No. 633 February 18, 2009 Health-Status Insurance How Markets Can Provide Health Security by John H. Cochrane Executive Summary None of us has health insurance, really. If you than healthy people, and to compete intensely develop a long-term condition such as heart dis- for all customers. People would have complete ease or cancer, and if you then lose your job or are freedom to change jobs, move, or change medical divorced, you can lose your health insurance. You insurers. Rigorous competition would allow us now have a preexisting condition, and insurance to obtain better medical care at lower cost. will be enormously expensive—if it’s available at all. Most regulations and policy proposals aimed at Free markets can solve this problem, and pro- improving long-term insurance—including those vide life-long, portable health security, while advanced in Barack Obama’s presidential cam- enhancing consumer choice and competition. paign—limit competition and consumer choice by “Heath-status insurance” is the key. If you are banning risk-based premiums, forcing insurers to diagnosed with a long-term, expensive condition, take all comers, strengthening employer-based or a health-status insurance policy will give you the other forced pooling mechanisms, or introducing resources to pay higher medical insurance pre- national health insurance. miums. Health-status insurance covers the risk The individual health insurance market is of premium reclassification, just as medical already moving in the direction of health-status insurance covers the risk of medical expenses. insurance. To let health-status insurance emerge With health-status insurance, you can always fully, we must remove the legal and regulatory obtain medical insurance, no matter how sick pressure to provide employer-based group insur- you get, with no change in out-of-pocket costs. ance over individual insurance and remove regu- With health-status insurance, medical insur- lations limiting risk-based pricing and competi- ers would be allowed to charge sick people more tion among health insurers. _____________________________________________________________________________________________________ John H. Cochrane is the Myron S. Scholes Professor of Finance at the University of Chicago Booth School of Business and a Research Associate at the National Bureau of Economic Research. Free and great individual freedom of choice in a dereg- competitive The Problem of Long-Term ulated, competitive—and hence—efficient and innovative market. markets are the Insurance Unsurprisingly, health-status insurance re- best way to spur None of us has health insurance, really. quires a thoughtful deregulation of insurance Most Americans have coverage through their markets, starting with an end to the strong innovation, employer, or the employer of a parent or tax and regulatory preference for employer- provide better spouse. But suppose you get cancer, heart provided group coverage. It does not need a service, and disease, HIV, have a stroke, discover a genetic new layer of regulation. The small individual defect, or develop any other long-term expen- insurance market is already starting to feel its reduce costs. sive health problem—and then lose your job, way toward health-status insurance. The divorce, outgrow your parents’ plan, or your deregulatory path will allow this effort to employer or insurer goes out of business. You blossom fully. lose your health coverage. You now have a preexisting condition, and insurance will be enormously expensive—if it’s available at all. Health-Status Insurance This happens to real people. A significant and expensive health problem is a common Market-based lifetime health insurance has root cause of catastrophic economic descents two components: medical insurance and in the United States. Many people stick with health-status insurance.1 Medical insurance bad jobs or bad marriages just to keep their covers your medical expenses in the current health insurance. year, minus deductibles and copayments. The lack of secure, long-term, portable Health-status insurance covers the risk that health insurance is the greatest single problem your medical insurance premiums will rise. If with our current health care system. Solving you get a long-term condition that moves you this problem is a central goal of every health into a more expensive medical insurance pre- care reform proposal from all parts of the mium category, health-status insurance pays political spectrum. There are plenty of other you a lump sum large enough to cover your problems with our health sector: the unin- higher medical insurance premiums, with no sured, hospitals’ hotel-minibar pricing poli- change in out-of-pocket expenses. cies, poor information, the drudgery of useless Why can’t medical insurers just charge paperwork, cost recovery of new medicines, everyone the same premium? In a competitive optimal copayment levels, and so on. But all of market, medical insurers must charge sick peo- these are fairly clear problems, each limited in ple higher premiums, and charge healthy peo- its reach, with fairly clear remedies. The lack of ple lower premiums. If an insurer charged long-term insurance, by contrast, seems a everyone the same price, then a competitor harder nut to crack. And unlike, say, the plight could woo away healthy low-cost customers, of the uninsured, it is a problem that faces and the original insurer would go out of busi- each of us directly. ness. Furthermore, the main reason insurance Free and competitive markets are the best companies refuse coverage, deny coverage for way to spur innovation, provide better service, preexisting conditions, or more subtly avoid or and reduce costs. So far, however, many people mistreat people with long-term expensive