• Health insurance market failures (and what can be done about them)

    In his textbook, Economics of the Public Sector, Joe Stiglitz categorizes market failures in general and those that exist in health care in particular. The following — focussed on health insurance, as opposed to health care — is based on his list, with a lot of my own thoughts added. Anyone know of good papers that discuss health insurance (or health care) market failures and how they might be addressed? (I will cover health care market failures in another post.)

    For the record, and for readers who don’t know, a market failure is any feature of the market that reduces allocative efficiency. (Jargon alert! Read the next sentence.) That is, it causes resources to be expended in a way that doesn’t maximize overall benefit to society. In principle, government intervention can increase that benefit (economic welfare) in such cases. In practice and in some cases, it’s debatable.

    Failure of competition. Health insurance markets are famously concentrated. There are lots of proposed solutions to this: antitrust enforcement, competition across state lines, deregulation at various levels, including elimination of minimum benefits standards, and so on. It’s important to recognize that these are government roles, all establishing the nature and scope of the market.

    However, there is one fundamental reason why competition can never be perfect in health insurance. The products, insurance policies, are not identical. They’re not commodities. As such, they don’t really compete with one another as equal goods. Roughly speaking you can think of each policy as a unique product with its own degree of monopoly power. This is a source of market power that cannot be purged from a market-based insurance system, no matter what government does or does not do.

    Incomplete markets. An incomplete market is one in which consumers would be willing to pay more than the cost of a good or service but it is not provided. Insurance markets are clearly incomplete. Today, there are millions of people who are denied participation in the market (due to medical underwriting) who might be willing to pay a fair premium. Given the low level of competition in insurance markets, it is very likely that products that would be profitable are not offered (because they’re less profitable than what is offered). Until 2006, the market for prescription drug insurance for Medicare beneficiaries was glaringly incomplete. Until 1966, the market for hospital and physician services insurance for the elderly was also obviously incomplete.

    Government responses in all these cases (banning medical underwriting, encouraging exchanges, offering Medicare and Medicare Part D) are designed to address the incompleteness of health insurance markets.

    Information asymmetries. An information asymmetry exists when one participant in a market transaction knows more than another in ways that pertain to cost or price. Such asymmetries abound in health insurance. Individuals have private knowledge about expected utilization that insurers lack, leading to adverse selection. Individuals also may know more about their personal value of the insured services than do insurers, leading to moral hazard. Providers know more than insurers about cost and quality, leading to inefficient levels of reimbursement.

    Private entities are likely just as capable of limiting moral hazard (e.g., by cost sharing or care management) and discovering cost and quality information (e.g., combating fraud) as government. Private entities can also address the degree of selection into their products, but not without exacerbating the problem of incomplete markets (e.g., not offering services that attract high risk enrollees or attempting to shed high risks).

    However, the entire selection problem can be solved by government, in principle, as proposed by Mark Pauly. In brief, Pauly recommends risk-adjusted government transfers that fully compensate for insurer experience rating. That is, throw community rating out the window and have government redistribute income in such a way that every consumer faces the same marginal cost for an insurance product. (Such “vouchers” or “subsidies” could, and should, also be income adjusted.) The key here is that government can address the selection problem more completely than the private sector.

    Are there more market failures in health insurance I missed? Did I leave out any private or public solutions? Likely “yes” to both. Let me know in the comments. And please suggest further reading.

    I cover health care (not insurance) market failures in another post.

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    • Pauly’s “solution” seems more complicated than any number of solutions such as a mandate and community rating.

      It does however, apparently maintain the profit margins of insurers.

      • @Cycledoc – Don’t see it as more complicated, just different. It also depends on how you think transfers should be done: from healthy to sick or from high income to low. The current, and foreseeable future, way is the former (at least for those not in public programs). Exchanges will have some of the latter. Meanwhile we’ve got a huge employer tax subsidy which goes counter to both of these. There’s a lot of wisdom in Pauly’s proposal.

