A Viable Alternative to Obamacare?

According to Insurebloghealth care reform will result in lower health insurance rates, up to 60% lower than current rates for those who live in Maine, where a new law has resulted in a drop in rates for small group plans while individual rates are expected to drop as much as 60% for some age groups. The seemingly ironic background, according to The Maine Wire:

PL 90, the free market based health reform law, was passed last March by a Republican majority in Maine’s legislature. Governor Paul LePage signed the bill in a ceremony at the statehouse amid cries from Democrats that it wasn’t right for Maine.

But how could that be? According to the analysis offered up on Insureblog:
PL 90 expanded the “rate bands” to allow a wider variation in cost between different aged applicants. In the past, insurance companies had to treat a 21-year-old and 55-year-old as basically the same. The new law allows for distinction in age groups. Once the new rates are approved, a 21 year old will pay $215 per month for a plan with a $2,000 deductible. Before health care reform, that person would pay $448 per month. The rates are still high, mostly because the guaranteed issue provisions remain in play, but are much more affordable. A healthy 21 year old in Atlanta, Georgia could buy a comparable plan from Cigna for $98 per month. So the Obamacrap-like guaranteed issue provisions mean healthy people will still pay double the normal premium so everyone can have health insurance. Seems fair, right?

“Getting more young people into the market is a major plus for all Mainers and was a primary goal of the law,” Allumbaugh notes. “As this happens, the claims experience tends to improve and it can lower the rates even further for all age groups,” Allumbaugh said.“This is precisely the impact the health reform law aimed for, lowering rates generally, but in a way that helps our insurance markets reverse the death spiral and begin to grow. 
Hyper-regulation by the Maine Department of Insurance has resulted in most health insurance carriers leaving the state. Anthem Blue Cross controls most of the health insurance market in Maine. Less competition, higher rates.
A sound analysis and solution, right? Not at all.

A Flawed Analysis

The Insureblog analysis goes like this: Obamacare (ie. PPACA) has two provisions that the author mistakenly believes drive premium rates through the roof:
  • Community rating: essentially everyone pays the same rate, regardless of age or gender.
  • Guaranteed issue: anyone can buy coverage, regardless of their health or existing medical conditions.
The flawed analysis follows:

“Insurance companies can no longer discriminate against you because you have a pre-existing condition. Yet insurance companies will be allowed to charge significantly higher premiums to those who are healthy to pay for the claims of those who have expensive medical conditions. That is analogous to auto insurance carriers charging drivers with perfect records the same rate as one who has had multiple DUI’s and speeding violations. Or banks imposing much higher interest rates to the most creditworthy so they can also extend credit to those with severely damaged credit.”

What’s wrong with that analysis:
  1. The Law of Large Numbers means that insuring more people can lower overall rates, while raising revenues for insurance providers.
  2. The PPACA actually allows for four levels of coverage, from platinum to bronze, so younger, healthier inureds entering the insurance pool can wade in at the shallow end and enjoy low premium coverage.
  3. Simply lowering the costs for uninsured doesn’t equate to “Getting more young people into the market.” 
  4. Finally, I have repeatedly shown that health insurance premium costs are not driven by the insurers but by the providers.
One of the important facts of insurance is that people who perceive that they need it less tend not to buy it. The actual fact is, the market has failed to get more young people into the market. The implication of the basic insurance principle of The Law of Large Numbers is that expanding the pool to include healthier participants who are the most likely to opt out of the insurance pool can reduce premiums. This is why the individual mandate is required for universal coverage to work. So the legislation in Maine is based on some basic misnomers about insurance.
Likewise, the analysis is based on some misunderstandings of the PPACA provisions.
  • Rates may not vary based on health factors. Rates may vary only based on 1) age, 2) tobacco use, 3) self only or family enrollment, and the rating area (as specified by the state.)
  • Coverage must be offered on a guaranteed issue and renewal basis.
  • Coverage must include the “essential health benefits package” which:
    •  covers essential benefits,
    • limits out of pocket payments
    • standardizes benefit packages into bronze, silver, gold and platinum coverage levels.