con- have thought that competition undermines ditions, is that they cannot charge those people long-term insurance, leading to the extensive- enough to cover their costs. If medical insurers ly regulated market we now face and to pro- can charge enough, they will compete for the posals for further regulation. Health-status business of every customer, even the sickest. insurance lets us break out of this dilemma. Freely risk-rated, competitive medical insur- Health-status insurance can give us both com- ance gives everyone access, albeit at a cost. It pletely portable, lifetime health insurance and leaves people vulnerable to the financial risk of 2 large premium increases, but health-status in- vidual insurance contract, and the same in pre- surance would fill that gap. sent value terms as those of a (hypothetical) The combination of health-status insur- successful group or pooling program, even ance and competitive, freely priced medical before we factor in cost savings from greater insurance solves the central problem of our competition. current health insurance market: the lack of real, long-term, portable health security. With An Illustration health-status insurance, you can always get Suppose that a healthy 25-year-old male medical insurance, no matter if you get sick, will incur $2,000 worth of medical expenses change or lose jobs, move, divorce, take some in a year, on average. A competitive medical time out of the labor force, or even let your insurance market will offer him insurance medical insurance lapse. The lump-sum pay- with a $2,000 premium, plus administrative ment from the health-status insurer means costs and profit. you can always pay your medical insurance Suppose that, along with potential short- premiums. term illnesses, he has a 1 percent chance of Health-status insurance would also give developing a chronic condition that will raise each of us much greater freedom and choice. his average medical expenses to $10,000 per No matter how sick you become, you would year. If he develops this condition, a compet- The combination always be free to change medical insurers. itive medical insurance market will still cover of health-status You could always afford the higher premi- him in following years, but his annual med- insurance and ums a new medical insurer will demand, just ical insurance premium must rise to $10,000, as you could afford the higher premiums plus costs and profit. This is a large financial competitive, your current insurer will require. You would setback. freely priced not depend on the good treatment of one To be covered over the long term, then, he insurer, the vagaries of one group, the link to needs a lump-sum payment large enough to medical insur- one employer, or the bureaucratic decisions cover $8,000 per year in additional medical ance solves the of one government-provided plan. insurance premiums. At a 5 percent interest central problem Best of all, when every consumer is free to rate, that sum is $148,370.2 The premium for switch insurers at any time, medical insur- health-status insurance is 1 percent of that val- of our current ance companies will compete for everyone’s ue, $1,483.70, plus administrative costs and health insurance business. They will compete for the business profit. In sum, he pays $2,000 for one year of market: the lack of expensive, high-risk customers, rather medical insurance, plus $1,483.70 for health- than try to get rid of them or “contain their status insurance, for a total of $3,483.70 in of real, long- costs.” They can also compete for the busi- out-of-pocket expenses in the first year. Now term, portable ness of people who are currently healthy, as he is completely covered, for short-term and such competition will not undermine the for chronic medical expenses. If he gets sick, he health security. implicit cross-subsidy to people with preex- is also still free to change medical insurers, isting conditions. Constant competition for with no change in out-of-pocket expenses. every consumer will have the same dramatic This example is simplistic, of course. Brad- effects on cost, quality, and innovation in ley Herring and Mark Pauly use data on the health care as it does in every other industry. incidence of a long list of chronic diseases to In sum, health-status insurance can simul- provide a realistic estimate of the sum of med- taneously give us complete and portable long- ical and health-status insurance premiums.3 term insurance, great individual choice, and Their estimate of annual medical insurance cost-containment beyond the dreams of any premiums for a low-risk male rises from $800 health policy planner. And, as I show below, it at age 25 to $3,038 at age 55, while a high-risk doesn’t cost consumers anything. The com- male pays $2,300 at age 25 and rises to $10,023 bined health-status and medical insurance pre- at age 55. Clearly, jumping from the low-risk miums are the same as those of a lifetime indi- to the high-risk category implies a large finan- 3 cial penalty. They estimate that the combined are funded by payments from an insurance medical and health-status premium starts at company, they can only be used for medical $1,487 at age 25 and rises to $3,936 at age 55. insurance premiums, and they should not be Subtracting, health-status premiums are $687 inheritable. Legally, health-status insurance at age 25, and rise to $898 at age 55. Total pre- accounts would be set up like a trust account. miums for younger people are lower than for However, health savings accounts are a older people, unlike in my example. That fact great first step, as they establish a legal and reassures us that young healthy people, who regulatory framework for accounts that are typically have lower incomes than older peo- limited