Friday, February 7, 2014

Innovative Free Market Solution for Reforming American Healthcare: Health Status (or Pre-Existing Condition) Insurance

Three Republican Senators have released a health-care reform proposal that has attracted much attention. One of the three, Orrin Hatch, is likely to chair the Senate Finance Committee if the Republicans win the majority in the Senate.

John Goodman has described the bill neutrally. At Forbes, Matthew Herper describes the effect of capping the employer-based exclusion at 65 percent of the cost of an average plan, and subsidizing people who earn less than 300 percent of the Federal Poverty Line (FPL) with tax credits to buy their own policies. Herper concludes that, for a household in the 25 percent marginal tax bracket, capping the exclusion will result in a tax hike of about $1,345.

One important part of the proposal that has not received enough critical attention is “continuous coverage protection”, in section 202 of the summary. This is basically a “super-HIPAA” provision and it has problems not immediately apparent to the casual reader. There is a better way.

HIPAA is the 1996 federal law that allows you to move from one employer’s plan to another’s without being underwritten and being charged a higher premium for pre-existing conditions. In co-ordination with state laws, it also allowed people to move from employer-based coverage to individual coverage with the same insurer without re-underwriting.

However, to enjoy this protection, a couple of things had to take place. First, you had to use (expensive) COBRA coverage after leaving your job until it expired. Then, even though you were not re-underwritten when going into the individual market, there was no guarantee that the premiums would be affordable. Some states had laws to mitigate the latter effect. In California, for example, a carrier’s post-COBRA HIPAA continuation coverage had to offer beneficiaries the two most popular plans in the individual market, at standard premiums.

HIPAA did not solve another big problem for those who maintained continuous coverage: If you wanted to switch insurers, the new insurer could re-underwrite and increase premiums for a pre-existing condition. The new Republican bill purports to solve this by simply extending the continuous coverage protection across all insurers. The proposal needs significant improvement, because it will demand finely detailed, complex, and burdensome regulations to overcome selection problems. ...

Insurers will design plans in the individual market that attract the healthy and repel the sick. For example, they might offer free health-club memberships while not having robust networks of specialist physicians. Clearly, the only way to avoid this is for the government to heavily regulate the design of health insurance. This leads to more bureaucracy, government meddling, and all the other things associated with trying to force people to do that which they do not want to do.

But there is a solution: Health-status insurance, as described by John Cochrane of the University of Chicago in a 2009 proposal and described by John Goodman in Priceless and here as “insurance against getting a pre-existing condition.” With health-status insurance, part of the insured’s premium pays for a policy that pays out if he falls ill and then tries to switch insurers. The payoff from the health-status insurance finances the insured person’s higher premiums in a new plan. It is a win-win situation: The sick person has a wide choice of health plans that he can afford, and the health plans compete to enroll — not avoid — the sick. ...

And this is from Dr. John Goodman from the National Center for Policy Analysis describing that very proposal for Health Status insurance:  

One of the most innovative thinkers in the field of health insurance is University of Chicago Professor John Cochrane. I’ve been meaning to write about him for some time and am spurred to do so now by a new policy report from the Cato Institute.

Here is the back story. After hail damages the roof of your house, your homeowner’s insurance is supposed to pay for the repairs. But there is no requirement that you continue paying premiums while your roof is being repaired. And if you switch to a new insurer, the new insurer doesn’t pay for damages incurred while the previous insurance was in force. These same principles apply to auto collision insurance and every other form of casualty insurance.

Yet health insurance is different. If you get sick, your insurer won’t keep paying medical bills unless you keep paying premiums. If you are unable to switch plans (because your new pre-existing condition causes you to be rejected or face exorbitant premiums), you are stuck in a continuing relationship with your existing insurer — regardless of the quality of service or the premiums charged. If you are able to switch plans, the new insurer has to start paying your medical bills, even though the illness (and all the premiums paid up to that point) occurred while you were on some other plan. This is why the new insurer doesn’t really want you and has no incentive to treat you well after you arrive.

To make matters worse, healthy people always have an incentive to leave a plan after some of its members get sick. The reason: the new plan formed by healthy people can charge much lower premiums. Meanwhile, premiums in the original plan (which now has only sick people) must rise to ever higher levels to keep paying the medical bills.

In a very real sense, health insurance isn’t insurance at all. It’s the artificial product of unwise tax and regulatory policies. But fret not. There is an ingenious solution to all this.  

Instead of paying the premium for all-purpose insurance, Cochrane proposes two premiums for two different kinds of insurance. The first premium is for, say, a year’s worth of health insurance for a healthy person. The second premium covers the risk of changes in health status that potentially increase premiums in future years. Suppose that during year one you are diagnosed with a costly-to-treat medical condition. If you shop for a new health plan in year two, your premium will be higher than the rate healthy people pay, as a result. But your health status insurance (which you purchased in year one) will pay the extra premium cost.

Voila.  We have in one simple step converted a completely dysfunctional market into a real market that solves real problems — for everyone.

Insurance for Pre-existing Conditions. Instead of trying to force insurers to ignore them, the Cochrane approach allows everyone to insure against them. In the Cochrane world, you don’t have to worry about financial consequences of developing a pre-existing condition. Your health status insurance will pay those costs.

Premiums for Pre-existing Conditions. In Cochrane’s world, premiums for pre-existing conditions would be determined in the marketplace. This means that the cost of a year’s worth of insurance for diabetics, asthmatics, cancer patients, heart patients, etc., would be transparent and competitively priced. By contrast, regulation in many insurance markets today tries to force insurers to ignore both the conditions and the cost of insuring them.

A Market for the Care of Pre-existing Conditions. Once there is transparency and competition in the market for insuring for pre-existing conditions, a natural extension is a competitive market for efficient, high-quality care for those conditions. Providers who find ways to lower the cost of care will allow insurers to be able to lower the cost of insuring that care.

The Cost of this Proposal. Some might suppose that adding health status insurance to routine health insurance would be very expensive. But since the only purpose of insurance is to pay medical bills and since the medical bills would be basically the same as under the current system, there would likely be little, if any, increase in total insurance premiums. In fact, to the degree that this proposal leads to more efficient chronic care, total premium payments may actually decrease.

Choice of Health Plans. Although, in general, I think long-term relationships with health plans are better than short-term ones, there is no reason in principle why people could not choose a different health plan every year under this proposal. The reason: Individuals (through premium payments made by them or on their behalf) would always pay an amount equal to the full expected cost they bring to any health plan they enter. No insurer would ever be forced to take an enrollee it did not want and no insured would ever be stuck in a plan he/she did not want to be in.

The Casualty Insurance Model. Cochrane’s proposal is a clever way of introducing the casualty insurance model into the world of health insurance. Alert readers will remember that my own proposal for ideal health insurance argues for incorporating other features of the casualty model as well. The proposal is also consistent with incentive-compatible health insurance, proposed by Brad Herring and Mark Pauly.