The Principles of Insurance Explained

What follows are exerpts from Insurance, by Richard Zeckhauser from the Concise Encyclopedia of Economics. Richard Zeckhauser is the Frank P. Ramsey Professor of Political Economy at Harvard University’s John F. Kennedy School of Government.

The Law of Large Numbers

In exchange for a premium, the insurer will pay a claim should a specified contingency—such as death or medical bills—arise. The insurer is able to offer such protection against financial loss by pooling the risks from a large group of similarly situated individuals or firms. The laws of probability ensure that only a tiny fraction of insured [losses will occur] , or only a small fraction of the insured population will face expensive hospitalization in a year.

If, for example, each of 100,000 individuals independently faces a 1% risk in a year, on average, 1,000 will have losses. If each paid a premium of $1,000, the insurance company would have collected a total of $100 million. This is enough to pay $100,000 to anyone who had a loss. But what would happen if 1,100 people had losses?

The answer, fortunately, is that such an outcome is exceptionally unlikely. Insurance works through the magic of the law of large numbers. When a large number of people face a low-probability event, the proportion experiencing the event will be close to the expected proportion. With a pool of 100,000 people who each face a 1% risk,  1,100 people or more will have losses only one time in one thousand.

The Identity and Behavior of the Insured

An economist views insurance as being like most other commodities. However, it is unlike many other commodities in one important respect: the cost of providing insurance depends on the identity of the purchaser. A year of health insurance for an eighty-year-old costs more to provide than one for a fifty-year-old. If a company mistakenly sells health policies to old folks at a price appropriate for young folks, it will assuredly lose money, just as a restaurant will lose if it sells twenty-dollar steak dinners for ten dollars. The restaurant would lure lots of steak eaters. So, too, would the insurance company attract large numbers of older clients. Because of the differential cost of providing coverage, and because customers search for their lowest price, insurance companies set different premiums for different groups, depending on the risks each will impose.

Adverse Selection

Those high-risk individuals whose knowledge of their risk is better than that of the insurers will step forth to purchase, knowing that they are getting a good deal. This is a process called adverse selection, which means that the mix of purchasers will be adverse to the insurer. The potential purchasers have “hidden” information that relates to their particular risk, and those whose information is unfavorable are thus most likely to purchase.

For example, if an insurer determined that 1% of fifty-year-olds would die in a year, it might establish a premium of $12 per $1,000 of coverage—$10 to cover claims and $2 to cover administrative costs. However, insureds who ate poorly or who engaged in high-risk professions or whose parents had died young might have an annual risk of mortality of 3%. They [the unhealthy insureds] would be most likely to purchase insurance. Health fanatics, by contrast, might forgo insurance because for them it is a bad deal. Through adverse selection, the insurer could end up with a group whose expected costs were, say, $20 per $1,000 rather than the $10 per $1,000 for the population as a whole; at a $12 price, the insurer would lose money.

Equity Issues

The same insurance policy will have different costs for serving individuals whose behavior or underlying characteristics may differ. Because these cost differences influence pricing, some people see an equity dimension to insurance. Equity issues in insurance are addressed in a variety of ways in the real world. Most employers cross-subsidize health insurance, providing the same coverage at the same price to older, higher-risk workers and younger, lower-risk ones. The government’s decision not to tax employer-provided health insurance as income acts like a subsidy. In pursuit of equity, governments may set insurance rates, as many states do with auto insurance.

The Massachusetts auto insurance market provides an example. High-cost drivers are subsidized at the expense of all other drivers. Thus, inexperienced, occasional drivers in Massachusetts paid, on average, $1,967 for insurance in 2004 compared with $1,114 for experienced drivers. In contrast, in neighboring Connecticut, where such cross-subsidies were not imposed, the respective rates are $3,518 and $845.