in some ways to health-related uses. ple, will not shy away from purchasing insur- Now, markets only need to create (and regu- ance. lators need to allow) a variant of something that already exists, rather than something Health-Status Insurance Accounts completely new. Lump-sum payments from health-status insurers should go into a special “health-sta- Calculating Payments tus insurance account” that can only be used Calculating present values of premiums to pay medical insurance premiums or med- sounds complicated. However, in the real ical expenses. This contractual requirement world we don’t insure people down to the last solves many problems associated with large dollar, so it is not necessary to key health-sta- lump-sum payments, and it makes health-sta- tus payments precisely to the exact present tus insurance less expensive, for three reasons. value of each person’s premium for a given First, large lump sums are a temptation to plan’s premium schedule. Home insurance fraud—get a fake diagnosis, take the money, markets work, even though the payment is and disappear. That’s much less tempting if all never equal to the exact value of the home. you can do with the money is buy medical Health-status insurance companies could insurance. Second, people who receive a large offer three or four levels of coverage, keyed to lump-sum payment may choose to spend it on surveys of the costs of three or four standard other things and then show up in the emer- levels of medical coverage. Similarly, medical gency room, unable to pay their bills. It is in insurers would probably have a short num- both consumers’ and insurers’ interest to pre- ber of classifications, say a 1–10 scale of “low commit against this option. Third, this provi- risk” to “high risk,” rather than publish a pre- Health-status sion makes it feasible to require that you mium schedule for every conceivable disease return the lump sum if your medical insur- history. This would make their job and the insurance can ance premiums decline because you become health-status insurer’s job much easier at a simultaneously unexpectedly healthier. In this circumstance, small cost. you no longer need the lump sum, so promis- A health-status insurance contract could give us complete ing its return does not hurt you. Returning the then be very simple. For example, the policy and portable unneeded lump sum lowers costs and thus could say “pays $50,000 if you are reclassified long-term reduces premiums for everyone. Of course, if from category 3 to category 5.” A simple table your health status deteriorates again, you will could advise people in a given medical insur- insurance, great receive another lump sum. ance plan that this is the right level of coverage. individual choice, Health-status insurance accounts are not and cost-contain- the same as health savings accounts. Health Interruptions savings accounts are tax-preferred savings Health-status insurance can provide long- ment beyond the vehicles. You choose when to put money into term security through interruptions or dreams of any a health savings account, you can withdraw changes in medical insurance. money for nonmedical purposes (with a As soon as you stop making premium pay- health policy penalty), and you can pass the assets on to ments with a conventional insurance contract, planner. your heirs. Health-status insurance accounts you lose any right to low premiums and to con- 4 tinued coverage of your (now preexisting) med- claring a $100,000 value for a $20,000 car, for Health-status ical conditions. This happens. People who lose obvious reasons. But since you can’t do any- insurance their jobs often can continue their health thing but buy medical insurance with the pay- insurance under COBRA—if they pay the entire outs, there is no such worry with health-status accounts offer a premium, including what used to be the insurance. good way to help employer’s portion. But this privilege doesn’t last forever, and people who just lost their jobs What about People Who Are Already people who are often have trouble paying premiums, especial- Sick? already sick. ly if the job loss coincides with an expensive ill- Private insurance cannot cover events that ness.4 People who take time off from work to have already happened. You can’t tell an insur- raise a family, or lose their connection to health ance company, “My house just burned down. insurance through divorce, don’t have any How about some insurance?” right to continue coverage in the first place. Many people feel that government should By contrast, anyone with a health-status insure events that have already happened, insurance account can switch to a lower-cost especially when no insurance was available medical plan, or miss some period of medical and the unfortunate are in some sense blame- coverage entirely in a time of economic misfor- less. Health-status insurance accounts offer a tune, and retain protection against the costs of good way to help people who are already sick. their long-term illnesses. When they’re ready to The government could simply deposit money reestablish medical insurance, or move to a in an individual’s health-status insurance more expensive medical insurance plan, the account and then get out of the way. Private health-status account is there and waiting. If charities could help people in the same way. they maintain health-status insurance, even This is much more straightforward, flexible, without medical insurance, they can be pro- and less distortionary of markets than directly tected against any new long-term illness. running a government-sponsored health insurance plan, or forcing private insurers to Changing Tastes and Quality take such patients and treat them well. Suppose you purchase an economical med- The