Search Articles

  • Search Full Site
  • Display Articles Titles
  • Display Article Paragraphs
29 paragraphs found in the 1 Article listed below
Economic Research on Direct-Purchase Health Insurance: New Models for Real Health Care Reform : Linda Gorman
29 paragraphs found.

For a discussion of moral hazard, see Insurance, by Richard Zeckhauser; and for introductory material on the health care industry, see Health Insurance, by John C. Goodman, and Health Care, by Michael A. Morrisey. Concise Encyclopedia of Economics.

Early History of Health Insurance

By 1910, an estimated one third of all adult males in the United States belonged to fraternal societies. Like modern HMOs, some societies provided prepaid health plans that controlled the supply of medicine to member patients by refusing to provide care considered beyond the organizations' means. They hired "lodge doctors" who worked for the plan and were less likely to side with patients in recommending more care than the plan wanted to deliver. The societies used a variety of tools to control moral hazard. These tools included home-visiting committees, waiting periods for benefits, and curfews on members receiving benefits. People not covered by the fraternal societies could choose from plans operated by trade and industrial unions, various governments, commercial insurers, and company-sponsored mutual benefit societies.


The hospital benefit plans offered guaranteed services in exchange for an annual premium. The Blue Cross monopolies were extraordinarily successful, particularly after the hospitals persuaded state officials to exempt them from insurance company capital requirements and taxes. By 1950, Blue Cross sold almost half of all hospital insurance. As economist John Goodman notes, Blue Cross and Blue Shield (the equivalent organization for physician services) so dominated the market that "they made it difficult for a commercial insurance company to adopt reimbursement procedures that differed fundamentally from those of Blue Cross and Blue Shield. If a commercial company attempted radical deviation, the medical community could threaten a boycott."3 At the beginning of the 1990s, Goodman estimated that "net revenues (premiums minus benefit payments) on group policies [were] usually less than 5 percent of total premiums, [therefore] a 2 to 3 percent premium tax is equal to about 50 to 60 percent of net revenues."4


The fraction of the U.S. population with health coverage stabilized in the 1980s. Since then, the percentage of Americans with health coverage has fluctuated in a narrow range between 84 and 87 percent. The favorable tax treatment bestowed on employer-based coverage after World War II encouraged most people to purchase coverage through their employers. In 2007, roughly 59 percent of Americans had employer-based coverage. Government plans, state-subsidized high-risk insurance pools for the uninsurable, Medicaid, Medicare, SCHIP, the Veterans Administration, and other forms of military health care, covered 28 percent of Americans. Just nine percent of Americans with health care coverage purchased their own coverage directly from insurers.5

The Market for Individual Insurance

Recent research has shown that such tight controls can do harm by reducing overall coverage and making medical care difficult to access. Economists have also realized that health policy has paid so little attention to direct-purchase health coverage that policy makers know very little about it. As late as 2002, Pauly and Nichols published an article entitled "The Nongroup Health Insurance Market: Short on Facts, Long on Opinions and Policy Disputes."6 They wrote that "there is considerable disagreement among policymakers and policy analysts about how the nongroup insurance market works now" and that "factual disagreements about this market are true impediments to policy consensus." In 2006, Marquis et al. noted that while a variety of proposals have been offered to overcome perceived weaknesses in the direct-purchase market, "until now, this market has been the subject of relatively little study. As a result, there is much disagreement about the importance of the advantages cited for this market, the extent of the barriers to participation, and the likely effects of policy proposals."7


Direct-purchase coverage is owned by an individual. Premiums are based on the costs that an insurer expects a particular individual will generate in the future. People with low health risk, where risk is shorthand for expected future expenditure, pay less in premiums. Because premiums in the direct-purchase market are paid with after-tax dollars, individuals know exactly what their coverage costs. Because paying for health care with insurance coverage is more expensive than paying cash, people who buy direct-purchase coverage are more likely to insure against large costs, relying on out-of-pocket cash to cover routine expenses.


Because employer-related coverage is tax advantaged, employer plans generally follow the more expensive route of insuring even low-cost routine care. Employees "pay" the bulk of their employer-provided group health premium in the form of lower wages. Their artificially low out-of-pocket costs insulate them from the true cost of health care. This increases the demand for health care. According to Manning et al., data from the RAND Health Insurance Experiment show that the higher out-of-pocket payment characteristic of direct-purchase plans "reduces expenditures 31 percent relative to zero out-of-pocket price."8


Charging everyone the same price does lower the premium for high-risk people. This increases the probability that they will buy coverage. However, as more high-risk people enroll, premiums must increase for everyone in order to cover the plan's higher costs. Some low-risk people respond by refusing to pay the artificially high prices for coverage caused by the one-price-for-all requirement. Insurance economists call this phenomenon "adverse selection." Although economists usually use the term "adverse selection" to refer to the result of the individuals having more information than the insurance company, this is adverse selection due to regulation.


