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Why Health Plans Should Be More Like Fire Insurance

By Steven Pearlstein
Wednesday, September 30, 2009

By their nature, insurance schemes involve a transfer of money from winners to losers. Everyone who buys fire insurance pays a premium calculated on the basis of a handful of factors that insurance companies use to estimate the probability of a fire. In the end, however, the companies' ability to predict which house will burn and which one will not is not very good, meaning that those who are lucky enough, or careful enough, to avoid a fire wind up subsidizing those who aren't.

Health insurance is much the same, only different.

There is a part of health insurance that is meant to protect us from unpredictable or unavoidable "catastrophes," such as getting cancer or having a heart attack. But there is also a part of health insurance that covers fairly predictable and routine medical expenses -- the annual physical, a kid's ear infection or a colonoscopy for a 55-year-old. In those cases, health insurance is not so much protection from catastrophe as it is a mechanism to "prepay" what is likely to be the bill for your own care. The advantage of using insurance for that purpose is that an insurance company can negotiate better prices from doctors, hospitals and drug companies and can pay those bills with pretax dollars.

One way to think about the current debate over health reform is to consider how it alters those basic characteristics of insurance.

Republican conservatives, along with some health reformers, have long argued that the prepayment component of health insurance unnecessarily enriches insurance companies while driving up health costs because it leads people to consume more medical care than they really need. Since there is little extra cost, there is little incentive to avoid a visit to the doctor, or decline an extra test, or choose a less-expensive treatment option that may be just as effective. Insurance companies try to reduce this "moral hazard" through copayments and deductibles. Americans, however, dislike these cost-sharing mechanisms, if for no other reason than that they are unaware how much money they save in annual premiums.

On the other side of this argument, liberal Democrats and public health officials like to point to evidence that people -- particularly those with lower incomes -- tend to forgo even necessary care when out-of-pocket expenses are involved. That's why they are insisting on a more comprehensive and more expensive basic benefits package that all Americans would be required to have.

For what it's worth, I come down in the "catastrophic" camp, with the caveat that even catastrophic policies should also cover essential preventive care and treatment of chronic conditions over which people have no control. Such a high-deductible policy could not only lower premiums (and the need for premium subsidies) by 10 to 15 percent, but also put downward pressure on the growth of health spending as people became more cost-conscious about non-urgent care. Those who want more comprehensive benefits could still buy supplemental coverage to avoid out-of-pocket charges, but they would do so without subsidies from taxpayers or other insurance customers.

Many of the other big issues in the health reform debate also come down to questions of who should subsidize whom.

The requirement that everyone buy a bare-bones health insurance policy, for example, aims to eliminate the subsidy that people now get when they show up at the hospital with a medical emergency and receive "free care." In reality, that care isn't free at all, but paid for through higher premiums on everyone who buys insurance. By one estimate, that subsidy now adds $1,000 a year to the cost of the typical family's insurance policy.

The proposed new tax on "gold-plated" health plans would reduce another hidden subsidy that now flows from all other taxpayers to those who have tax-free health benefits that require them to pay little if any of the premium and few if any out-of-pocket expenses, and offer extraordinarily comprehensive benefit coverage.

Then there are those who are demanding that Medicare pay more to doctors and hospitals in areas with high medical costs. In reality, this is nothing more than requiring the rest of us to subsidize the inefficient lifestyles and cost structures in rural communities and big cities.

Those who want to prohibit insurance companies from charging higher premiums to people who smoke, drink heavily, abuse drugs or have unhealthy diets apparently take the position that these behaviors should be subsidized by those who take better care of their health.

And those who rail against limits to end-of-life care are effectively saying that patients willing to follow the best medical evidence about what works and what is cost-effective should be required to subsidize those who don't.

In a free country, people have the right to decide what to buy, where to live, what to eat and drink, and how much medical care to buy. They're even free to negotiate for health benefits instead of wage increases. What they don't have is the right to expect that everyone else should pay for their choices through higher taxes and higher health insurance premiums.

One of the aims of health reform should be to make health insurance more like fire insurance, reducing as much as possible the moral hazards and the cross-subsidies while protecting all Americans from medical catastrophe.

Steven Pearlstein can be reached at pearlsteins@washpost.com.

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