problem of people who have preexist- ical plan and health-status insurance. You con- ing conditions is most critical at startup, when tract a high-cost condition. What if you then people will not yet have had a chance to buy decide you want to move to a more expensive health status insurance. Once health-status medical plan? insurance is widely available, people will be Insurance can cover misfortune, but it can’t able to insure against more events than one cover changing tastes. If you want to move to a might think. Parents could buy family insur- more expensive plan, you’re going to have to ance that provides health-status insurance pay more. However, insurance companies accounts for their children. Then, children could sell, and you could buy, economical who develop rare long-term diseases would be medical insurance together with health-status covered for life without government interven- insurance that covers changes in a more ex- tion. Health-status insurance could even apply pensive medical plan’s premiums. In the above to unborn children, and thus insure against example, you could opt for a policy that pays genetic defects from birth. $70,000 rather than $50,000 if you are reclassi- Having the government set up such fied from category 3 to category 5. That would accounts for people with preexisting condi- cost a little bit more, but if you get sick, a larg- tions might also be useful in getting the whole er sum will be deposited in your health-status process going. This step would establish the insurance account. This option would be legal and regulatory framework for health-sta- attractive for young people or people in tem- tus insurance accounts, and it could be done porarily reduced circumstances. Home and car at the same time government deregulates pre- insurers will not let you be “overinsured,” de- miums: regulators and legislators would be 5 more willing to allow free risk-rating if they a long-term promise from a medical insurance knew that the most vulnerable populations company. Plus, you would still have the right to could afford the extra payments. choose any medical insurer you want. You could just have a transferability right Other Implementations rather than a health-status insurance account. The contracts I have described, combining Your current insurer could agree that, when competitive one-year medical insurance policies you want to leave, it will pay a lump sum to any with health-status insurance payments held in new insurer, such that the new insurer will a custodial account, show most clearly how free- now be willing to take you in a plan of similar market long-term insurance can work. quality with no change in your out-of-pocket However, markets may devise many other expenses. The lump sum could be the same implementations that may be more attractive to amount that your current insurer charges to consumers, insurers, and regulators—even if take on a new customer of your age and health they don’t seem as elegant to economists. status. Transferability obviously would not Consumers could purchase health-status give consumers quite as much freedom as a insurance and medical insurance from differ- health-status insurance account with real ent companies. Since health-status insurance money in it, but it might work almost as well Simple long-term is largely a financial transaction, a financial in practice and might be simpler for con- insurance policies services company might be able to handle it sumers to understand. are undermined better than a medical insurance company. On the other hand, consumers may prefer to Choice and Security by competition, have the two forms of insurance bundled as Why not just mandate that premiums and if you get “long-term health insurance” and not worry cannot rise when you get sick? As it happens, about two separate contracts. federal law already requires that individually sick, nobody else The health-status insurance account need purchased medical insurance be “guaranteed will take you. not be settled up every year. For example, you renewable,” meaning that the insurance com- Health-status could have a long-term medical insurance pany cannot drop you or increase your pre- policy in which health-status payments occur miums if you get sick. insurance is the only when you leave. On the other hand, with There are two problems with this arrange- natural remedy. insurance—as in all social endeavors, there is ment. First, as with all pooling arrangements, less chance of a dispute if long-term debts are simple long-term insurance policies are under- settled up more frequently and in smaller mined by competition. Second, if you get sick chunks, rather than in one large chunk after you depend on the good graces of one compa- one party has already decided to leave. ny, for the rest of your life, as nobody else will Rather than an account with a dollar figure take you. It is possible to fix the first problem, in it, your health-status insurer could simply and markets are heading in that direction promise to pay any increases in medical insur- already. The second problem remains, and ance premiums. The exact kinds of payment health-status insurance is the natural remedy. would have to be spelled out in some detail, To see the first problem, return to the either by specifying the qualifying plans or by above illustration, in which there is a 1 per- specifying how much extra will be paid out for cent probability that a person’s expected various risk conditions, but that’s fairly medical expenses would transition from straightforward in practice. In this implemen- $2,000 per year to $10,000 per year in the first tation, we wouldn’t have to worry about the year of an insurance contract. The average insurer retrieving lump-sum payments if a per- medical