Such practices raise a new class of equity issues. Should the government force people who live quiet, low-risk lives to subsidize the high-risk fringe? Because most of us think we should not encourage people to engage in behavior that is costly to the system, we conclude, for example, that nonsmokers should not have to pay for smokers.

Government’s Role in Insurance

Government plays four major roles with insurance:

  1. Government writes it directly, as with Social Security, terrorism reinsurance, and pension guarantees—via the Pension Benefit Guaranty Corporation (PBGC)—should a corporation fail.
  2. Government subsidizes insurance: in some programs, such as federal flood insurance, but only de facto in other cases.
  3. Government mandates a residual market for high risks (e.g., Florida’s program for hurricanes or many states’ programs for high-risk drivers). Governments hold down prices in such markets either by creating a state fund to cover losses or by requiring insurers who participate in the voluntary market to pick up a certain portion of this high-risk market.
  4. Government regulates matters such as premiums, insurance company solvency, and permissible criteria for pricing insurance (e.g., for auto insurance, race and ethnicity are banned everywhere; Michigan bans geographic designations smaller than a city).

Not surprisingly, government participation—as a setter of rates, as a subsidizer, and as a direct provider of insurance services—has become a major feature in insurance markets.

The PPACA In Perspective

The PPACA Model Successfully Expands Coverage: The PPACA, which is based on ex Governor Romney’s Massachusetts model, and in turn, derives from the Swiss model, has been successful in expanding coverage to most people where implemented.  In short, it is highly successful in addressing the economic barriers that prevent insurance companies from providing coverage to all individuals.

It is Only The First of a 2-Step Solution: It expands coverage, but it is not a prescription for lowering health care costs.  This must come from reform of the providers who actually drive the costs – the large hospital groups, medical equipment suppliers and pharmaceutical companies.  Piecemeal attempts like Maine’s are flawed from the outset, for this reason, as well as the reason that they are based on the fundamentally disproven premise that age-rated premiums will provide sufficient incentive for the free market to expand the pool of insureds sufficiently to keep premiums low. Such “solutions” overlook the fact that insurers still negotiate service costs with providers who have the market clout to continuously set them higher.

The Next Step: The PPACA is only the first step in a continual process of reform that needs to take place. It addresses the problem of universal coverage, and discrimination issues that arise due to the insurer’s need to address the issue of adverse selection.

What’s now needed is an honest look at the real cost drivers of health care in the United States, and a plan to contain these. In the meantime, in a highly polarized political environment, the providers are pushing hard against step one, the PPACA in order to continue the status quo. By creating ever expanding number of uninsureds, they stand to gain by opening clinics that provide selective care at lower prices at the expense of the quality of service. And the plan is to derail government’s role in healthcare to create a “wild west” in which health care standards will be further eroded.

The Corrupt Fight Against Reform

Aside from the dumbed-down politicization of issue that results in false campaign ads like these, the source of the problem of rising healthcare is largely just being ignored, and, as a result, costs will continue to spiral out of control. Moody’s predicts the large for-profit hospital groups will get bigger and consolidation will continue. This bodes ill for the future of US health care as mercenary large firms like Hospital Corp. Of America look to maximize profit while minimizing quality of care.

On March 19, 1997, investigators from the FBI, the Internal Revenue Service and the Department of Health and Human Services served search warrants at Columbia/HCA facilities in El Paso and on dozens of doctors with suspected ties to the company.[3] Following the raids, the Columbia/HCA board of directors forced Rick Scott to resign as Chairman and CEO. He was paid a settlement of $9.88 million, and left with 10 million shares of stock worth over $350 million, mostly from his initial  investment. In 1999, Columbia/HCA changed its name back to HCA, Inc. In settlements reached in 2000 and 2002, Columbia/HCA pleaded guilty to 14 felonies. They admitted systematically overcharging the government by claiming marketing costs as reimbursable, by striking illegal deals with home care agencies, and by filing false data about use of hospital space.  HCA also admitted fraudulently billing Medicare and other health programs by inflating the seriousness of diagnoses and to giving doctors partnerships in company hospitals as a kickback for the doctors referring patients to HCA. They filed false cost reports, fraudulently billing Medicare for home health care workers, and paid kickbacks in the sale of home health agencies and to doctors to refer patients. In addition, they gave doctors “loans” never intending to be repaid, free rent, free office furniture, and free drugs from hospital pharmacies.