There are more low-risk people harmed by one-price requirements than high-risk people who benefit from them. Pauly and Herring find that regulations on insurance premiums raise the average premium considerably, by 12 to 15 percent, and that the number of people who drop coverage exceeds the number of higher-risk people who sign up. In all, "the overall proportion of eligible people in the individual market with insurance [falls] by 6.0-7.4 percent." They note that policies that reduce administrative costs and create high-risk pools are likely to cover more people than government control of premiums. Avoiding price controls on premiums also "avoid[s] regulation-induced incentives to insurers to avoid money-losing high risks." In short, allowing competitive markets to set the price for coverage will end up covering more people.

The Benefits of Variety

Results like this underline the fact that health insurance has value only because it allows those who buy it to pay for expensive medical care without forcing them to liquidate their assets or suffer big drops in current consumption. Some people are willing to pay a lot to have an insurance company bear the risk of large medical payments. Others are willing to pay very little. Cutler, Finkelstein, and McGarry find that individuals who have a higher risk tolerance, as revealed by engaging in risky behaviors such as smoking, drinking, and employment with high mortality rates, are less likely to purchase all kinds of insurance, including life insurance, private health insurance, annuities, long-term care insurance, and Medigap coverage.14 This suggests the variety of plans offered in the individual direct-purchase market, a variety not present in employer-based coverage or government plans, adds to individual welfare. Health coverage is not necessarily the most important thing in life, and as circumstances, finances, and risk tolerance change, people are better off if they can change their coverage to match their circumstances.


Assertions that people without coverage have no access to health care ignore the fact that people can and do access care by paying cash. Though the self-employed are less likely to have health coverage than comparable wage earners, Perry and Rosen show that they use health services at roughly the same rates as insured wage earners.15 Glied's findings on the spending patterns of the uninsured suggest that, in addition to cash payment, even low-income "uninsured people have some de facto insurance coverage available to them through the uncompensated care system and Medicaid conditional coverage."16 Overall, national estimates suggest that the uninsured pay for about half of their care and that government and private spending for uncompensated care equals roughly 3 percent of total personal health spending, about $150 for an average annual premium of $5,000. As the budgetary disasters in Massachusetts, Kentucky, and Tennessee have shown, government programs seeking to eliminate uncompensated care by requiring insurance for all typically cost more than the uncompensated care they seek to eliminate.17


Recent work also makes it clear that people adjust their coverage as their estimate of their individual risk changes, something that mandated coverage, controlled enrollment seasons, and government standardized policies discourage. Bundorf et al. find that higher-risk people are more likely to have coverage, even at incomes of less than 200 percent of the poverty level. Regardless of income, the probability that someone will have coverage rises 17 percent when his health risk changes from low to high.18 This increase in coverage is remarkable in view of the fact that low-income people are especially sensitive to premium cost. In Massachusetts, a $10 increase in monthly MassHealth premiums increased the odds of leaving the MassHealth program by five percent.19 Small increases in already low subsidized premiums have been associated with significant enrollment declines in government programs in Oregon, Vermont, Wisconsin, and Rhode Island. Gruber and Simon conclude that price-sensitive people substitute government insurance for private insurance in large numbers. For every 100 newly enrolled children in state children's health insurance programs, they estimate, 60 had previously been privately insured.20


The substitution may also go the other way. George Borjas found that the 1996 law limiting Medicaid eligibility for immigrants increased the likelihood that affected households worked and, therefore, increased the probability of eligibility for employer-sponsored health insurance. Their health insurance coverage rates at least remained the same after their Medicaid eligibility was curtailed.21 Without government coverage programs, he wrote, "the targeted immigrants themselves would have taken actions to reduce the probability that they would be left without health insurance coverage."


Eighty years after governments began seeking to determine the shape of U.S. health coverage, economists who study direct-purchase insurance have created a body of literature suggesting that market-oriented health care reform has far more promise than the decades-old plans that seek to impose the Blue Cross model on the entire population. In view of Medicare's insolvency, reform plans calling for further expansions of the Blue Cross single-price guaranteed-issue model, both via Medicare/Medicaid expansions and so-called "public" policies designed by government and sold through government run connectors, are unlikely to succeed in providing more medical care for more people at current expenditure levels.


Amy Finkelstein. September 2005. "The Aggregate Effects of Health Insurance: Evidence from the Introduction of Medicare," National Bureau of Economic Research Working Paper No. 11619, p. 31.