costs for all individuals would be son gets healthier. You would still be depen- dent on a long-term contract, but it is much (0.99 x $2,000) + (0.01 x $10,000) = $2,080. more reliable to receive an annuity from a financial services company than it is to rely on It seems the insurer could break even by offer- 6 ing guaranteed-renewable policies for $2,080 they solve the second problem of long-term per year. However, if there is any competition, individual contracts. Sick people must stay this arrangement will fall apart after the first with their original insurer forever in a guaran- year. Another insurer charging just $2,000 per teed-renewable contract, whereas a health-sta- year could woo away all the healthy people. tus insurance payment frees them to choose The same competitive pressures unravel another insurer. People value choice. As forced-pooling arrangements, as discussed Thomas Buchmueller and colleagues write: below. Fortunately, markets can solve this problem People do not want to be locked into by front-loading the premiums.5 If each person the same health insurance plan year pays $3,483.70 in the first year and $2,000 in after year. When new medical services subsequent years, the insurer will still break are developed, people want access to even, but healthy people will no longer have an those services. . . . If people move, they incentive to leave. Even if another insurer lures want to be covered by new providers, them away, the additional first-year premiums not the providers in the town they would cover the long-term costs of the people moved from. Under guaranteed-renew- who got sick. Bradley Herring and Mark Pauly able policies, only those who remain call this an “incentive-compatible” guaranteed- healthy can hope to switch coverage.7 renewable contract.6 Notice that the premiums and calculations If people are bound to one insurance carri- of an incentive-compatible guaranteed-renew- er, furthermore, the original insurer doesn’t able insurance policy are exactly equal to the have any incentive to treat sick people well. Yes, combined premiums of a medical insurance reputation and court enforcement of con- policy plus a health-status insurance policy, tracts can help to prevent insurers from treat- and the present value of both is the same as ing sick people badly. But the freedom to leave those of a $2,080-per-year pooling arrange- is a much more effective force to keep insurers ment, if the latter could be made to work. and providers on their toes. Competition for More importantly, a health-status plus med- people with long-term diseases will also A health-status ical insurance policy is exactly equivalent to an induce the whole medical industry to improve incentive-compatible guaranteed-renewable treatment of those diseases. plus medical policy, in which the insurance company peri- Finally, insurance companies don’t last insurance policy odically “marks to market” its long-term forever. They can go bankrupt, change own- obligations to the customer, or the two parties ers, change policies, and so forth. Periodically is exactly occasionally settle up the long-term debt retrieving the present value of long-term equivalent to an implied by the promise to treat the expensive promises adds to the safety of any contract. incentive-compat- customer. At the end of the first year, the We do not have to have a policy debate insurance company selling guaranteed-renew- between guaranteed-renewable and health- ible guaranteed- able coverage should look at each patient who status insurance, however. Market partici- renewable policy, developed a long-term illness and say, “This pants can decide how often it is optimal to set- person is going to cost us (say) $8,000 per year. tle up, as long as both options are permitted by in which the two We should write down the company’s value by law and regulation. Guaranteed-renewable parties occasion- $148,370”—the present value of $8,000 per individual insurance is also a great start, ally settle up the year in my example. In the health-status insur- because it provides a natural stepping stone to ance model, the insurer would pay out health-status insurance without requiring long-term debt $148,370. The company would then have no major policy shifts. implied by the more long-term obligations and the consumer promise to treat would have no long-term contract to enforce. What about Adverse Selection? The implications of periodically settling People who know they are sick and can the expensive up a long-term contract are profound, and hide it tend to buy more insurance, which the- customer. 7 We should oretically can cause insurance markets to or she always has the resources to purchase a eliminate the unravel. Realistically, however, “adverse selec- medical insurance policy. If long-term health tion” is not a serious problem for long-term insurance is bundled with medical insurance, it tax regulatory health insurance markets. True adverse selec- is important that this is an individual, portable preferences tion refers to things patients know that the policy—no matter who pays for it. insurer cannot know—what economists call Second, we need to allow and encourage for employer- “asymmetric information.” But does a patient insurers to adjust medical insurance premi- provided group who knows his or her aches and pains really ums freely, so that anyone can get coverage, health insurance know more than an insurer can learn by look- albeit at a price, and so that healthy people ing at his or her entire medical history and a will not flee the market. Finally, we should and encourage careful health exam? (Hiding one’s history is lift the many other competitive restraints on insurers to adjust fraud, and can invalidate a contract.) insurers.8 medical insurance