Congress Can't Risk Ignoring Risk

One thing that always amazes me is the almost visceral tendency of many on the left to reject market forces out of hand as a relevant factor when considering policy. No where is this more true than in the current debate over health care reform, particularly as it applies to the new regulatory framework to be imposed upon insurers.

House and Senate Democrats have made it quite clear that under no circumstances are insurance premiums to reflect the health status or behavior of the individual beneficiary. In regular-speak, this means that it would be illegal for insurers to offer discounted rates to policy-holders who quit smoking, keep their cholesterol in check, or otherwise remain healthy.

Proponents maintain that, should such premium flexibility be permitted, insurers would "cherry-pick" their customers, seeking out the healthy while avoiding the sick, in an effort to keep their potential liabilities down. Sick people use more medical costs than healthy people.

While such a policy is noble in its intent, it is also erroneous in its assumption. This view fundamentally mistakes the purpose and nature of incentives, and the tendency of market forces to encourage desireable behavior.

In allowing insurers to charge different rates to different people, not only do beneficiaries have an incentive to take care of themselves, and thus earn lower premiums, but insurers are finally given a reason to compete for the business of everyone, even the sickest of us, creating and marketing policies to more people. The one-size-fits-all benefit package would be a thing of the past.

I'll explain:

During the Democratic primary last year, then-candidate Obama famously said to Hillary Clinton that the main reason people do not have health insurance isn't that they don't want it, it's that they can't afford it. True. For the overwhelming bulk of the "uninsured," insurance simply isn't of sufficient value for purchase. This means that, being generally healthy, their expected medical costs are less than the costs of an insurance policy. Thus, they opt out of the market.

This tendency is exacerbated by restrictions such as guaranteed issue and community rating, meaning that nobody can be denied coverage and insurers are forced to charge the same rate to all comers. In effect, this means that the healthy who are enrolled are charged artificially high premiums to cross-subsidize the coverage of the sick or otherwise unhealthy. This encourages many young or healthy people to forgo insurance as, simply upt, it just isn't a good buy. Driving more people out of the market in this way reduces the overall level of indemnification that an insurer can achieve. Further, it sends the message that, regardless of how healthy or unhealthy you are, medical costs will remain the same for you.

Scott Harrington of the American Enterprise Insistute summed up this point nicely in an article in the Wall Street Journal last week:

"The proposals' strong aversion to having insurance rates ... related to health status reflects the view that either the need for health care is immune from individual control, or that a person should not be financially responsible for behavior that contributes to poor health, or both. These views are difficult to reconcile with the consensus that unhealthy behavior contributes significantly to obesity, diabetes, heart disease and cancer, and thus accounts for a substantial proportion of health care costs."

While many in Congress gasp at the suggestion of tying insurance premiums to risk or behavior, the industry has been doing this successfully for years. Auto insurers, for instance, advertise lower premiums for drivers who incur fewer tickets or accidents. To attract the very riskiest demographic, the teenage driver (whom one would think insurers would hesitate to touch with a 10-foot pole), many companies offer discounts for good report cards. This accomplishes, or at least provides incentives for, a myriad of things that we would all find desireable: safer driving, lower premiums and good grades; the trifecta!

Given the popularity of innovations such as these, it is somewhat curious that we would go to such great lengths to avoid similar progress in the field of health care which, as we are consistently reminded, is essential for all people.

Although intended to help the sick or chronically ill, the prohibition against tying health insurance costs to risk (a contradiction since, after all, insurance itself is intended to insulate one from the risk of unanticipated illness or injury) ignores or even exacerbates what economists typically agree to be the main drivers of health care cost inflation: an unhealthy population lacking any incentive to take care of itself or be a prudent purchaser of medical services. Given this reality, coercive government control of costs is all but inevitable, as the strains on budgets become too great to bear. This is already the case in the Medicare program, which is set to cut payments to participating physicians by more than 20% this year.

You simply cannot keep this up indefinately and expect access to medical care to remain what it is. Let us hope that Congress realizes this before it is too late.