The Problem With Health Insurance: It Isn’t

Image by SavaTheAggie via Flickr -- Mandate or Preexisting Conditions, either way, someone has to pay the fire department.

Alan Grayson just introduced what is perhaps the most simplistically brilliant health-care legislation yet seen by the 111th Congress.  The “Public Option Act” [PDF] would allow individuals to buy into Medicare at cost.  That’s it; no strings, caveats, or gotchas, just reasonably priced access to the most efficient health insurance available in the United States today.

Except it isn’t, health insurance that is.

Insurance is a means of distributing risk.  Take auto insurance, for example.  In a group of 1000 people perhaps one will have an auto accident in any given month.  The cost of such an accident is large – tens of thousands of dollars – but by having all thousand pay a much more modest sum on a monthly basis no one has to shoulder the burden alone.  Since no one really knows when or if any given individual will be involved in an accident, there’s no meaningful advantage to buying into the system earlier or later.  In short, each monthly premium represents one subscriber’s portion of the collective risk.

Health insurance doesn’t work that way. 

A given driver might never be in an auto accident but he’ll still need oil changes, brake repairs, tune-ups, and other regular maintenance.  Auto insurance doesn’t cover those things because they are not insurable expenses.  For an expense to be meaningfully insurable it has to be rare and occur fairly randomly within a given population.  Since break repairs and oil changes are regular expenses involved in owning an automobile and since everyone pays them, distributing the risk of those expenses is fairly meaningless since everyone who owns a car already has roughly equal exposure to them.  There are normal expenses associated with the care and maintenance of the human body as well: checkups, routine blood work, cancer screenings, vision tests, dental exams; all of these a part of the normal preventative care that makes up a healthy lifestyle.  Most health insurance plans pay a large portion of some or all of this type of expense and we expect that service in return for our monthly premium check, yet those costs are fundamentally not insurable.

What Americans call health insurance is really two products rolled into one.  The one that helps defray the expense of broken arms, appendectomies, chemotherapy, and other insurable expenses is rightly termed health insurance.  By buying into a health insurance pool we spread the risk of these infrequent but expensive treatments around so that no given individual has to pay the full cost.  Unfortunately, even this is a bit of an oversimplification.  Unlike just about every other form of insurance, patients and insurers can get a fairly good idea of what costs will strike whom and when.  As a result, insurance companies have a strong incentive to avoid insuring patients who are likely to prove expensive and patients have a strong incentive to put off buying into an insurance pool until doing so proves absolutely necessary.  The free-market solution to this problem, the pre-existing condition, has become politically unpopular in the United States and the government-regulatory solution, the insurance mandate, is not proving a great deal more popular.  One way or the other, however, the bills have got to be paid; insurance can not and does not work if the only people buying into it are the ones who need it.

The other major product that comprises American health insurance is an elaborate means of amortization.  Preventative care is uninsurable because it is frequent and fairly uniform but that also makes it reasonably predictable.  Sum the cost of that care for an average year and divide by 12 and you have the monthly cost (absent some accounting wizardry that adjusts for inflation).  Add that to the premiums already being paid for health insurance and you have a single product that covers both preventative and non-preventative care.  This is what Medicare (and almost every private insurance option available) is, a combination of these two related but financially distinct means of defraying the costs of health-care.

To be fair, there is nothing really wrong with this system as it is presented above.  It makes sense and it turns medical costs into a fairly manageable and predictable expense for the average consumer.  So of course, there has to be a catch.

Under most European systems of medical care, when a hospital or doctor submits a bill to an insurance provider (public or private) it is functionally an order to pay [PDF].  There is a key word there: “order.”  Here in the United States there is not so much an order as a request and the entire apparatus of health-care billing as it exists in the United States exists because insurance companies may choose not to pay for a given procedure on a case by case basis.  Insurance companies contain vast bureaucracies whose job it is to sort through mounds of paperwork determining what is and is not applicable.  It often takes months for a bill to percolate through this review process and, since there is a profit motive involved, health insurance companies often err on the side of the shareholders when a question comes up and refuse payment.  The resulting appeals kick the bill back through the entire system again, creating yet more paperwork and delay.

The “request” rather than “order” based system and thus the review process it necessitates create a number problems as a result of their interaction with the combined insurance product described above.  The review system is really designed to deal with the insurable expenses, those large and unpredictable costs that are the impetus for health insurance in the first place, but everything gets routed through the same system.  As a result, payment to doctors and hospitals is delayed significantly by the paperwork apparatus of private insurance.  Medical establishments must be able to float health care costs for the entire practice over the multi-month billing cycle.  In addition they must dedicate time and money to filling out and filing bills with the various insurance providers they support and take on the risk of a patient’s inability to pay should insurance decide not to cover the expense.  As a result of all of this, “administration consumes 31% of health spending in the U.S,” according to Dr David Himmelstein, Associate Professor of Medicine at Harvard University.

Medicare, on the other hand, enjoys a much lower overhead cost with estimates as low as 3%.  Part of that efficiency, as Fox Business critic Elizabeth MacDonald points out, is that Medicare is able to defer certain costs (like premium collection) to other Federal agencies.  MacDonald also charges that Medicare efficiency studies engage in a bit of accounting slight-of-hand, cherry-picking statistics which make the program look more efficient than it really is.  One thing is for certain, Medicare’s claim review process is not terribly dissimilar from the review process used in the nation’s major private insurance companies.  Claims are subject to denial based on a host of conditions and the process is still fairly paper-work intensive.  Yet, Medicare lacks a profit motive and as a result, of the insurance options presently available in the United States today, it is the only one that could viably make the transition to the European model of “order” rather than “request” for payment.

At worst, Grayson’s bill opens the door to the generational stabilization of a government program beset by an influx of aging baby-boomers.  At best it is the first step towards a saner and more sustainable means of dealing with the rising cost of health care.