If we observe adverse selection in today’s We do not need a carefully planned and marketplace, it is because government artifi- choreographed deregulation. Once we premiums freely. cially forbids insurers from using informa- remove the tax and regulatory preferences for tion they do posses to charge more for people employer-based group insurance, much of whom everyone knows are going to be more the rest will follow naturally. We will first see expensive. This fact does not represent a fun- much more individual insurance emerge, and damental information problem that would that insurance is already incentive compati- stop a less-regulated market from working. ble, guaranteed renewable, and portable. Adverse selection is exactly the same issue Competition and consumer demand for the for health-status insurance as it is for long- freedom to change insurers will push insur- term insurance with a single company. The ers toward the incentive-compatible front- portability engineered by lump-sum pay- loaded premium structure with periodic set- ments doesn’t make adverse selection any tling-up clauses. Health-status insurance better or worse. So at a minimum, this isn’t a accounts will follow quickly if you think special issue for health-status insurance. about how the insurance contracts are writ- ten. As health-status insurance develops, there will be no reason not to allow insurers What Needs to Be Done to fully risk-rate medical insurance policies and compete ruthlessly. Each step can coexist What policy steps should be taken instead with the last and can happen as quickly or to allow health-status insurance to emerge? slowly as regulators are willing to let go. The basic message is “get out of the way,” but Regulators could help, too. They could we need to describe a set of steps that nervous encourage medical insurers to publish explic- regulators and politicians could actually take. it premium schedules based on health risk, so First, we should eliminate the tax and regu- that health-status payments can be more eas- latory preferences for employer-provided group ily calculated. Insurers may rightly fear that health insurance. Employers can still pay for publication of such a premium schedule now insurance, or even provide medical insurance. would draw all sorts of political and regula- We could even retain the tax-advantaged status tory ire. Hearing the opposite would help. of health insurance payments by companies or individuals. Those features cause many distor- tions, but those distortions don’t harm long- Markets Are Showing term insurance. It is crucial that the employee the Way owns any health-status insurance account, just as he or she owns defined-contribution retire- It is encouraging that even in our highly reg- ment accounts and health savings accounts. ulated environment, the individual market is That way, if the employee gets sick and leaves, he already moving in the direction of health-status 8 insurance. Three-quarters of private medical most pressing health insurance problem, insurance policies were guaranteed renewable why haven’t we deregulated it already? There even before this feature was mandated in 1996.9 is in fact a clear story for how we got stuck Bradley Herring and Mark Pauly find evidence where we are. Understanding this story can that individual health insurance premiums are give us confidence that the deregulatory path beginning to reflect the front-loaded “incentive- outlined above will work, and it shows us compatible” structure,10 which exactly mimics why further regulation will not cure the medical plus health-status insurance premi- health insurance system. ums. Most encouraging of all, the Employer-provided group insurance is the UnitedHealth Group, one of the nation’s dominant form of medical insurance in the largest health insurers, just announced a prod- United States, encouraged by a strong tax uct that gives customers the right to buy med- advantage and regulatory pressure. The tax ical insurance in the future. The future premi- advantage emerged in WWII, as a way for um will be based on the customer’s current firms to attract workers in the face of federal health status, even if their health worsens in the wage and price controls,13 not from any care- interim. The New York Times reports: ful study of long-term health insurance. Group insurance is a long-term pooling “What this product is designed to do, arrangement. The premiums of healthy people One of the for a very modest premium, is to essen- cross-subsidize the expenses of those with long- nation’s largest tially protect your insurability for the term illnesses over long periods. Competition health insurers future,” said Richard A. Collins, the undermines long-term pools. A competitive president of UnitedHealth’s individual insurer can woo the healthy away with a lower just announced a insurance unit, who says he is the first premium, leaving the original insurer with only product that gives policy holder. His monthly fee is $50.11 sick people.14 And people with long-term ill- nesses who lose their job or other tie to the pool customers the This product only gives customers the right won’t be able to join another pool in a compet- right to to buy a UnitedHealth policy, rather than a itive market. buy medical policy from any insurance company. But it is However, these problems were not evident clearly a big step toward full health-status when health insurance markets first emerged insurance in insurance. Further steps may be forthcom- and health expenses were largely temporary. the future based ing. The Times continues: There wasn’t much one could do about the on the customer’s chronic conditions for which we now have Private insurers are increasingly inter- expensive treatments. The long-term