Markets and Medicare

Paul Ryan made a lot of news this past year with his budget blueprint and plans to transform Medicare.   Before long, most of his party may be running away from his as fast as they can as they media tries to cast any Democratic victory as a referendum on Paul Ryan.   We’ll see.  As Marc pointed out, it is all too easy to produce “throw Grandma over the cliff” videos to demonize any kind of Medicare reform, which makes serious reform unlikely.

I like the spirit of Ryan’s plan and the fact he recognizes that solving our fiscal mess means reforming entitlements, but I think there are serious problems beyond the political nightmare.  Here are my central concerns:

The first words out of Ryan’s mouth are always how those over 55 won’t have their coverage or premiums affected.  The problem is that Medicare for those currently over 55 will already sink the system even if those under 55 move into a new system.    All those babies born in the late 40s and early 50s are retiring, and everyone is living longer.  The demographics are not pretty, but even more important (and this is true of health care generally) is a lack of a mechanism to reign in the growth in costs.

Ryan and many others have an overly optimistic view of the ability of markets to solve the cost problem.  The idea behind market reforms is that insurance companies will compete for customers, thereby holding down costs.  This is where chalkboard economics runs into a hard reality: health insurance companies are extremely averse to competing on the basis of price.  When was the last time you saw an advertisement touting how one insurance plan or health provider had better prices than another.  I’m pretty sure the answer is never.  This is the sort of implicit collusion that is not supposed to happen in markets but often does.  There is some competition as insurers try to sell group plans to employers, who are more price sensitive than their workers, but health exchanges envisioned in the ACA are designed to be marketed towards individual consumers.

Auto insurance companies like Progressive and Geico have in recent years undertaken price competition, but there has been nothing like this in other types of insurance or in health care delivery.  To the extent that there is advertising in health insurance, it is always on the basis of quality, not price.  And I don’t think there is any desire on the part of insurance companies to enter into a system where they compete on price.  In fact, they will likely be very hostile to it.  They are happy to take government subsidies, just don’t expect them to offer lower premiums.

My state of Utah is the first to implement a market-based health insurance exchange.  Unlike the Massachusetts plan, there is no mandate.    It is still very small, and insurers have been brought to the table somewhat grudgingly.  When the program was in its pilot stage, insurers were actually offering plans in the exchange at higher prices than they were offering the same policies outside the exchange (in part because of the difficulty of adjusting premiums for risk within the exchange).   And, since then, insurers have hardly been racing to the exchange with the view that “Hey, I can get new customers by offering lower prices to customers than my competitors do.”  As a free-market economist, I’m supposed to be committed to the idea that economic rents will be driven out by the downward pressure on prices caused by competition.   Health care is industry that severely tests my convictions.

One problem among many is that neither health care or health insurance have a history of transparent pricing.  No one except a few actuaries buried in their offices know what anything actually really costs and hardly anyone observes the real prices, especially patients or providers.  Any given insurance plan has so many pages of details that it is virtually meaningless to say that Company A offers a cheaper plan than Company B because no two plans across companies are the same.  Having the government (or someone contracted by the government) write standard plans that would facilitate price competition is a natural first step to a solution, but this is something the industry is hostile to.  Again, they are extremely averse to institutional changes that incentivize price competition.   Insurance companies have been making good profits for their shareholders for decades by not being transparent about prices and quantities, so why would they be eager to start now?   Will prices respond to market pressures in the long run?  Yes.  But that adjustment, will be long and painful, and politicians are unlikely to institute the kind of reforms necessary create true price competition.

So, the idea that insurance companies are going to jump up and down with the opportunity to compete for customers is naïve.  This is even more true when we are talking about the elderly.  Old people get sick a lot, and if there is something that insurers really don’t like, it is sick people.  Insurers would be more than happy to take subsidies from the government to sell policies to people as long as they can charge what they want to (ObamaCare in a nutshell), but, again, they are not going to compete on price.

The private market for individual insurance policies is not friendly to consumers and any amount of risk in one’s profile can send premiums sky high.  And that market doesn’t even serve the elderly to any great extent.  What would a large scale private insurance market look like for those over 65?  One thing is certain.  Premiums would be extremely expensive.  To have any kind of private insurance market that covered the needs of all seniors would require extensive oversight and regulations to deal with the huge cracks that would surface all over the place.  I highly doubt that such a new regulatory regime would be that much more palatable to libertarians than is the current single-payer system.

At this point, I may sound like a hostile critic of the insurance industry.  I’m not.  The main reason insurance costs continue to rise rapidly is not because of insurance market failure, it is because the underlying costs of health care keep rising rapidly.  Insurance companies have some sway over those costs because, since they ultimately pay the bills, they place limits on what they will pay for.  The market might develop mechanisms to hold down those costs, given that consumers have limits on their ability to pay, but that is an uncharted path.

I’m afraid that cutting Grandma a check and telling her to go buy health insurance is not going to work.  This is asking the insurers to take on people they don’t want and behave in ways they never have before.  More than that it will leave millions of seniors without insurance.  Whether or not that is morally acceptable is a date for another day, but politically it is not sustainable.

2 thoughts on “Markets and Medicare

  1. Health care and insurance are separate things. Insurance is a promise to pay if something specific occurs. The cost of this promise is determined by the insurance provider based on the expected total payment and the likelihood (risk) that it will be required. Any profit that an insurance company adds to the premium calculation is the only component on which they can price compete. In many cases, insurance companies (those that underwrite the policy) do not profit off the premium, they profit from investing the premium dollars between the time they are collected and the time when a claim is paid.

    The relationship among health care providers, consumers, and insurance providers is distorted by the imposition of government mandates: to cover certain procedures, to cover specific individuals regardless of risk, and to charge uniform premiums with no allowance for differences related to risk. The usual capitalist price mechanism is also blunted by the fact that the government and insurance companies are between the consumer and provider of health care services.

    Allowing the government to set prices and mandate services is most likely to cause of shortage of health care service delivery; fewer doctors, fewer procedures, reduced incentive to innovate, and so on.

    I don’t know what the answer is, but I’m pretty sure that mandating coverage, restricting premiums and payments, and forcing the insurance industry to be a defined benefit provider (payee) is not it.

  2. I’ve often wondered what the world of health insurance would be like if Geico or Progressive or Nationwide could compete. There are two factors that I see, at least here in Minnesota, that disallow such competition. The first is the size of BlueCross-BlueShield. It’s doubtful they’d allow competition. The second is the types of coverage mandated by rule and statute. There are a couple of smaller companies (which I think are subsidiaries of BC-BS) for instance that offer insurance, but through coverage from any of them, I, a 51 year old male, am required to be covered for OB-GYN. With health insurance in Minnesota, it’s either all or none. Imagine what it would be like if any of us could go online to say, Progressive, and check the boxes for the coverages and deductibles we wanted. If we could “name our own price.” And then like auto coverage from All State or Nationwide, we were rewarded with vanishing deductibles.

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