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Opinion
How to Reform Health Insurance Using Casualty Principles
By Michael A. Walters 

Now that the Affordable Care Act of 2010 (ACA) has been found to be constitutional, there may well be a movement after November to repeal it. While the mandate to purchase insurance was ruled unconstitutional under the commerce clause, the law itself is justified as a federal tax. Yet the tax itself and the penalty for not paying it may both be inconsequential, so the number of young uninsureds who will chose to pay overpriced premiums to subsidize the other more generous coverage expansions may be quite small.

Therefore a new system may be needed to accomplish many of the goals of ACA, but without the perceived infirmities of ACA. Such a system could be developed that offers coverage for preexisting conditions, more competition from insurers, and portable policies that can stay with the insured when changing jobs and have guaranteed renewability.

This article will outline a new personal health insurance system (PHIS) that will, at first, seem radical to many because of how the current health insurance system has evolved. Most coverage today is marketed through employers and the price of this coverage for individual policies is heavily influenced by government controls. An example of such a control is community rating to prohibit rating by age, which presumably obligates young people to subsidize the expensive policies of older Americans.

PHIS is modeled after programs that have worked successfully for decades in auto, homeowners, and hurricane insurance, where residual markets have been designed to provide coverage for hard-to-place risks. The goal is to maintain the competitive market for the 90% or more who have been satisfied with the results of the free market, which has yielded good coverage at relatively low profit margins due to the hundred or so insurance companies licensed to write those coverages in each state.

Yet health insurance does have some additional problems that must be addressed. One such issue is preexisting conditions coverage, which even if priced at an actuarially sound rate, would be unaffordable for many insureds without some premium support—hence, an insurance stamp system could soften the blow for these insureds by providing outright subsidies from Medicaid block grants back to the states. This insurance stamp system would be an improvement over government price controls that attempt to make coverage more affordable, but ultimately could destroy the ability of the competitive market to function.

High Costs—A Major Problem
The reasons why medical costs are so high today and inflating faster than most other goods and services are numerous and complex. The box on page 18 lists some of the underlying reasons flowing from supply, demand, inefficient pricing mechanisms, and the tort system.

The Other Problem—Uninsured Population is Large (But Not Uniform)
There are four broad and very different categories of the uninsured today:

  • Higher Cost/Hard to Price—including those with preexisting conditions or other lifestyle problems that could lead to a greater need for treatment in the future   
  • Rejecting Insurance as Not Worth the Price—including the young who perceive their risk of needing treatment as low, as well as the wealthy who can self-insure and use preventive methods to keep costs down.   
  •  Chronically Ill or Poor—including homeless   
  • Non-Citizens—in the shadow economy

Even these four broad categories can be broken down further so that the answer can vary greatly from the one-size-fits-all solution adopted by ACA, which said that everybody must buy a government-specified policy.

The Basic Goals of PHIS in dealing with the above problems are to (1) contain costs, (2) make healthcare available, and (3) affordable, and to (4) use the free market rather than government controls to keep the system efficient, innovative, well supplied, and competitive.

The Subsidiary Goals of PHIS are that healthcare be portable, and guaranteed renewable. Other subsidiary goals are to use incentives rather than mandates to maintain the system and, finally, to acknowledge that insurance is not always the answer to healthcare access.
Health Care

A better insurance system, based on sound insurance principles along with free market approaches, can help solve a number of the overall cost and availability problems. The solution should avoid the controversial approach of mandating overpriced insurance coverage to some in order to subsidize underpriced coverage for others. It also should not hide the true insurance cost in a “community rating” system that ignores relevant information that can identify where cost controls are the answer rather than just paying total claims.

