'Free market' makes health insurance suck

Why Insurers Suck and Five Ways to Make Them Better
By Ezra Klein
February 13, 2008 | Prospect.org

"The state's largest for-profit health insurer is asking California physicians to look for conditions it can use to cancel their new patients' medical coverage," says the first line of this article in The LA Times. What more even needs to be said?

Lets start from a basic proposition: In the current system, insurance companies add negative value, which is to say, they make health care worse, not better. Conservatives often complain that health insurance is not "insurance" in any real sense, it is not protection against unexpected costs, but insulation from largely predictable costs. We know we will need to purchase health care. We contract out with health insurers to smooth those expenditures -- render them predictable and manageable over the course of years, rather than unexpected and crushing in the course of months. That's why we pay insurance premiums so we can one day get chemotherapy, rather than simply paying for chemotherapy.

But "we" here is misleading. Not all of us make this deal with insurers. And among those of us who do make this deal, we make it in different ways, purchasing different levels of insulation, on different time periods. So the insurers, quite naturally, turn their attention to making deals with the most profitable among us, and avoiding deals, or finding ways to break contracts, with the least profitable. They are very innovative in their attempts to do this. But there's nothing good about those attempts. Competition among drug dealers does not aid the neighborhood, and currently, competition among insurers does not aid the ill. Indeed, their inattention to actual care is startling. America, for all its technological advancement, has among the lowest adoption of cost-saving, care-improving, electronic records in the world. That is the fault, in part, of our insurers.

And here's why: It is actually counterproductive for insurers to compete on giving us the best care. It's not simply that they're not doing it, but given the structure of the marketplace, they shouldn't do it. Imagine insurer X creates the best damn diabetes protocols in the country. And they begin advertising this fact. What happens on Day Two? Well, they're flooded with individuals suffering from diabetes, or individuals who fear they will one day be suffering from diabetes. These people, in the current system, are a bad deal. Not only is it near impossible to insure them at a profit, but pooling their costs (which is what insurers do, after all) raises premiums for all the insurer's other customers. When the average customer of an insurer gets sicker, prices go up for all their customers. So the healthy folks contracting with that insurer quit the pool, and go find a cheaper deal, which forces the insurer to raise premiums again, driving out more healthy folks, which forces them to raise premiums again, which drives out more healthy folks, and so on. It's what we call an insurance death spiral, and it ends with the collapse of the insurer.

Given those incentives, insurers cannot compete to offer better care, because if they offered better care, all that would happen is they would attract worse deals. Which is why, in the current system, insurers make things worse. Tyler Cowen has a vision for how insurers could, in a more perfect world, compete to our benefit. And I don't necessarily disagree with it. But let's be clear on what's necessary:

1. Universality: Insurers cannot compete effectively unless everyone is in the pool. If the healthy can leave, insurers cannot compete to offer better care. They'll have to compete to attract the healthiest, which means offering the lowest costs, which means insuring the fewest sick people. The system has to be universal.

2. Community Rating: Insurers cannot be allowed, before offering insurance, to use demographic subslicing to cherrypick the market. That means no more preexisting histories, no complex formulas around age and income and race and region. They offer insurance to anyone who wants it for the exact same price. No exceptions.

3. Risk Adjustment: Merely having everyone in the system won't be enough, and nor will forcing insurers to do away with their most delicate cherrypicking tools. Insurers will just become sophisticated at advertising on G4 Tech TV, and in snowboarding magazines, and in urban centers -- in places, in other words, where the young and the healthy gather. So atop the universal system, atop the community rating, you need risk adjustment, which means either that insurers are reimbursed more for taking on sicker patients, or, my preferred method (and the one used in Germany), insurers with particularly healthy pools pay into a central fund that redistributes to insurers with less healthy pools. At the end of the day, it has to be as profitable for an insurer to insure a sick person as a healthy one.

4. Information Transparency: It needs to be easy for individuals to compare insurers on plan comprehensiveness, price, outcomes, etc. That means we need a marketplace where folks can go to shop for insurers, and they need to have standardized comparisons, or non-partisan rating authorities, providing information they can use.

5. One Market: This is contained in the last point, but there needs to be a singular place, or set of them, where individuals can shop around for insurance. This is hard stuff to find, and harder yet to understand, and real effort needs to go into constructing an easily accessible marketplace that customers can effectively navigate.

There are probably more, but those are the major ones. It's not impossible to imagine a scenario in which insurers actually compete to offer better service, in which the marketplace really does work to the consumer's benefit. That could take a million different forms, from personalized care coordinators to electronic records to online access to your health information to negotiated discounts on gym memberships to a million things I haven't thought of. But none of them happen with any sort of frequency now because insurers operate in a perverse market in which their incentives are to make the system, and our care, worse.