3 problems with a market-based health care plan

The Republican health care plan is meeting considerable resistance. On one side are Republicans who believe the government should get out of the way and leave health care and health insurance to a market system. They’re unhappy that the Paul Ryan-led House proposal leaves so much of Obamacare in place, leading them to call it “Obamacare 2.0.”

They’re particularly upset that the mandate in the Affordable Care Act forcing people to either purchase insurance or pay a penalty has been replaced by what amounts to a mandate in a different form, a penalty for not maintaining continuous insurance coverage.

On the other side are those who are unhappy that so many essential parts of Obamacare will end, with the likely result being the loss of health care insurance for millions of people, and higher costs for those who do have insurance.

But here’s the problem Republicans face in satisfying those who want markets to deliver health services as free as possible from government intervention: Health insurance and health care both suffer from significant “market failures,” and any proposal must find a way to overcome them, or the market for health insurance could go into a death spiral. One important question is whether the Republican plan is restrictive enough to prevent this.

Any plan will have to confront three important market failures in health insurance markets.

The first failure is called “adverse selection.” It concerns how to cover people with preexisting conditions. If insurance companies are allowed to set premiums for each person based upon their expected health care costs, the young and healthy would have very low premiums, while those who are older or already have medical problems would face insurance costs that are too high to be affordable. They would be forced to go without.

The solution to this problem is to put people into a large group that includes people with both low and high expected costs, and then set premiums based on the average expected health care costs for this group. 

However, in this case the healthy are likely to drop out because their premiums, which are set based on covering some very-high-cost members of the group, would be greater than their expected health care costs. Many will decide it’s better to go without insurance, and then either pay when care is needed or go to an emergency room for more severe injuries (a more expensive way to deliver care).

As the healthier people decide to go without insurance, it leaves a higher relative number of people with larger expected health costs in the group. Then premiums will go up further, more of the relative healthy will exit, premiums will be forced up again, more people will exit, and so on until the only people left in the group have very high expected costs and face unaffordable premiums.

Thus, if you want universal coverage to be available at affordable rates to all, some sort of mandate is needed to keep healthy people in the system (along with subsidies for low-income households). This is a highly controversial part of the both Obamacare and the Republican proposal, but it’s hard to see how you can achieve universal coverage without something like it. 

Obamacare accomplished this through a mandate requiring people to purchase insurance along with a financial penalty if they don’t. The Republican proposal replaces this with a 30 percent penalty for failing to maintain continuous coverage (your premium will jump if you get insurance after a pause in coverage). It’s not clear, however, that this is sufficient to prevent the problem of healthier people (especially the young) going without insurance and leading to the demise of affordable coverage.

The second failure is called “moral hazard” -- once people have insurance, they have less incentive to take care of themselves, no reason to limit the number of trips to the doctor and no reason to limit how much health care they use. 

The solution to this problem is to make sure that people pay for some share of their health care costs through deductibles and through less-than-100-percent repayment for health care spending. However, if the deductibles are too high or the repayment rates too low, so that the insurance essentially covers only catastrophic events, many people will forego the basic care they need to keep small problems from growing into big ones. That would raise health care costs over time.

The third failure is called “asymmetric information,” and it’s a stumbling block for the idea that unregulated markets would be the best way to deliver health care and health insurance. That’s because consumers have very little ability to evaluate the need for health care procedures, the relative skill of doctors (something I’d want to know if shopping around for the best price) or even in many cases, an inability to evaluate the quality of work after a procedure is completed. 

Someone needs to stop doctors who own imaging facilities or other testing centers and then ordering more tests than are needed to increase profits. It’s hard for the patient to know if that test is really necessary, they have to rely on doctors, and the insurance company will pay for most of it, anyway.

Government regulations are one way to solve these types of problems (e.g. declaring that owning testing facilities creates a conflict of interest for doctors and prohibiting it). And insurance companies play a role by intervening on behalf of consumers to prevent unnecessary spending (though, in some cases, they go too far and cut necessary spending to maximize their profits). Professional groups play this role as well, though such self-policing isn’t always effective.

The point is that consumers don’t have the information they need to make decisions in a way that would allow the market system to function effectively, and regulations, institutions and other constraints on the market are needed to protect consumers and ensure they get the care they need. Otherwise, they’re liable to be subjected to either unnecessary care by health providers maximizing profit, or too little care due to insurance companies trying to do the same.

All around the world, you see heavy government involvement in health care. There’s a reason for this. The market will not deliver universal, affordable health care on its own. If the preliminary evaluations of the House GOP “repeal and replace” plan is correct, the number of people with health insurance will fall significantly, and costs will go up -- not exactly a step forward as I see it.

Of even more concern, the 30 percent premium penalty for not keeping continuous coverage -- the new “mandate” -- may not be strong enough to prevent the individual health insurance market from collapsing, an outcome that would be far worse than a step in the wrong direction.