The PHIS Solution’s Nine Basics

  1. The Free Market Works—Use It
    Sustainable solutions have to abandon the notion of heavy government control that thwarts the efficiency of the competitive market. Front-end government controls lead to an everincreasing need for even more mandates to keep that inefficient system going.   
  2. Price Controls Don’t Work
    Under government price controls (either federal, state, or local), the supply of products and services drops and innovations cease. Government tries to make decisions it is ill-equipped to make, under the mistaken impression that all customers want the lowest possible price, without regard to quality or availability. Mandating a common coverage that government deems to be the desired product usually means many insureds will overpay for some coverages that they don’t want or need. The implication would be to let the market offer options.   
  3. Copy Successes from Other Insurance Programs by State
    For risks that are hard to place because of uncertainties and a higher expected loss, but not a catastrophic one, an assigned risk plan works well. Each of these unplaced risks goes into a system that assigns them randomly to voluntary carriers for coverage in each state. The assigned carrier collects the adequate premium for the assessed risk and investigates and pays the claims under the policy. If the premiums collected are insufficient, an insurer is entitled to pass the loss onto its voluntary insureds in future premiums if it is likely the shortfall will continue. Auto insurance generally works well this way, as a small subsidy is paid by the remaining market. (An underpricing of, say, 20% on 5% of the population that needs an assigned risk plan translates to only about a 1% surcharge on voluntary market rates.) For catastrophic-type risks (e.g., those with preexisting conditions that make extra high future health costs likely), a separate involuntary market mechanism is needed, similar to a catastrophe wind pool on homeowners insurance.   
  4. Don't Give Workplace Advantages Over Individual Policies
    Employer-based health insurance expanded during World War II, when wage controls spawned tax deductibility to attract workers by this added benefit. Yet the model of working for the same company for one’s whole career is now an anachronism and being unemployed for more than a short time is a higher risk that group policies can’t handle. Furthermore, health issues may be an impediment to a person even getting a new job if the applicant were viewed as raising the cost of the employer-supplied health plan. Lastly, tax deductibility has caused abandonment of basic insurance principles, like efficient direct payment for the small losses and transferring risk for the large ones. Individual insurance policies like those in auto and homeowners insurance may be the answer here, especially if they carry guaranteed renewability in the future. If someone develops a subsequent condition after initial underwriting, that can be priced for in the original policy so no extra premium is warranted at renewal. And larger deductibles will bring more control of costs by the insured paying the small bills directly and restoring the buyer/supplier give and take.   
  5. Combat Overutilization
    With more traditional individual policy insurance, higher deductibles, copays, and coinsurance can usually deal better with the problem of overutilization. Costs tend to be higher when the patient is insulated from payment participation decisions and when the costs are paid by somebody else.   
  6. Use Premium Support, Not Price Controls
    Other needs in life do not require federal government intrusions with price controls in the marketplace. Periodic state and local government attempts to provide affordable shelter (e.g., housing projects and rent controls) have usually resulted in failures. Food stamps, on the other hand, have been a partial aid to affordability without the government trying to control prices. Price controls invariably lead to supply problems (shortages) when competitive markets are short-circuited. Food stamps in theory only go to those who need them without imposing price controls on suppliers. Health insurance stamps could be used similarly as a partial solution to affordability problems for health insurance without intrusive price controls on healthcare service providers. But, in a lesson from food stamps, effort must be made to eliminate any abuses of the program. The number of recipients of food stamps has doubled in the last 10 years. Government bureaucracy in the program has led to expanded amounts of fraud by those attempting to qualify, with poor incentives to remove the unqualifieds. One answer may be to outsource management of the program to the private sector, possibly varying by state.   
  7. Avoid New Federal Laws, If Possible
    Federal mandates are questionable under the U.S. Constitution. Furthermore, Public Law 15 already exists (passed in 1945 as the McCarran-Ferguson Act) that allows states to regulate the insurance business and preempts most federal action. This law has allowed personal auto insurance and homeowners insurance to flourish with over 100 competitors selling those products in most states, with fairly low profit margins (3% to 4%) typical of highly competitive industries. States also administer the market assistance plans for hard-to-place risks that need these coverages. One change in federal law is needed, however, to remove the special tax deductibility of group health insurance at work—a deduction that individual policies do not have. This would allow individual policies, with complete portability, to compete with workplace-offered policies.   
  8. Customize Solutions by Type of Uninsured Today
    “One-size-fits-all” solutions mostly don’t work. There are many reasons people do not have health insurance today. It is useful to analyze why and craft solutions for each of those major segments, and not to try to solve the whole problem en masse. See the box on page 21 for ways to approach the different types of uninsureds today.   
  9. Pass Tort Reform by State to Deal With Medical Liability Lawsuits
    The fear of lawsuits has spawned the practice of defensive medicine, which is estimated to have increased costs by as much as 10% without really benefiting patients. Spurious lawsuits and outrageous allegations of “pain and suffering” have caused MMLI premiums to exceed $100,000 a year for some specialties. This is ironic because the quality of medicine now is so much better than it was when MMLI coverage was about as cheap as auto collision insurance coverage.
    situation-solution
       

    In 1975, California enacted its Medical Injury Compensation Reform Act (MICRA), limiting non-economic loss in medical malpractice cases to $250,000 with caps on attorney fees. This has worked well to bend the cost curve downward. States can be encouraged to innovate with tort reform or to adopt successful models by varying the amount of premium support from the federal government using block grants of Medicaid funds.

