Monday, September 14, 2009

WSJ inadvertently supports case for health care reform: do you want to trust your health to profit and loss?

Yesterday's WSJ has a piece defending the health insurance industry practice of rescission against "demonizing" by the President. You'd think it would be pretty hard to defend companies for revoking sick customers' insurance policies after the fact, but the Journal does a surprisingly good job. It's a utilitarian case - insurance companies mostly trust people to report their health histories truthfully; after-the-fact rescission is much less costly than the alternative to the honor system - extensive verification of every applicant's medical history prior to approving a policy.Moreover, the article cites testimony by insurance company CEOs noting that the 20,000 policies rescinded over the last 5 years, though seemingly a large number, amounted to only 0.5% of the total policies issued over that period. And of those that were rescinded, many were done so legitimately - i.e. the patient had actually concealed medical information which, if it had been known when the person first applied for insurance, would have prevented the insurance company from issuing the policy in the first place. Very few rescissions, then, were truly egregious.

The implication, if true, is clear: if you sign up for health insurance, you have a very low risk of losing it.

But that's a misleading way to look at it, since calculating the percentage of policies that get rescinded from the total number of policies includes mostly healthy customers. In any given period, few policies will be rescinded, simply because few people will file for major medical expenses. Remember, rescission is only triggered when a patient files a claim that threatens insurance company profits - cost-savings from not having to screen everyone upfront is the argument for the practice in the first place. The proper question to ask is therefore not, "if I have insurance, what are the chances I will lose it," but rather, "if I get sick and need to use my insurance, what are the chances it will be taken away?" (Note: this only applies to people who get their insurance on the individual market or through a small business.)

As long as you're healthy, you don't need to worry about losing your coverage - insurance companies are happy to keep taking your premiums as long as you aren't filing for expensive benefits. It's when you get seriously sick, and you actually need coverage, that you need to worry about rescission. And since the purpose of insurance is to pay for unexpected major medical expenses, the proper population to look at is the number of people who lose their insurance when they find themselves in a dire situation.

So now that we're asking the proper question, what are those chances? If we're unrealistically generous and assume that insurance companies target the most expensive 10% of all insurance claims for rescission, 5% of people will lose their insurance if they become sick. But it's probably more realistic to assume that insurance companies target only the most expensive 1% of claims, in which case you would have a whopping 50% chance of having your insurance revoked - a far cry from the 0.5% cited by the CEOs. This blog explains better than I can - I recommend you read the whole post:

An individual adult insurance plan is roughly $7,000 (varies dramatically by age and somewhat by sex and location).

It should be fairly clear that the people who do not file insurance claims do not face rescission. The insurance companies will happily deposit their checks. Indeed, even for someone in the 95th percentile, it doesn’t make a lot of sense for the insurance company to take the nuclear option of blowing up the policy. $11,487 in claims is less than two years’ premium; less than one if the individual has family coverage in the $12,000 price range. But that top one percent, the folks responsible for more than $35,000 of costs – sometimes far, far more – well there, ladies and gentlemen, is where the money comes in. Once an insurance company knows that Sally has breast cancer, it has already seen the goat; it knows it wants nothing to do with Sally.

If the top 5% is the absolute largest population for whom rescission would make sense, the probability of having your policy cancelled given that you have filed a claim is fully 10% (0.5% rescission/5.0% of the population). If you take the LA Times estimate that $300mm was saved by abrogating 20,000 policies in California ($15,000/policy), you are somewhere in the 15% zone, depending on the convexity of the top section of population. If, as I suspect, rescission is targeted toward the truly bankrupting cases – the top 1%, the folks with over $35,000 of annual claims who could never be profitable for the carrier – then the probability of having your policy torn up given a massively expensive condition is pushing 50%. One in two. You have three times better odds playing Russian Roulette.

