Health insurance markets won’t work without good policy

Early this morning, 48 Democrats and three Republicans in the Senate rejected a partial repeal of the Affordable Care Act.

While the Senate GOP called it “skinny,” the impact would have been huge: the Congressional Budget Office (CBO) estimated that the bill, if passed, would have left 15 million people uninsured with premiums rising by 20 percent.

{mosads}The CBO’s numbers undermine the Republicans’ refrain that doing away with government regulations and tax subsidies will make healthcare and insurance markets more efficient. But as anyone who has taken a good Econ 1 class knows, non-regulated, “free” markets cannot achieve the lowest possible price for a given quality of a good or service when key conditions are missing. Monopolies block competition, for example. In healthcare and health insurance markets, lack of perfect information is the key missing condition.

There is no way — even with online apps — that most of us can determine what’s wrong or what we should do when we have a serious medical problem. We depend on physicians and other healthcare providers who have spent years learning about various conditions and diseases to diagnose symptoms and guide us in choosing among an ever-expanding set of treatment options.

It also takes a lot of time and effort to find out what different physicians and hospitals might charge for various treatment options. If you are considering an elective treatment such as a knee replacement, you have time to try to obtain such information. But when an emergency strikes — such as chest pains or symptoms of a stroke — obtaining cost information about different diagnostic tests and then about different treatment choices (which themselves depend on the diagnosis) is simply impossible. And given that everyone responds differently to treatment options, any cost estimate for a very serious condition is really just a guess.

Similarly, insurance companies can’t predict with certainty which of their customers will have extremely high medical expenses. Although insurers use models to identify certain characteristics (like age or medical history) that are correlated with above-average medical costs, they cannot fully anticipate every need for expensive medical care in the upcoming year.

This lack of perfect information — for insurers and individuals — is the basis for creating an insurance pool for sharing risks. But pooling risks and keeping average costs at a reasonable level means the pool needs to have many people with low costs to balance out the small number who have extremely high costs in any given year. In the U.S., half of us account for only 3 percent of all healthcare expenses in any given year — and insurers need such people to balance the 10 percent of us who account for 70 percent of expenditures each year.

Over time, a given individual’s medical costs will inevitably vary, which is why most of us want and need health insurance — to avoid unexpected high medical expenses. Insurers prefer to work through large employer groups because the individuals are in the group independent of their risks of needing high-cost medical care.

But when people have a choice of purchasing insurance in the individual market, insurers fear that younger and healthier people will apply for insurance only when they believe they have a medical problem. Insurers must assume the risk pool has a smaller share of low-cost people so they set higher premiums to make up for it.

The Affordable Care Act attempted to addresses the insurers’ information problem by creating funds to compensate insurers that enrolled a disproportionate number of people with high costs. (Unfortunately, Congress has not financed these funds.) It also provides individuals with income-based subsidies so that larger numbers of healthy people enroll in plans, while offsetting insurers’ losses when they have unexpectedly high numbers of high-cost people.

If those regulations were gutted, insurers in the non-group market would be emboldened to act as they did before the Affordable Care Act was passed. They could deny coverage, restrict coverage for some conditions, or charge higher premiums to people their models suggested would have high costs. This effectively denied coverage to people with pre-existing medical conditions who could not obtain or afford health insurance.

The reality of the healthcare insurance market is more complicated than the simplistic rhetoric of “free markets” and “competition.” If we want to continue to have private health insurance, we need smart government programs that help markets focus on delivering efficient services.

The GOP’s plan wasn’t just cruel policy — threatening to leave millions with healthcare needs in limbo — it also made no economic sense.

Katherine Swartz is professor of Health Economics and Policy at Harvard T.H. Chan School of Public Health. 

The views expressed by contributors are their own and are not the views of The Hill.