    • Reminds me of the old riddle:

      The person who makes it doesn’t need it.
      The person who buys it doesn’t use it.
      The person who uses it doesn’t know it.
      What is it?

      As you point out, there are many things which make health insurance unique and a lot of expected market and economic principles don’t apply. I’m sure this drives economists crazy as they try to fit the “health care market” to their “economic principles”.

      (If you haven’t figured it out, you can Google the riddle to find the answer.)

    • On failure of competition: Medicare supplement (Medigap) policies address this problem by forcing the companies to offer a product from the approved list of 12 (A-L). Ditto for the bronze, silver, gold and platinum plans in the exchanges. Mandatory minimum auto coverage has a similar effect – everyone has the same base and agents sell the add-ons separately.

    • “That is, it causes resources to be expended in a way that doesn’t maximize overall benefit to society.”

      This is a meaningless definition. It would be akin to saying, “A market failure occurs when the market produces a result “we” (i.e. central planners aka government officials) don’t like.”

      Who gets to decide what outcome “maximizes the overall benefit to society?” You? Me? Should we take a vote?

      One other thing, have you considered that concentrated health insurance markets allocate resources in a more efficient manner compared to a less concentrated market. This would be true if providers (i.e. hospitals and medical groups) exert significant market power over insurers. The only way to “balance” this power is a concentrated insurer with a large market share (which is exactly what we have in health care).

      • @kingstu – You’re new here, right? (I’ve covered your points in other posts. One of them was today! The other is in one of my publications in the left sidebar, as well as in many, many posts.)

    • You neglect to mention two key reasons for the failure of the healthcare/health insurance market:

      1. Health care itself is not a commodity like an iPad or a car. As an example, you can choose to buy a car. You can choose a luxury car or a used car. Or you can walk or take public transit. You can wait to purchase a car with money you’ve saved or you can take out a loan for the price of the car. AND you can shop around to get the best price possible.

      When your appendix needs to come out, it must come out immediately or you die. There is no choice in that particular purchase, unless you feel that the choice to die or live is a choice akin to choosing leather or cloth seats. When you break a leg, you must go to the hospital to address this compelling need. And there is absolutely no way to shop around for the best price, i.e. the most affordable hospital (at least in my experience.)

      What happens if you have cancer that MAY be cured by a chemotherapy that can cost 12,000 a month for six months? And even after that happens, you could still die? Who decides if that cost is worth it? The consumer (the patient) will want to purchase that health care. The insurance company may decline the chance to purchase this chemotherapy for the patient. Who is “the market” in this situation? This type of situation has too many non-numerical considerations to fit comfortably in an economic “model.”

      2. Which brings me to the second issue you neglected. Very few people in American actually understand and know the true cost of their healthcare. If you are covered by an employer, do you know how much your insurance costs? By that, I mean how much it costs outside of the amount your company deducts each month from your paycheck for insurance. What is the TOTAL out-of-pocket cost your company pays to insure you and your family? And then, what is the cost of a well-child visit? Or a preventative check up? It’s significantly more than the co-pay. But do consumers understand that? Or do they view the co-pay as the price?

      How is pricing for healthcare determined? It’s negotiated through third party vendors like insurance companies and group purchasing organizations. Is that efficient? I personally don’t think so. And most people cannot find out the price of their healthcare (and by this, I mean the actual doctor visit or prescription product, not the insurance premium) until they get the EOB after they’ve “consumed” the “care”.

      The cost of health insurance is just one factor in the inefficiencies of the American healthcare market. The actual costs of the services and products used in healthcare have spiraled out of control in part because consumers have no real idea about the costs of their healthcare. And when one requires healthcare (as in needing an appendectomy), consumer choice is not a factor when faced with a do-or-die need. How to pay for it becomes an after-the-fact dilemma – especially for the large number of uninsured Americans.