Transitioning to PHIS
The alternative health insurance system described herein would take a few years to fully implement, as it depends on the pace at which individual state legislatures take the initiative to foment an aggressive set of assigned risk plans for health insurance. The National Association of Insurance Commissioners (NAIC) and the National Conference of Insurance Legislators (NCOIL) could help with supporting and crafting model legislation, but they would have to wait for the U.S. Congress to take action on the tax deductibility of today’s employer-based group insurance policies.

In the atmosphere of lowering overall tax rates by eliminating exemptions and taking tax deductibility away from employer- supplied insurance, PHIS would seem easy to implement. It would then take time for the more than 1,000 insurers in this country to crank up capacity to handle individual health insurance policies and to rate them using new rating criteria allowed by free market principles.

There may be a need for a step-up in actuarial capacity to meet that demand in the U.S. as well. Pricing of individual health insurance policies for over 100 million households has not been needed in the past, as group policies sold through employers have met those needs with relatively few insurers supplying the pricing and using large commercial risk concepts such as experience rating as the pricing mechanism. Having a robust individual risk rating system, such as the model that exists in auto insurance, would be a major expansion of the health insurance pricing challenge, especially when removing the concept of “community rating” where rating variables were not allowed by government fiat. Predictive modeling, a mainstay in the personal auto pricing arena, can be adapted to the huge number of individual health policies unleashed in this new PHIS concept.

Final Perspective on Costs
In reality, with something as vital as one’s health, the proportional cost of healthcare may be appropriate if total health spending stabilizes at 15% or even 20% of GDP. Many would rather have another 20 years of higher quality of life than an 80-inch 3D TV. Most Americans would not trade our medical care facilities for those of other countries where rationing, delays for MRIs, and earlier deaths from preventable outcomes are more accepted.

Health care might well deserve to be the third most costly item in one’s annual budget behind shelter and food. The main problem then becomes the need for wider availability of insurance to spread out those costs over time, so that one-year variations don’t break the bank. And if an alternative healthcare insurance system (namely PHIS) can actually help to bend the cost curve down, even better.

Michael Walters, FCAS, is former CAS president who has written three CAS Proceedings papers on risk classification, homeowners ratemaking, and catastrophe risk that were included on the CAS exam syllabus. He retired as a senior partner of Tillinghast-Towers Perrin (now Towers Watson). Previously he was senior vice president and actuary (in charge of all actuarial and statistical operations) at Insurance Services Office.   

Some of the author’s ideas in the article came from the following key sources:

Friedman, Milton, “How to Cure Health Care,” Hoover Digest, July 30, 2001;

Wheelan, Charles, Ph.D, “The Top Ten Reasons for Soaring Health-Care Costs,” Finance, February 28, 2006.


Reasons for High and Escalating Healthcare Costs   
  1. Demand is great and growing.   
    • Everyone wants maximum healthcare—what’s more important than your health?   
    • The population is aging and older people need more healthcare.   
    • Doctors are motivated to do more, given more techniques available and the threat of lawsuits.   
    • Increased affluence allows more inclination to spend on the crucial service of healthcare.   
    • Some lifestyles today are not conducive to good health, e.g., little exercise, obesity, alcohol.   
    • Knowledge and awareness of insurance programs promote more usage.
  2. Supply is not unlimited.   
    • New technologies are very expensive.   
    • Training of new doctors is time-consuming and expensive.   
    • Many uninsureds use emergency rooms in a crisis (more expensive than alternatives, and hospitals’ unrecompensed costs are passed along to others in the form of higher prices).   
    • Medicare’s governmental controls on fees discourage new doctors from entering the profession and cause existing ones to consider leaving.
  3. Usual price mechanisms to deal with demand/ supply issues are not being applied.   
    • Someone else usually pays the bill—insurance through employers or the government—so customers have little incentive to shop for value.   
    • It is difficult to change insurers (if employer-supplied) if one is dissatisfied with service.   
    • Not all expensive procedures are equally valuable; shopping for value is not very common.   
    • Lack of information on cost and outcomes further limits the ability to comparison shop.   
    • There is a complex trade-off involving the certain costs of annual checkups and expensive diagnostics versus the cost of treating more advanced problems later.
  4. The tort system creates special cost problems.   
    • Defensive medicine to avoid a tort claim is a wasteful add-on to overall costs.   
    • Medical malpractice liability insurance (MMLI) for some specialties can far exceed $100,000 a year in premiums, driving up doctor and hospital bills.   
    • These extra MMLI costs can often deter doctors from practicing in some specialties (e.g. obstetrics) and in some locales.

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