Finally (?): Healthcare Reform

What are the problems with our universal healthcare system (no one is denied the care they need “Health-care-plan-B”) that Congress is trying to fix? At the broadest level America’s health care costs much more than it should for the results it delivers and the distribution of its financing is neither efficient nor equitable. Six years ago Democrats made the mistake of sneaking through the Affordable Care Act without significant debate. This year Republicans committed the same error but failed to pass a law. This provides congress (thank you Senator McCain) with the opportunity to fashion a healthcare reform law the proper way (open committee hearings, etc.).

A new attempt to reform the system would no longer be restrained by the limitations of a budget law that limited what earlier attempts were able to do. In particular a new law should address the factors that drive up the cost of medical care in the U.S. These include relaxing legal limitations on who can provide what services and how they may be performed, requiring that the cost of services be transparent and requiring stronger incentives for customers (patients) to care about cost when choosing medical treatments. “Heath-care-reform-fatigue

How medical services are paid for influences the incentives of both suppliers of these services as well as the users to seek and provide the most cost effective options. Medical services are paid for by patients (because they are uninsured, or pay deductibles or copays), insurance premiums, or taxpayers. Each provides its own set of incentives for choosing what is delivered. When patients pay for the services they have a financial incentive to choose the option with the highest benefit-cost ratio. When third parties pay for medical services, (insurance companies or government) they must impose choices that patients, in consultation with their doctors, would otherwise make.

Some commentators have complained that third party payers, whether a single payer (government) system or many insurance companies, introduce rationing. However, all scarce goods and services are necessarily rationed. The relevant issue is how they are rationed, whether on the basis of the preferences of patients or the judgment of the third party payer of what is reasonable.

To the extent that medical costs are paid for by taxpayers, the incidence of such financing depends on and is determined by the structure of the government systems of taxation. In the U.S. these are currently unfair and inefficient and in bad need of reform quite independently of the issues of healthcare delivery. Medical insurance financing is complicated by the ill advised post World War II tax incentive for employers to provide and help pay for medical insurance. This practice establishes insurance pools (the firms employees) that generally mix the number of healthy and sick policyholders in a representative way. The very purpose of insurance is for the healthy to share the costs of the sick and thus reduce the financial burden of medical surprises. Most Americans with health insurance buy it through their employers’ plans.

The most serious problem with the existing American health insurance system is for those not receiving insurance from an employer (or those changing employers and needing to establish new insurance policies). These people must use the so-called private market for which the Affordable Care Act established the insurance exchanges. The cost of insurance purchased in this private market depends on the mix of healthy and sick people that sign up. Employer provided plans are essentially mandatory for a firm’s employees (and enjoy a tax subsidy) and thus result in a well mixed (sick and healthy) risk pool. Private market plans were made mandatory by the ACA but with a penalty for remaining uninsured that was so low that large numbers of young healthy people choose not to join. Thus private market plans were increasingly populated by the sick (and those expecting that they were likely to become sick). This undermines the cost sharing the insurance exists to provide and thus drives up the premium cost. The simple cure for this problem is to make healthcare insurance mandatory as originally proposed by the Heritage Foundation.

Mandatory healthcare insurance should cover every health service for which society believes financial assistance should be given. It undermines the purpose of insurance to allow policy holders to pick and choose which services will be covered. Premiums might very with age, lifestyle choices that effect health (such as smoking or obesity) and the choice of the level of deductions and copays but policy holders should not be able to opt out of services society intends to provide and finance one way or another even if they never expect to need them. The issue of preexisting conditions would not arise when insurance is mandatory and policies are not linked to individual employers. “Health-care-in-America”

The individual policyholders’ choices of the level of deductions and copays (but not the scope of services covered) would determine the division of financing between patients and third party payers. In addition, government (the voting public) would choose the extent to which the cost of medical services would be taken over by taxpayers as a result of government financial assistance to the poor. A further policy option is whether the cost of catastrophic health care needs would be lifted from insurance premiums and paid for by taxpayers via a reinsurance plan. But the cost of medical services that must be paid over all (by patients, insurance premiums, or tax payers) can be greatly reduced by taking those measures that will lower the cost of these services in the first place.

Hopefully this time around congress will entertain open public discussion of all of these issues so that the public will understand the purposes and tradeoffs of the policies ultimately adopted.

