This post is meant to help my non-economist friends think more clearly about how we pay for health care. I’ll talk about markets, but the truth is that the American system is built of deeply bastardized markets. If our car markets worked like our health markets, most of us would walk to work. I’m trying to focus on the essential logic of the situation which is going to sound Utopian because Congress isn’t going to give us any sort of logical policy any time soon. But we aren’t going to get a logical solution until we as voters understand the logic of health care finance.

I’ve got a few big points to make:

1. Trying to health insurance also work like charity is bound to end poorly for everyone.
2. A single-payer system has a lot of nice features for individuals, but a lot of systemic problems.
3. It’s fundamentally impossible to insure pre-existing conditions. Insurance is about sharing risk, not unavoidable expenses.

(This post is longer than I’d like, so thanks for your patience!)

Markets and Charity

I’ve said it before, and I’ll say it again: we don’t have to ruin markets to do charity.

The essence of markets is that they aggregate knowledge about the relative costs and benefits of different goods based on the preferences of the real people involved in producing and consuming those goods.

The demand side of markets provide information by giving you (as a consumer) a choice between more of something you like and more money to spend on other stuff. On the supply side they give you (as a supplier–probably of your own labor) the choice between providing more of what people are willing to pay for or having less money to buy the stuff you want. Markets crowdsource cost-benefit analysis.

Prices also give suppliers an incentive to produce things that consumers want while trying to save resources (i.e. cut costs). In other words, a price is a signal wrapped up in an incentive.

So what about fairness? The bad news is that markets are a system of “from each according to their ability, to each according to how much other people are willing to pay for the product of their ability.” (Not very catchy!) It’s mostly fair for most of us, but doesn’t do much good for people who are just unlucky (e.g. kids born with genetic defects). Here’s the good news: we can use charity alongside markets.

We can debate how much role government should play in charity some other time. For now, let’s whole-ass one thing instead of half-assing two things. We have to appreciate that interfering with markets interferes with the ability of those markets to function as sources of reliable information. It doesn’t matter how good our intentions are, we face a trade off here… unless we do something to establish a functioning charity system parallel to the health care finance system.

Single Payer

Anecdotes about the merits of a single-payer health care system are powerful because they shed light on the biggest benefit to such a system: individual convenience.

Part of the appeal has to do with the general screwiness of the American system. It’s a cathedral built of band-aids. But even in an idealized market system, a single-payer system has the advantage of not making me go through the work of evaluating which plan best suits my needs.

A single-payer system is, from an individual perspective, about as ideal as having your parents pay for it. But we don’t really  want our parents buying our stuff for us.

Single payer system sacrifice the informational value of markets (probably even more so than America’s current system of quasi-price controls). Innovation would be harder as long as new treatments had to be approved by risk-averse bureaucrats (and again, we already face a version of this with Medicare billing codes and insurance companies).

Essentially, a single payer system creates a common pool problem: each of us gets the individual benefit of being able to be lazy. But then we’re left trusting bureaucrats, special interest groups, and think tanks to keep an eye on things. It could be an improvement over the current American system, but that’s like saying amputation is better than gangrene.

Insurance

Premium = expected cost + overhead

Consider two alternatives. In scenario A you start with $150, flip a coin, and if it comes up tails you lose $100. In scenario B you get $90. The expected value of A is $100, but most of us would still prefer the sure thing.

Here’s how insurance works: You start with $150, give $60 to the insurance company, then flip the coin. If it comes up tails, you lose $100, but the insurance company gives you back $40. You’ve just gotten the sure thing. And by taking on thousands of these bets the insurance company is able to make enough money to pay their employees.

But here’s the thing: the premium they charge is fundamentally tied to that expected value. Change the odds, or the costs (i.e. the claims they have to pay for) and you’ll change the premium.

(BTW, Tim Harford did a nice ~8 minute podcast episode on insurance that’s worth checking out.)

Pre-existing conditions are the equivalent of changing our thought experiment to a 100% chance of flipping tails. No amount of risk sharing that will get you to the $90 outcome you want. You can’t insure your car after you’ve been in an accident and you can’t insure a person against a loss they’ve already realized. If you’re Bill Gates, that’s no big deal, but for many people, this might mean depending on charity. That’s a bummer, but wishful thinking can’t undo that.

If we insist that insurance companies cover pre-existing conditions* the result can only be higher premiums. This is nice for people with these pre-existing conditions, but not so great for (currently) healthy poor people. Again, charity matters needs to be part of the debate, but it needs to be parallel to insurance markets.

Covering more contingencies also affects premiums. The more things a policy covers, the higher the expected cost, and therefore the higher the premium. We each have to decide what things are worth insuring and what risks we’re willing to face ourselves. Politics might not be the best way to navigate those choices.

High deductibles and catastrophic care

Actuaries think about the cost of insuring as a marginal cost. In other words, they know that the odds that you spend $100 in a year are much higher than the odds that you spend $1000. So the cost of insuring the first dollar of coverage is much higher than the cost of insuring the 5000th dollar. This is why high deductible plans are so much cheaper… they only pay out in the unlikely situation where something catastrophically bad happens to you. This is exactly why most of us want insurance. We aren’t afraid of the cost of band-aids and aspirin, we’re afraid of the cost of cancer treatment.

For those of us firmly in the middle class, what we really need is a high-deductible plan plus some money in the bank to cover routine care and smaller emergencies. (Personally, my version of this is a credit card.) Such a plan has the added benefit of encouraging us to be more cost conscious.

A big problem with our current system is that it’s set up like an all-you-can-eat buffet. You pay to get in (your premiums) but once you’re in the hospital, any expenses are the insurance company’s problem (read: everyone else on your health plan). The logic here is the same as with pollution. When I drive my car I get the benefits of a quick and comfortable commute but I also suffer a little bit more pollution. But I don’t have incentive to think about how that pollution affects you so I pollute more than would be ideal. Multiply that by millions of people and we can end up with smog.

tl;dr

If I were trying to put together a politically palatable alternative to our current system, I’d have an individual mandate with insurance vouchers for the poor (it’s not very libertarian, and it’s far from my Utopian ideal, but I think it would be a huge improvement over what we’ve got now). I would also expand the role of market competition by encouraging high deductibles plus flexible health savings accounts.

Reality is complicated, but I’m trying to get at the fundamental logic here. We don’t have a properly functioning market system. To get there we need competition, transparency, and a populace with the mental tools and mathematical literacy necessary to understand what their insurance can and can’t do. That’s a tall order, but it doesn’t mean we shouldn’t keep trying to move in that direction.

To have a fruitful debate we need to understand what we want from our healthcare system: help for the poor (charity), convenience, and efficiency from an individual and social perspective. By trying to lump all these things together we muddy the waters and make it harder to understand one another.

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*I don’t know what the deal is with the idea that the AHCA will treat rape as a pre-existing condition. Some webpages give a bunch of random tweets as evidence of this, and others call bullshit. Let’s just leave it at this: in a competitive market this would be considered terrible marketing and savvy companies wouldn’t do it. The lesson then is to keep calling companies on bad marketing, and avoid protecting politically powerful companies from market competition.