Tuesday, December 06, 2005

Just wanted to point out...

...that Mitt Romney's health care plan for Massachusetts is really smart. Basically, he intends to make health insurance mandatory. Those with the means will have to pay for it themselves and the poor will receive subsidized (or free) insurance. Everyone in Massachusetts will have some sort of policy.

Why is this smart? Because the main problem in the health insurance market is adverse selection. A fair insurance policy (one that costs what is paid out in benefits to the average insuree) is not viable. Those that are less likely to get sick will not purchase the policy, while those that are more likely to get sick will buy it. The result is that insurance prices are pushed up and many are left uninsured.

Romney's plan forces everyone to purchase insurance. In this case, insurance companies can charge the fair price without fear of adverse selection. Result: everyone is insured at a lower price.

Isaac, what do you think?


Anonymous Battlepanda said...

I don't understand though. Unless the insurance companies are forced to accept all comers on the same terms, the adverse selection problem is still going to be there. Seeing as how that is the main way insurance companies differentiate themselves, the cynical view is that the insurance market in Massachusetts would become little more than window dressing on what is effectively single-payer healthcare.

Don't get me wrong, I would really like to see romney's plan work. And who knows, perhaps once the temptation to make easy money through adverse selection is removed, insurance companies would really come up with other ways to cut costs and boost profits that actually makes the heathcare market more efficient rather than less.

1:10 PM  
Blogger Isaac said...

I really have no clear idea. Like Battlepanda, I'd be skeptical. Health insurance companies are rather intelligent. Even if they are required to offer insurance to everyone, they don't have to offer a good plan. They'd offer high deductible plans or else just offer really premiums. But I'd have to look at it more to have any clear idea. Models of physician induced demand call!

4:36 PM  
Blogger henry said...

I don't want to be pedantic, but here's an example. Suppose there are 4 people, each with a chance of incurring a $1000 medical bill. They have different probabilities of getting sick, 25%, 50%, 75%, and 100%. Suppose that individuals know their own risk level, but the insurance company does not. Also assume that the insurance company can tell the overall risk level of their clientele. Then they expect to pay out $250 + $500 + $750 + $1000 = $2500. They charge everyone $2500/4 = $625.

The 25%-guy is paying $625 for only $250 in expected benefits and the 50%-guy is paying $500 for the same. Assuming they are risk-neutral, they realizes that it's a bad deal and quits. Now, the insurance company expects to pay out $750 + $1000 = $1750, so they charge the remaining 2 people $1750/2 = $875 each. The 75% is suddenly paying $875 for $750 worth of expected benefits. So he leaves too. Everyone ends up uninsured (the last guy is just paying $1000 for $1000 in benefits), even though there are mutually beneficial insurance policies to be sold and bought. The problem is that the company and the clients have different information *and* that clients can act on it.

It's just a thought experiment, but you can see how bad risk pushes out good. Of course insurance companies have some information about their clients, people are usually somewhat risk-averse, insurance markets may not be perfectly competitive, etc. But it's easier to see in a stripped-down model.

Let's see what effect Romney's plan would have. Everyone must purchase health insurance, even the 25%-guy. This is exactly the first situation, but the less risky clients can't leave, starting the cascade. So some people pay more than they'd like to, but everyone gets insured and risk gets appropriately shared. It's the same reason that many employers have mandatory health plans: to reduce the effect of adverse selection.


The insurance companies aren't forced to accept all comers on the same terms, the point is that they can't tell which comer is which. If they could tell, there wouldn't be a problem. Also, there's no easy money through adverse selection as I have described it. Rather, there are competitive markets and zero profits. But I don't think that, even in monopoly or oligopoly, anyone is making a lot of money from informational asymmetries. They just destroy markets. Finally, it's not so much that they would have a new incentive to cut costs, but that everyone gets insured and risk is spread around equally.


Health insurance companies are intelligent, yet they still have to compete. I don't think that charging high premiums is a sustainable strategy in this case. Moreover, the new insurees would be low-risk, not high-risk, so they wouldn't want to charge them more, but less.

7:53 PM  
Anonymous Battlepanda said...

I don't think I'm entirely convinced. What would probably happen absent regulation to prevent it is a tiered system -- people who are very healthy and know so would purchase extremely stripped-down insurance with high deductables, leaving the rest of the more diseased pool to face higher rates. The companies would not have to have any information on the patient for this to happen -- people can self-select.

The comparison to employer-provided heathcare is invalid because the plans are chosen and paid for on a company rather than an individual level.

9:25 PM  
Blogger Isaac said...

The question really is what kind of health insurance the company is required to provide. For example, if I'm poor I might not be able to afford health insurance so I'd buy a policy that costs $1 and has a $1,000,000 deductible, or whatever. So there have to be more restrictions on the kind of health insurance that qualifies before this has any meaning.

12:05 AM  
Anonymous Battlepanda said...

Exactly. By the time you're done regulating what the health insurance companies have to provide, you have to ask yourself if you are left with a viable free-market at all.

12:25 PM  
Blogger henry said...

A good point from both of you, the jist of which is "why wouldn't the
currently uninsured people just purchase barebones health insurance?"
To the best of my knowledge, the Romney plan would require the uninsured to purchase some substantial level of health insurance. This doesn't require any insurance company regulation, it just requires that individuals purchase some high-deductible, yet meaningful, health insurance. And I'm sure that insuring 200,000 new low-risk clients is something that insurance companies would love to do.

4:32 AM  
Blogger Isaac said...

Yeah, I was wondering if there was a minimum-level of insurance requirement, but was lazy. How will this minimum stuff actually work? Money, extent of coverage....? It is always possible to screw people at a different level...There is an article in the current issue of Health Affairs arguing that the future battles over health insurance won't be the monetary stuff but rather the precise extent of coverage, what is covered and what isn't. Plus, as soon as you get managed care you get physician review and attempts to standardize care which facilitates denying marginal people care...

I agree on the broad point that if you require everyone to buy health insurance you may well be able to solve most adverse selection problems.

I just feel like there is some catch I'm missing because it is too happy to have an elegant partial solution.

3:17 AM  
Blogger henry said...

Yeah, I've looked for a more precise formulation of Romney's plan but can't seem to find it. But I think that there will be a maximum deductible allowed.

I see how some things haven't been laid out to the public, but if those can be resolved the idea is a very good one.

4:53 AM  

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