Author: Warren Coats

I specialize in advising central banks on monetary policy and the development of the capacity to formulate and implement monetary policy.  I joined the International Monetary Fund in 1975 from which I retired in 2003 as Assistant Director of the Monetary and Financial Systems Department. While at the IMF I led or participated in missions to the central banks of over twenty countries (including Afghanistan, Bosnia, Croatia, Egypt, Iraq, Israel, Kazakhstan, Kenya, Kosovo, Kyrgystan, Moldova, Serbia, Turkey, West Bank and Gaza Strip, and Zimbabwe) and was seconded as a visiting economist to the Board of Governors of the Federal Reserve System (1979-80), and to the World Bank's World Development Report team in 1989.  After retirement from the IMF I was a member of the Board of the Cayman Islands Monetary Authority from 2003-10 and of the editorial board of the Cayman Financial Review from 2010-2017.  Prior to joining the IMF I was Assistant Prof of Economics at UVa from 1970-75.  I am currently a fellow of Johns Hopkins Krieger School of Arts and Sciences, Institute for Applied Economics, Global Health, and the Study of Business Enterprise.  In March 2019 Central Banking Journal awarded me for my “Outstanding Contribution for Capacity Building.”  My recent books are One Currency for Bosnia: Creating the Central Bank of Bosnia and Herzegovina; My Travels in the Former Soviet Union; My Travels to Afghanistan; My Travels to Jerusalem; and My Travels to Baghdad. I have a BA in Economics from the UC Berkeley and a PhD in Economics from the University of Chicago. My dissertation committee was chaired by Milton Friedman and included Robert J. Gordon.

6 thoughts on “Finally (?): Healthcare Reform”

  1. Warren,
    Here’s my two cents on the role of government in health care.
    Suppose all illness were the result of bad luck. Since healthcare is viewed by the public as a basic need (Harberger), there is a willingness to subsidize health insurance, with the amount of subsidy declining in household income. (Genetic propensity for disease can largely be regarded as a subcategory of bad luck.)
    Leaving aside economies of scale and scope, adverse selection only becomes motive for government regulation (e.g. additional subsidies or mandates) because of legal restrictions on sorting individuals into risk classes.
    Unfortunately for policy design, disease and accidents result from bad behavior as well as bad luck. The public is less willing to subsidize bad behavior and it is difficult to untangle the causes. The more you mandate and subsidize health insurance, the greater the moral hazard – both negative negligence or the failure to take precautions such as exercise/wearing-a-seatbelt and positive negligence e.g. excessive eating, smoking, drinking and driving. Again, government restrictions limit the extent to which insurance companies can condition premiums and indemnities on behavior.
    I am tempted to conclude that we should either untether the market (beyond limits on monopoly power), thereby allowing insurance companies to govern adverse selection and moral hazard, or go to what Peter Diamond claims is the only sensible solution – a single payer system. Current efforts at messing about on some middle ground may be doomed to failure.

  2. I think there is an important confusion, or equivocation, in this problem. We know that insurance in general “cross-subsidizes” the claims paid from the premiums of all who have not claimed. In the case of our modern Health Care sensitivities, a cross-subsidy in that old framework is too narrow.

    This new “healthcare is a right” is a “welfare claim.” It demands the anonymous taxpayer must pay for pre-existing conditions and really bad luck. It is catastrophic and ought to be paid as re-insurance by the welfare state. We all seem to be socialists now, in the new sense of equal outcomes.
    Will any advocate come forward to “free the insurance pricing market!”?

    Half of America already lives under “single payer” – medicaid, VA, et al.

    1. Joe, We generally object to people claiming rights to our property. But Hayek, who defined socialism as the state commend of the means of production not the provision of welfare, supported welfare/safety net as a gift rather than a right. We chose to provide healthcare to those who need it because we can afford it. The real question is how we do it.

      1. I agree with you, and healthcare is certainly NOT a “right.” But if the public policy intends to make prices of such healthcare economically meaningless in order to make it “affordable,” with cross subsidies among those who buy or may be forced to buy insurance, this is a “welfare” kind of intervention.
        I say let the market continue to perform a pricing function but extract the subsidies from anonymous taxpayers instead of pretending a price-controlled insurance market will not simply collapse. Cross subsidies should be abandoned and at best replaced with direct government subsidies (the House Bill tried to do this with refundable tax credits).
        I would advocate the same separation of economic prices from government subsidy mandates in the minimum wage controversy: why should hapless employers be forced to pay for what amounts to a welfare mandate supposedly “to help” low wage people.

  3. Joe, I am not sure that I understand you comments. You seem to equate “cross subsidies” with “insurance”. Yes, the purpose of insurance is to share risks. All or most health insurance plans have deductibles and copays to give patients some skin in the game, i.e. to keep prices meaningful.

    1. If it is a price, asked by an insurance company, it can be understood as pooling funds and risks like many other investments, but the mechanism is hijacked and becomes only cross-subsidies when regulators and price controllers step in. Particularly when other criteria, such as “income” is used to determine rates. I am only saying, if political values and political power require cross subsidies (e.g. ACA), let the “redistribution” take the form of direct welfare grants to the individual families.

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