insur- current health ested in coming up with new plans that ance problem emerged as expensive treat- status. offer coverage even to those individuals ments for long-term conditions became avail- with pre-existing conditions, said Bob able. Vineyard, an insurance broker in A lot of health insurance regulation makes Atlanta. He said he expected such plans some sense when viewed as a patchwork aimed to be introduced next year.12 at trying to prohibit competitive forces from undermining long-term pools. The federal tax Markets can provide long-term, portable exemption for employment-based group insurance—but only if we allow them to do so. insurance does not allow healthy workers to direct their employer’s pre-tax premium con- tributions, or their own pre-tax dollars, to an Competition and individual plan. This fact forces healthy work- Regulation ers to stay in their employer’s plan and to cross-subsidize the sick. Additional regula- Why then do we have such a regulated sys- tions to encourage employer-sponsored group tem? If deregulation would quickly solve our insurance help workers with illnesses to get 9 coverage at a new job if they leave their old one. Regulations that limit risk-rating and exclu- The Obama Plan sions for preexisting conditions or that man- date coverage of certain conditions try to force As I write, the most relevant health care the individual market to be a catch-all for peo- reform proposal is the one presented by ple who have lost group coverage. Restrictions President Barack Obama’s campaign. It is a on competition attempt to keep insurers from good specific example of these general points. poaching each other’s healthy customers. The Obama campaign plan promised to Most policy proposals aimed at providing bring “portability and choice” to health insur- better long-term health insurance try to fur- ance. It promised that Americans “will be able ther limit competition and expand forced to move from job to job without changing or pooling. They strengthen incentives for jeopardizing their health care coverage.” It employer-provided group insurance, create called for “stable premiums that will not pools based on geography (e.g., the Clinton depend on how healthy you are,” and promised administration’s 1993 proposal), force insur- that “no American will be turned away from ers to take all comers at the same price, assign any insurance plan because of illness or pre- high risks to insurers, prohibit competition existing conditions.”15 Those goals are exactly for healthy customers, force (or “mandate”) what health-status insurance can accomplish. healthy people to buy high-priced insurance, Unfortunately, the Obama campaign pro- mandate payment levels and treatments for posals go in the standard direction of expensive diseases, and so forth. reduced competition, forced pooling, and Alas, each of these steps reduces competi- mandates. For example, the Obama cam- tion, and reduces people’s freedom to choose paign plan proposes a “National Health the insurers and providers that best serve their Insurance Exchange” through which the fed- needs. That reduction begets poor service, eral government would ban pre-existing con- higher costs, and less innovation. Reducing dition clauses and force insurance companies competition and choice is not an unfortunate to take everyone at the same price. The cam- side effect of the regulatory approach to long- paign plan proposes to mandate coverage for term insurance—it is the point of that ap- children and most workers. It foresees, and proach. Competition undermines forced pool- indeed promises, the inevitable result of a ing arrangements, so to strengthen forced nationalized health-insurance system: pooling, you have to reduce competition. Even these sterner measures will not be Obama will make available a new enough, so long as people have any need or national health plan . . . The plan will Reducing freedom to change pools. National health cover all essential medical services, insurance—a single, mandatory pool—is the including preventive, maternity, and competition and only way to provide ironclad long-term insur- mental health care. . . . Individuals and choice is not an ance following this logic. But national health families who . . . need financial assis- unfortunate side insurance completely eliminates consumer tance will receive an income-related choice and insurer competition. federal subsidy to buy into the new effect of the We seem to face an unpalatable tradeoff public plan.16 regulatory between competition and choice on one approach to hand and better long-term insurance on the Clearly, President Obama and his health other. Health-status insurance removes this policy advisers are genuinely concerned about long-term unpleasant tradeoff. With health-status long-term insurance, and they recognize that insurance—it is insurance, a completely deregulated market choice, competition, and lower costs are desir- with complete freedom and competition can able in health care. They are neither for nor the point of that also provide lifetime portable health insur- against health-status insurance in any mean- approach. ance. ingful sense. They simply have never heard of 10 it. They advocate more regulation and nation- gram to address market failure. However, we We need not alized health insurance simply because they, have not so far had a vision of how a com- choose between like most people, think they have to choose pletely free market could provide long-term between long-term insurance and competi- and fully portable health insurance. Without freedom and tion. They do not know that a market alterna- that vision, one could have a nagging sense competition on tive that delivers both is possible. If they knew that there is some hidden market