The WSJ's reply would be, "yes, of course, but that still beats the alternative, which is to extensively investigate EVERYONE for preexisting conditions. They have to screen people somehow - after all, the insurance company can't make money if it has to cover expensive patients."

And that, right there, is the rub: a health insurance company can only stay profitable so long as it excludes the people most in need of its services. The problem isn't just the existence of rescission - the very fact that insurance companies have to exclude anyone is an indictment of unregulated private health insurance, proof that free market principles don't apply to health care.

Standard economics teaches that the best way to predict the behavior of a firm is to understand its incentives. An insurance company's incentive is to collect as many premiums as possible while minimizing the amount it pays in health care costs. Paul Krugman explains:
Actually paying for your health care is a loss from an insurers’ point of view — they actually refer to it as “medical costs.” This means both that insurers try to deny as many claims as possible, and that they try to avoid covering people who are actually likely to need care. Both of these strategies use a lot of resources, which is why private insurance has much higher administrative costs than single-payer systems.
According to basic economics, then, leaving health care to the free market will result in a nation of healthy people who can afford health care and sick people who cannot - the exact opposite of what's best for society. This, in fact, is why Medicare exists. Conservatives like to use Medicare's looming bankruptcy as proof that government can't run a health insurance program, but Medicare's problems stem not from government inefficiencies but from the nature of its patients: the oldest, sickest, and most expensive Americans to cover. 65+ Americans spend 3.3 times as much per capita on health care as Americans in the 19-64 age group (and 85+ spend 5.7 times as much - more than $25,000 per person). Medicare exists because no private insurer can cover senior citizens and remain profitable - leaving health care to the market would mean old people dying in the streets or crushing financial burdens on their families.

And it's not just in insurance companies' interest to exclude sick patients from the beginning; it's actually more profitable to sign them up and then maximize the number of rescissions, stringing patients along and extracting premiums for as long as possible before revoking their coverage right when they make a claim for benefits.

To illustrate the point, imagine a hypothetical insurance company that can see perfectly into the future. A woman is applying for health insurance, and the company knows in advance that in 5 years she will get breast cancer and need $50,000 in treatments. The company also knows that she has failed to disclose a medical condition on her health history questionnaire, justifying rescission once she applies for breast cancer treatment. Because the company knows it will not have to pay for her treatment if it so chooses, it is in the company's best interest to sign her up anyway, soak her for 5 years of premiums, and then rescind the coverage to avoid the $50,000 charge.

In fact, the incentive for the insurance company is to make the woman's health care questionnaire as confusing as possible in order to maximize the chance that she makes a mistake - it's an escape hatch that allows the company to cancel an expensive policy, a way to guarantee a few years of premiums without the risk of ever incurring medical costs. It's not the moral thing to do, but it is the most profitable.

People who work for health insurance companies are good people. But the system creates powerful financial incentives to do bad things.

We've been conditioned to believe in the Invisible Hand, that if each individual is allowed to pursue his or her own self-interest, everyone will benefit. But in the health care market at least, what's profit-maximizing is by definition not socially optimal - in what other market can a company take back a product you've paid for, just as you need to use it? Insurance's role in society is to ensure that, in exchange for a predictable fee, society's members will not be ruined by an unexpected calamity. Instead, our system ensures that those who become the sickest are the least able to afford treatments they need to get better. In a free market, a health insurance company that does its job to society cannot stay in business.

State Farm made headlines at the beginning of the year when it announced it would withdraw from the Florida property insurance market - it was simply too expensive to cover houses that kept getting destroyed by hurricanes. Of course, you can choose not to build a million-dollar home on a hurricane-prone beach. You can't choose not to get pancreatic cancer. Do you really want to trust your health to a corporate P & L?


The catch-22 for opponents of health care reform

There's no money in selling insurance to sick people: more reasons free markets don't work in health care

The Takeover: What opponents of health care reform don't get

Are Sarah Palin and Martin Feldstein closet universal health care supporters?


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