Mark V. Pauly and Len M. Nichols. October 23, 2002. "The Nongroup Health Insurance Market: Short On Facts, Long On Opinions And Policy Disputes," Health Affairs, web exclusive,


M. Susan Marquis et al. May 2, 2006. "Consumer Decision Making in the Individual Health Insurance Market," Health Affairs online, W227.


Willard G. Manning et al. June 1987. "Health Insurance and the Demand for Medical Care: Evidence from a Randomized Experiment," American Economic Review, 77, 3, p. 251.


AHIP Center for Research and Policy. December 2007. "Individual Health Insurance 2006-2007: A Comprehensive Survey of Premiums, Availability, and Benefits." At some price everyone is insurable. In the current regulatory environment, however, people who already have expensive chronic conditions are unlikely to be offered individual insurance. They will be dependent on the high risk pools or guaranteed issue policies that states are required to provide by federal law. The prevalence of uninsurable chronic conditions is unknown and the subject of debate. In 2006-2007, the average annual premium for all age groups in the more than two million policies surveyed by the AHIP Individual Health Insurance Survey was $2,613 a year for single coverage and $5,799 a year for family coverage. Of the approximately 1.5 million survey policies that ultimately went through medical underwriting, about 89 percent were approved. Denial rates ranged from 4 percent of people under 18 to 29 percent for those aged 60 to 64.


Mark V. Pauly and Bradley Herring. 2007. "Risk Pooling and Regulation: Policy and Reality in Today's Individual Health Insurance Market." Health Affairs, 26, 3, 770-779.


M. Susan Marquis and Melinda Beeuwkes Buntin. October 2006. "How Much Risk Pooling Is There in the Individual Insurance Market?" HSR: Health Services Research, 41, 5. pp. 1782-1800. M. Susan Marquis et al. May 2, 2006. "Consumer Decision Making in the Individual Health Insurance Market," Health Affairs, 25, online publishing, w226-w234.


David M. Cutler, Amy Finkelstein, and Kathleen McGarry. January 2008. "Preference Heterogeneity and Insurance markets: Explaining a Puzzle of Insurance." National Bureau of Economic Research Working Paper No. 13746.


Craig William Perry and Harvey S. Rosen. September 2001. "Insurance and the Utilization of Medical Services Among the Self-Employed," National Bureau of Economic Research Working Paper No. 8490.


Glied, Sherry A. 2003. "Is something better than nothing? Health insurance expansions and the content of coverage" Frontiers in Health Policy Research, Volume 6 Ed. Cutler D., Garber A. MIT Press Cambridge, MA 55-86.


For Tennessee, see Sandra Hunt et al. March 1999. "Actuarial Review of Capitation Rates in the TennCare Program," prepared for the Tennessee Office of the Comptroller by PriceWaterhouseCoopers. Tennessee's TennCare Medicaid expansion was "characterized as planning to 'do away with' uncompensated care" because everyone would have insurance coverage. Charity care payments initially dropped by 25% through 1995. By 1999 it had risen to pre-TennCare levels. By 2004, TennCare was consuming a third of the state budget. The experiment was stopped, and hundreds of thousands of people were cut from the rolls. See Council for Affordable Health Insurance. March 2005. Tough Lessons from TennCare. Issues & Answers No. 125. In 1993 Kentucky created Kentucky Kare to provide universal coverage for all. After it drove out 45 insurance companies, increased the cost of health care, and virtually bankrupted a government employee health plan, it was terminated. For a contemporary report see Rachael McCubbin, June 6, 1997. "The Kentucky Health Care Experiment: How 'Managed Competition' Clamps Down on Choice and Competition," Heritage Foundation Backgrounder No. 1119, Costs for the Massachusetts universal coverage program are running far higher than expected just three years after passage. Costs have spiraled from $630 million in 2007 to $1.3 billion in 2009. For an example of current opinions see Susan L. King. March 2, 2009. "Mass. Health care reform is failing us," The Boston Globe, accessed May 20, 2009,


M. Kate Bundorf, Bradley Herring and Mark Pauly. September 2005. "Health Risk, Income, and the Purchase of Private Health Insurance." National Bureau of Economic Research Working Paper No. 11677.


Jonathan Gruber and Kosali Simon. January 2007. "Crowd-Out Ten Years Later: Have Recent Public Insurance Expansions Crowded Out Private Health Insurance?" National Bureau of Economic Research Working Paper No. 12858.


George J. Borjas. June 2003. "Welfare Reform, Labor Supply, and Health Insurance in the Immigrant Population." National Bureau of Economic Research, Working Paper No. 9781.


M. Kate Bundorf and Mark V. Pauly. October 2002. "Is Health Insurance Affordable for the Uninsured?" National Bureau of Economic Research Working Paper 9281.