Why buy insurance for the little, predictable stuff?

In recent weeks, I’ve noticed the reemergence of the question of why people insure for relatively low cost, predictable health expenditures. This has come up in the context of contraceptive coverage, but it applies to many other things like routine prescription drug use or physician office visits. There are a variety of reasons why insurers might want to provide coverage for routine care. Many boil down to the fact that it might be cost effective to do so if encouraging policyholders to consume such care offsets a greater amount of more expensive care in the future. Certain types of coverage may also serve to attract certain types of (cheaper) consumers.

But there are other reasons, pertaining to why consumers might want coverage for routine health care use. First, if it’s through an employer, the consumer benefits from the employer-sponsored health insurance tax subsidy. That makes covered care cheaper than it would be if consumers paid for it with after-tax dollars on their own.*

There’s another reason too. Not recently, but in past years I’ve blogged a lot about the bargaining power of health insurers, that they act like bulk purchasers to negotiate volume discounts. Buying coverage for routine care is like prepaying for access to lower prices. This idea is the subject of a recent NBER paper by Robin McKnight, Jonathan Reuter, Eric Zitzewitz titled Insurance as Delegated Purchasing: Theory and Evidence from Health Care. Turns out, according to their work, this delegated, bulk purchasing function is a pretty big deal.

First, we highlight the fact that insurance provides an incentive-compatible means of engaging the services of an expert buyer. Second, we demonstrate that the discounts obtained by insurance companies are economically meaningful. When we study drug prices, we find an average discount of approximately 10%. When we study the prices paid for other medical services, such as doctor’s office and hospital outpatient visits, the average discount is even larger.

This suggests another limitation of self-insurance.

[A] form of self-insurance that has expanded recently is high-deductible health plans, which have grown from 4% to 17% of enrollees from 2006 to 2011 []. In these plans, households are responsible for the first $2,000-$5,000 of expenses, with a median deductible of about $3,500 []. Had all households been enrolled in plans with a $3,500 deductable, 38% of households would have failed to meet that deductable, and the average household would have borne 62% of expenditures (using our weighted MEPS data, and adjusting to 2011 dollars using the CPI – Medical Care). Advocates of these plans [] highlight the beneficial incentives they create for consumers to control their own health care costs. Set against this incentive, these plans weaken the price-negotiation incentives for insurers even more than employer self-insurance, as individuals have less ability to shift away from plans administered by insurers who negotiate poorly. Whether the benefits of stronger incentives for consumers will offset the weaker cost-minimizing incentives for insurers is an open question; the answer may differ for different types of care, depending on the potential for overconsumption, postponability, and price shopping.

I assume that it is typically the case that consumers paying out-of-pocket in the deductible range have access to the insurer’s price. If that’s so,** one thing that might help is more price transparency. Even if consumers are paying their own way in the deductible range, they do care about price (especially those who do not predict that they will blow through the deductible). If they are aware of how much better the insured vs. uninsured price is, then the pressure for plans to negotiate vigorously would remain.

* However, care purchased with dollars saved in a health savings or flexible spending account would be bought with pre-tax dollars.

** If this is not so, it drives me crazy. Why not? Anyway, can anyone tell me if this is typical, universal, rare, or what?


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