    • “Today, there are millions of people who are denied participation in the market (due to medical underwriting) who might be willing to pay a fair premium.”

      The only people denied the opportunity to buy an insurance policy at a fair premium are done so when government regualtion prevents the carrier from selling a policy at a fair premium. Rate bands, some as low as 20% from healthiest to sickist, are the only thing that prevents everyone being offered a policy at a fair price.

      ” That is, it causes resources to be expended in a way that doesn’t maximize overall benefit to society. In principle, government intervention can increase that benefit (economic welfare) in such cases. In practice and in some cases, it’s debatable.”

      In many histroical cases it is the exact opposit. 1973 HMO Act for example. Up until the late 80s or early 90s it was a federal law that employers had to offer HMOs in numerous situtions. Even if it was a bad HMO and detremental to the plan as a whole they were still required to do so. COBRA was a terribly written bill that cost employers billions in compliance cost and legal fees and put some out of business.

      Biggest example would be Medicare. Medicare was passed so grandma wouldn’t lose the shirt off her back if she had a prolonged illness. At this time 13% of seniors needed help paying some part of their lifetime medical expenses. Medicare was passed, excluded coverage for prolonged illness and today 19% of Medicare beneficiaries are on Medicaid.

      “Health insurance markets are famously concentrated.”

      Reason number one would be government licensing and reserve requirements. If government didn’t impede entry into the market and keep competition out there would be far more competition.

      ” The products, insurance policies, are not identical.”

      No two apples are identical. Service at one diner is not identical to another nor is the food. A Ford is not identical to a Nissan. Over 50% of private insurance is ERISA self funded plans. What material difference is there between one carriers 75K 12/15 contract and another carriers?

      ” There are lots of proposed solutions to this: antitrust enforcement, competition across state lines, deregulation at various levels, including elimination of minimum benefits standards, and so on. It’s important to recognize that these are government roles, all establishing the nature and scope of the market.”

      Dereg, state lines, minimum benefits are all undoing government action. If government hadn’t initated these problems in the first place they wouldn’t need undone. Antitrust enforcement? When has there been a merger not apporved by the state or feds? Take United’s growth for example, states and feds approved every acquization they made. If you disagree with their market pentration in NV for example why did they government allow them to buy Pacificare and Sierra?

      ” As such, they don’t really compete with one another as equal goods.”

      In 20 years of selling I have never seen an employer hold up one carriers $1000 deductible policy and say another carriers $1000 deductible policy can’t compete. I see thousands of them spreedsheeted each year and it sure looks like competition when presented to the buyer.

      “Until 2006, the market for prescription drug insurance for Medicare beneficiaries was glaringly incomplete.”

      The market was more then complete for products charging a fair, sustainable price. It wasn’t until government stepped in and heavily subsidized it that people were willing to buy. That is not a market failure. I don’t drive a ferrari, if the government subsidized my lease so it only cost me $300 a month I would, is the ferrari market incomplete?

    • Regarding the 12,000/month drug for cancer. Sadly there are few (Gleevac an exception) if any such drugs that promise cure, or even a 10% chance of prolonged survival compared with standard therapies. At this stage of the game, the drugs at best seem to have a slight effect on the course of disease.

      Ironically Gleevac, and many of the others, were developed with government funds, taken private, patented and marketed at these confiscatory prices.

      Imagine buying a car, for example paying $50,000 and having the expectation that it will last 2-4 months. That’s what’s happening with these drugs.

      Drug companies learned in the 80’s and 90’s that patients, whether insured or not have unlimited expectations of treatment. Those without insurance and serious illness most often find some way to get coverage, or go bankrupt and get on medicaid, or simply appear at ER’s and get emergency treatment.

      They also learned that patient’s demand for drugs is not price sensitive and that expectations of treatment over ride any common sense reasoning. Everyone wants a chance to win the lottery.

