the company should be required to pay for the catastrophic treatment and subsequent chronic care. This does not necessitate an insurance policy unless the business is small, but it is possible that businesses will purchase policies to cover financial costs merely to outsource the administration details. In this situation, the worker is made more remote from the insurer. For this reason, a strict and narrow standard should be used: individuals should purchase their own catastrophic coverage which covers all non-workplace related health calamities; businesses purchase coverage which covers their cost of paying for medical expenses that result from workplace accidents or chronic ailments.

If a business has a practice that results in 20% of its workers developing back injuries due to repetitive strain, the business should pay the cost of this care. Even if this means that the business has to charge more for its products, society isn't paying the real cost of production unless it pays this extra. If this contributes to other countries outcompeting the United States, one must ask if tariffs really don't make sense. After all, these foreign countries dotted with sweat shops aren't making their own businesses pay the real cost of production, and so they don't deserve this competitive advantage. Businesses, of course, will have an incentive to treat their workers well when they have to pay for injuries. When they don't, they won't.

As a final note on this issue, the practice of using temporary employees and independent contractors must be regulated and disincentivized. A company that contracts with a third party to bring workers into its own factory or production process should be required to treat these individuals as its own employees. There are far too many abuses that manifest under the alternatives.

D. General Regulations

Regulations take the form of rules that determine what is acceptable and allowed. They also form the groundwork from which individuals make decisions in the context of market competition. Regulations can improve health outcomes mainly through information sharing requirements and intercompatibility rules.

Healthcare, being a complex process of coordination, negotiation, and expertise-dependent decision making, is prone to the development of proprietary architectures. The role of the government in this situation is to spare the consumer from the horrors of learning a separate system for each different clinic or hospital that (s)he visits. Because of the way that businesses operate, often they will not see an individual incentive to change their system to conform to those of other businesses, but massive improvements in efficiency can be realized through standardizations. The creation of standard forms and intercompatibility rules should have very strong positive impacts on efficiency.

Many things that need to be required or regulated may already be so. A person's health record should be available to be transferred in total from one provider to another. Privacy rules should be uniform and strict.

Insurance must be prevented from worming out of commitments. Customers need a credible belief that they are actually buying something. This is especially true if the government plans to force individuals to purchase catastrophic coverage.

E. Disclosure and Oversight

I return now to the topic of disclosure, as it was mentioned at the beginning of this essay.

Disclosure is the keystone of any effective partnership between public and private. The necessity of disclosure is absolute. Without knowing what all health companies are doing with the money they earn, it is not possible to know if services are being provided efficiently. Similarly, insurance companies can conspire to gouge consumers if their profit margin is not public knowledge. The main obstacle to disclosure requirements are several arguments against them, which I must now turn to.

Some will argue that disclosure requirements harm firms by forcing them to share proprietary information or trade secrets. However, there shouldn't be these kind of things in healthcare. If a company has a way to do something better or more efficiently, it is that company's duty to share it.

Others will argue that there is a high cost associated with creating and maintaining the records needed for disclosure requirements to be met. However, these records should be kept by the company even in the absence of them being required to publicly disclose them. Should a hospital keep track of the success rate of its operations? Probably. If there is any credible argument to be made that businesses strive to provide quality of service, these same businesses should be measuring the quality of the services they provide.

4. In conclusion

So long as healthcare is provided entirely through an insurance system or a centralized "single payer", incentives to select for true quality of service at an affordable price will be muted. Real savings are best realized through a sober dissection of the healthcare question. Insurance has its role in catastrophic care. Markets and consumer choice are key to routine and preventive care. Chronic care must be treated as a different beast entirely. The government's role in Medicare and Medicaid should be expanded.

There are many many details behind each and every generalization I have made here. Much of what can be realized will depend on the work that is done to craft accurate payment schedules, savvy negotiation of prices, and work through the details. These details must equal the whole: I am writing with the expectation that good faith is followed. This is always the case, with any statement of what must be done. Arguments that what I have imagined cannot be done are welcome.

After writing most of this, I noticed that a soda tax has been proposed. This is an excellent idea.