Fighting Reform

Rick Scott’s money is at the forefront of the fight against health care reform, and greed is the motive. He seeks to introduce a new health care treatment model based on discounted clinics that would lower the standards of care while maximizing profit.

While this is not a political blog, and I am a political Independent, Scott’s political clout  is symptomatic of the problems meaningful reform faces:

Scott created, chaired, and bankrolled a group called Conservatives for Patients’ Rights that spent millions of dollars on TV commercials attacking health care reform, especially a proposal calling for the federal government to create a public health insurance option to compete with private insurers. In one ad, the narrator said the votes of a few key senators could determine whether or not Americans would be able to keep their own doctors and their own health insurance planns. The implication was clear — people would lose the ability to choose their own doctors if health reform passed…Well, guess what. A few days ago, Scott, now governor of Florida, said he had decided to reduce choice and competition that state workers have enjoyed for years.

According to the Tampa Bay Times, Scott’s Solantic Corp. is a chain of 32 urgent centers, which he co-founded in 2001, and was involved in the operation of until last year, when he transferred controlling stock to his wife’s trust to avoid the appearance of conflicts of interest with his position as governor of Florida.

Solantic’s walk-in clinics, clustered in mid-Florida and along the east coast, handle everything from stitches and sprains to school physicals and immunizations. Charges are posted like fast-food prices and there’s a three-day feel-better guarantee — if you’re not feeling better after three days, your follow-up visit is free. The company partners with hospitals in several markets, including Shands HealthCare in Gainesville.

The business model requires an uninsured public.

Solantic has built a successful business without state help, relying on patients who have commercial insurance, Medicare or cash. Medicaid accounts for only 3.1 percent of all patient visits. But as Solantic has grown, so too have the number of state agencies using its services. And in the urgent care business, high volume, along with low overhead, is crucial to profits. Bowling said Solantic billed state agencies $110,657 for services in 2010 and $20,061 so far in 2011. Scott worked with Bowling when he was chief executive of the Columbia/HCA hospital chain and she was a marketing executive there. In 1997, Scott was forced out amid a federal billing fraud investigation that resulted in the company paying a $1.7 billion penalty. Scott, who left with $10 million in severance and $300 million worth of stock and options, was never charged with any wrongdoing. Four years later, Scott used part of that wealth to start Solantic with Bowling. Scott was active in the company and on its board until January 2010, when he began his run for governor.

Snap! principle of partisan anti health care activism:

Follow the money. Those who lobby against it seek to create a permanent uninsured demographic to exploit financially.

Further Readings

Arrow, Kenneth J. “The Economics of Agency.” In John W. Pratt and Richard J. Zeckhauser, eds., Principals and Agents: The Structure of Business. Boston: Harvard Business School Press, 1985.
Arrow, Kenneth J. Essays in the Theory of Risk-Bearing. Amsterdam: North-Holland, 1971.
Cutler, David, and Richard Zeckhauser. “The Anatomy of Health Insurance.” In Joseph P. Newhouse and Anthony Culyer, eds., The Handbook of Health Economics. New York: Elsevier, 2000.
Cutler, David, and Richard Zeckhauser. “Extending the Theory to Meet the Practice of Insurance.” In Robert E. Litan and Richard Herring, eds., Brookings-Wharton Papers on Financial Services. Washington, D.C.: Brookings Institution Press, 2004. Pp. 1–53.
Gollier, Christian. The Economics of Risk and Time. Cambridge: MIT Press, 2001.
Huber, Peter W. Liability: The Legal Revolution and Its Consequences.New York: Basic Books, 1988.
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