failure. about it, there is no reason they should not At a minimum, the possibility of health- one hand, and embrace it. status insurance gives us that vision, reassur- long-term health ing us that there are no such failures, and security on the that these are needless regulations. Free-mar- Conclusion ket economists no longer need to hem and other. Markets haw, saying, “Well you have a point there, but can deliver both. With health-status insurance, a complete- do we have to make the regulation quite so ly private, less-regulated, and competitive intrusive?” We can instead say with confi- insurance market can solve the central prob- dence, “We can have long-term insurance lem of health insurance in America: the lack with a less-regulated health insurance mar- of secure long-term portable protection from ket, and here’s how.” health risks. We need not choose between Of course, I also hope that it actually hap- freedom and competition on one hand, and pens: that our government takes the simple long-term health security on the other. steps necessary to let long-term health insur- Markets can deliver both. ance emerge in place of highly regulated Getting there requires us to move in long-term pooling systems. We could then exactly the opposite direction of current reg- watch with delight as the resulting competi- ulation and most policy proposals. We need tion does its usual magic of raising quality, to end the tax and regulatory preference for lowering costs, and spurring innovation in employer-provided group insurance over both health care delivery and finance. portable individual insurance, not strength- en that pressure. We need to allow medical insurers to compete—to charge more for peo- Notes ple with long-term expensive conditions and The author thanks Joe Feldman, Mark Pauly, and less for healthy people—not prohibit them especially Michael Cannon for helpful comments. from doing so. We need to allow health-sta- tus insurance to emerge so that people can be 1. The contracts in this article are described more fully in John H. Cochrane, “Time-Consistent insured against higher costs. Health Insurance,” Journal of Political Economy 103 Any good policymaker looks for market (June 1995): 445–73. failure before regulating something. Where is the market failure behind bans on risk-based 2. To keep the math simple, I assume that he wants medical insurance only until age 65, when premiums, medical insurance competition, or he will transition to Medicare, and that he is cer- tax preferences favoring employer-provided tain to live that long. A realistic calculation group health insurance? No one has seriously should include the actuarial probability of death documented natural monopoly, missing at each age, and can therefore handle the absence of Medicare. Of course, Medicare would be property rights, adverse selection, asymmetric unnecessary with an effective long-term health information, or any conventional source of insurance market. market failure motivating these interventions, or preventing the emergence of private long- 3. Bradley Herring and Mark V. Pauly, “Incentive- Compatible Guaranteed-Renewable Health Insur- term health insurance. Those regulations ance Premiums,” Journal of Health Economics 25 emerged as a patchwork response to the his- (2005): 395–417. As I explain below, the “GR” or torical accident of employer-provided group guaranteed-renewable premiums shown in their insurance, not as a coherent regulatory pro- Figure 3 and Table 3 are identical to the combina- 11 tion of health and health-status insurance pay- 10. Herring and Pauly, pp. 395–417. ments described here. 11. Reed Abelson, “UnitedHealth to Insure the 4. See Mark V. Pauly and Robert D. Lieberthal, Right to Insurance,” New York Times, December 2, “How Risky Is Individual Health Insurance?” 2008, http://www.nytimes.com/2008/12/03/busi Health Affairs Web Exclusive, May 6, 2008, http:// ness/03insure.html content.healthaffairs.org/cgi/reprint/hlthaff.27.3 .w242v1.pdf. 12. Ibid. 5. Mark V. Pauly, Howard Kunreuther, and Richard 13. See, e.g., Robert Helms, “The Tax Treatment of Hirth, “Guaranteed Renewability in Insurance,” Health Insurance,” in Empowering Health Care Journal of Risk and Uncertainty 10 (1995) 143–56; Consumers through Tax Reform, ed. Grace-Marie Mark Pauly, Andreas Nickel and Howard Kun- Arnett, ed. (Ann Arbor, MI: University of Michigan reuther, “Guaranteed Renewability with Group Press, 1999), pp. 1–25. Insurance,” Journal of Risk and Uncertainty 16 (1998): 211–21. 14. Tom Daschle, Scott S. Greenberger, and Jeanne M. Lambrew give a splendid description of 6. Herring and Pauly, pp. 395–417. how competition for healthy people undermined the Blue Cross/Blue Shield “community rating” 7. Thomas Buchmueller, Sherry A. Glied, Anne (i.e., pool) system of the 1940s, helping to create Royalty, and Katherine Swartz, “Cost and Coverage “the flawed system we are saddled with today.” Implications of the McCain Plan to Restructure See Tom Daschle, Scott S. Greenberger, and Health Insurance,” Health Affairs 27, no. 6 (Septem- Jeanne M. Lambrew, Critical: What We Can Do about ber 16, 2008), web exclusive, http://content.health the Health-Care Crisis (New York: Thomas Dunne affairs.org/cgi/reprint/hlthaff.27.6.w472v1.pdf. Books, 2008), pp. 56–57. 8. See, e.g., Henry Butler and Larry Ribstein, “The 15. All quotes are from Obama ‘08, “Barack Single-License Solution,” Regulation 31, no. 4 Obama’s Plan for a Healthy America: Lowering (Winter 2008–2009): 36–42. Health Care Costs and Ensuring Affordable, High-Quality Health Care for All,” p. 7, http:// 9. Mark Pauly and Bradley Herring, Pooling Health www.barackobama.com/pdf/HealthPlanFull.pdf. Insurance Risks (Washington: American Enterprise Institute, 1999), p. 18. 16. Ibid.