Chocolate and Gold Coins

Sunday, February 13, 2005

Dual Insurance for Health Care

Recently, Russell Roberts who helps write the very entertaining and world famous blog café hayek and John Irons who writes the blog argmax debated health insurance at econoblog. Russell Roberts is a libertarian economics professor at GMU which is a libertarian department in general, so it was not surprising that he blamed government meddling for rising health care costs. He came closest to identifying the problem when he mentioned the government mandates that stipulate what must be covered by health insurance (he provides a link to Virginia mandates). However, the things he mentions are really more symptoms of the problem and not the core of the problem.

John Irons works at a progressive think tank in D.C. called The Center for American Progress. He doesn’t think that the fact that our health care costs are heavily subsidized is the reason why health care costs are rising rapidly. He believes that private health care markets in the way that Russell Roberts envisions would collapse because of adverse selection. He is right, but for the wrong reason. He says that

One problem with the health insurance market is that you, as a purchasers (sic) of health insurance, know much more about your health than do health insurance companies.
This statement isn’t even close to being relevant. It doesn’t matter what insurance companies can know about you. Their hands are tied.

I’m not a health care economist (my wife is), however, I do know what is the fundamental problem with the way we do health insurance in America. The problem with health insurance is fundamentally a problem with social insurance. People want private insurance, and they want social insurance, and they want the private insurance companies to provide that social insurance. It just doesn’t work.

The problem with privately provided social insurance

A good example of private insurance as it should work is private automobile insurance. If I have a car, I am required by law to provide proof of liability insurance. I just show up at the insurance office and ask for a quote. They type in the information into their computer and determine what premium would cover my expected annual automobile insurance cost. Private insurance does one thing well, computing my expected payout. They charge this amount, plus a little commission, and they pay out the actual payout. Simple.

Now suppose a person comes into the insurance office and says “I need auto insurance.” “Why certainly, what type of car do you have?” asks the agent. “I don’t have a car anymore. I totaled it this morning. That’s why I need auto insurance.” This guy isn’t getting any private insurance. He needs social insurance.

Health insurance is a mixture of social and private insurance. Laws prevent insurance companies from discriminating on the basis of almost anything in computing premiums. Everyone where I work (or any other workplace) pays the same amount for the same type of health care regardless of anything. I get coverage for things I could never need. And I don’t pay extra even if I am already sick! Fair? Certainly, but it is expensive. There’s no way I can shop around for a better deal because it’s my employer’s choice, not mine, and because they couldn’t cut me a deal even if they wanted too: it discriminates.

Society likes having social insurance but doesn’t like paying for it. So governments regulate. They pass minimum wage laws as if this will magically impart added productivity to low-wage employees. And they decree that we are all equal in the eyes of the insurance company, even though some are obviously much more expensive.

The path back to free markets: dual insurance

The way to improve the health care market is to create a free market for health insurance just like the free market for automobile insurance. We have to realize that we want two kinds of health insurance: private and social. We need to separate out the social insurance from the private health care market to make private health insurance efficient. What we need is a public insurance company that insures the private insurance companies against the risk they face.

How would dual insurance work? For the social insurance, everyone would pay into a collective fund (kind of like social security) and this fund would reimburse part of your private health insurance costs. People will be categorized by many myriads of dimensions. Suppose you are placed into one of these categories. The health insurance companies will announce how much they would charge someone who fits into that category. The social insurance chooses some kind of average of the various charges that insurance companies announce (maybe knocking out the highest bid). This is what you get from the social insurance. If you choose the high-end plan, you must pay for the frills out of pocket. If you opt for the low-end plan, you pocket the difference. This puts market pressure on insurance companies to cut costs and provide excellent service.

Social insurance will cover you for the possibility that you were born with bad genes. That’s like insuring against an accident that already happened. Social insurance can do this. I know that libertarians would say that social insurance really isn’t insurance; it’s redistribution. Whatever. Most people would endorse it in this context. Realistically, this is the only way to avoid racial and sexual discrimination in insurance markets while maintaining market efficiency. I think it is a good idea. Of course, never underestimate the government’s ability to muck up a good idea.


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