      The challenge in our non-system of care that spends an order of magnitude more per capita than other similar countries, is how to limit expenditures without abandoning care for a large segment of the population. And how to do it when the expectations of patients for care is unlimited, and the earnings expectations of providers and suppliers are also unlimited. That’s quite a challenge.

    • There are millions of German, and Canadian citizens who do not have the faintest idea what any of their health care really costs. There are millions of French citizens who do not have the faintest idea what their hospital care really costs.

      Yet these nations have some control of health care costs, and none of them is in a deep recession, and none of them has millions uninsured or deeply in debt to medical providers.

      The answer is regulation and price controls. The government does know what everything costs, and stomps on any provider or drug company that attempts price-gouging.

      As Joseph White pointed out in numerous books, health insurance is not something that you decide to buy in these countries. Health insurance is not something that a private insurer decides to sell you. There is no “market” which fails or succeeds.

      No form of private insurance is comprehensive in the USA. Life insurance has been getting cheaper for the last 30 years, but many families are still underinsured. Long-term care and disability insurance have had a nice free market to work in, and they cover less than 10% of those who need coverage. Casualty insurance is closer to universal, although in many cases because lenders require it.

      Social insurance is necessary because private insurance is unreliable. We will benefit more by beefing up social insurance, than by tinkering with private insurance.

      Bob Hertz
      The Health Care Crusade

    • ” Health insurance is not something that a private insurer decides to sell you. ”

      Bob, All three of the countries you mentioned have private health insurers.

      “We will benefit more by beefing up social insurance, than by tinkering with private insurance.”

      Its our two public insurance programs, Medicare and Medicaid, that are in financial ruin and dragging everyone else down. Social Insurance has been a complete failure, how does beefing up a failed system improve anything?

      • Nate, to answer your comments:

        The private insurance that exists in other nations is for the most part supplemental, and in all cases is strictly regulated far beyond American standards. In France, carriers must pay all claims in 30 days or the next year’s premium is free. In Denmark, one half of each premium goes into a risk adjustment fund, and any carrier which shows a profit must share it with all other funds.

        In other words, the carriers are legally private but they operate on social insurance principals. I could live with that.

        As to Medicare and Medicaid:

        Medicare has not changed its payroll tax percentage for over 30 years. In that time, the ratio of workers to the elderly has fallen, and it will continue to fall. Medicare will indeed be in financial ruin if we do not raise taxes

        The baby boom has required public funds in every stage of its existence. School taxes went up greatly in the 1950’s. Federal funding for higher education went up greatly in the 1960’s. Then there has been a “break” when boomers entered their peak earning years.

        I do not say that this is gping to be easy. America may have to choose less Defense spending in order to preserve Medicare.
        Sometimes I am not sure our democracy can do that.

        Medicaid is in “ruin” to the extent that states must pay for part of it, and individual states in general cannot raise taxes. If and when Medicaid is fully funded by Washington, the same budget issue as above comes into play.

        Thank you,

        Bob Hertz
        The Health Care Crusade

    • “In other words, the carriers are legally private but they operate on social insurance principals. I could live with that.”

      What do you consider community rating, guarantee issue, small group reform and all the other legislation they operate under here?

      “Medicare will indeed be in financial ruin if we do not raise taxes”

      And when you collecting 90% of people’s income in taxes and still short then what are you going to do? The problem is not a lack of revenue its how the revenue is spent. Medicare is over funded and provides a terrible return on investment for the public. Raising taxes is just throwing more money down the drain.

      “America may have to choose less Defense spending in order to preserve Medicare.”

      So we should ignore one of the few things the federal government is actually called upon to provide in the constitution to make sure it continues to fail to provide that which it never should have. In that case just collpase the government and disinvow all previous debt and start fresh.

      “Medicaid is in “ruin” to the extent that states must pay for part of it,”

      Medicaid is in ruin to the extent it suffers rampant fraud, distorts other healthcare markets by underpaying for care., and delivers a bad product.