Nobody knew health care could be so complicated,” was Donald Trump’s now famous pronouncement on the issue. The Congressional Republicans were struggling too. Not only did they fail to reach a legislative solution, but, even worse, they were confused about where to even search for a solution. All told, health care begins to look insoluble. But is it really that complicated? Actually, no.

Some progressives claim that they have an easy solution, one that proceeds from their belief that more government it is often the answer: Medicaid or Medicare for all.1 What is the easy solution of classical liberals? There are two sets of reforms: one on the demand side and one on the supply side. On the demand side are a surprisingly simple combination of out-of-pocket payments, a new type of event-based health insurance, traditional care-based health insurance for some, and, perhaps, judicious subsidies. A later article will deal with reforms on the supply side.

The Affordable Care Act (ACA) was supposed to solve many health insurance and health care problems, but it appears to have exacerbated them. One such problem is that those with pre-existing conditions are getting worse care.2 Patients with pre-existing conditions are generally more expensive to treat, but insurance companies cannot charge more for them, and so health plans are designed to dissuade these types of customers through restricted access to specialists and expensive drugs. “Anything sick patients like, Obamacare’s preexisting conditions provisions punish. Anything sick patients hate, those provisions reward.”3 Another is that insurance premiums for many people have approximately doubled in just the four years that Obamacare has been in force.4

Three Health Care Myths

Three prominent and persistent myths helped lead us down the path to more regulation and more government intervention.

  1. 1. Myth: Preventive care is a good investment.

The ACA assumed that preventive care is a good investment and that people typically underinvest in it; therefore, they must be “nudged” in that direction. It turns out that’s not true.

In 2010, physician Joseph W. Stubbs noted: “Experts suggest that only about 20% of preventive measures, such as counseling a smoker to quit smoking, vaccinating against influenza, and screening men for colorectal cancer, actually generate true cost savings.”5

The previous year, Douglas W. Elmendorf, then director of the Congressional Budget Office, stated: “Although different types of preventive care have different effects on spending, the evidence suggests that for most preventive services, expanded utilization leads to higher, not lower, medical spending overall.”6

  1. 2. Myth: When previously uninsured people get insurance, their health will improve, and overall health care costs will fall because many of the newly insured will use office-based doctors instead of expensive emergency rooms for their health care.

On the Oregon Medicaid experiment, see the EconTalk podcast episodes “Jim Manzi on the Oregon Medicaid Study, Experimental Evidence, and Causality”
and “Austin Frakt on Medicaid and the Oregon Medicaid Study”.

For more information on the topics in this article, see “Economic Research on Direct-Purchase Health Insurance: New Models for Real Health Care Reform,” by Linda Gorman, Library of Economics and Liberty, June 1, 2009.

For introductory background, see John C. Goodman, “Health Insurance,” and Michael A. Morrisey, “Health Care,” in The Concise Encyclopedia of Economics.

A fascinating 2008 experiment in Oregon punctured this double-barreled myth. Oregon’s government conducted a lottery to enroll a limited number of low-income adults in Medicaid. The results? According to an article in the New England Journal of Medicine, those in the Medicaid group spent about 35 percent per person more than those in the control group.7 But, although the increased spending did lead to some improvement in mental health, it “generated no significant improvements in measured physical health outcomes.”8 If Medicaid were a new drug, the Food and Drug Administration would reject it.

Has the Affordable Care Act improved Americans’ health? The usual way proponents have argued for measures like the ACA is to point to higher life expectancies in countries with more government control of health care but lower spending per capita. That was always too crude an approach for comparing across disparate countries. But, interestingly, in the four years before the ACA was passed, preferred provider organization (PPO) plan premiums rose 15 percent; in the four years since the ACA was enacted, PPO premiums have increased by 66 percent.9 It is difficult to say whether the ACA has made Americans healthier, but in 2015 and 2016, according to the National Center for Health Statistics, life expectancy declined by 0.2 years. It hadn’t declined since 1993.

  1. 3. Myth: Insurance should cover all medical expenses, including inexpensive and predictable goods and services.

Insurance is an actuarial-based product. People, when spending their own money, typically buy insurance when they face a small probability of a large loss. Insurance companies pool roughly equal risks and charge accordingly. Both parties benefit via this arrangement: insurance companies generate revenues that exceed their costs, and consumers offload substantial risk.

We don’t buy insurance for everything, though. We don’t insure our blue jeans against holes in the knees or our cars for an oil change. Instead, we “self-insure.” That is, we cover those small out-of-pocket costs ourselves. This makes sense. Insurance companies must charge more for insurance than they pay out because they need to cover all their costs. A simple rule of thumb is that your insurance premium will be twice the expected loss. If you have a one-percent chance of a $100,000 loss, you have an expected loss of $1,000 (0.01 times $100,000) and should expect to pay about $2,000 for the insurance to cover this event. If insurance companies were not able to charge the extra amount to cover the other costs, they would go out of business.

When we buy “insurance” for annual physical exams or to purchase our monthly statin prescription, each of which has a probability approaching 1.0, we are effectively pre-paying for a known expense; we aren’t buying insurance. When we do that, we expose the system to multiple administrative steps as a third-party payer must negotiate with hospitals and drug companies, among others, and approve, pay, and monitor our expenditures. At each step, additional organizations are involved and regulatory costs are incurred, resulting in, perhaps, a doubling of costs for these predictable expenditures.

Further, when patients are spending someone else’s money, they are less careful with their purchases and effectively cease to be the ultimate customer—”someone else” is—and prices become opaque and widely variable, with one person paying a small amount and another a large one. When prices, which convey information to help buyers and sellers make decisions, become so distorted, shopping wisely becomes difficult for consumers and investing wisely becomes difficult for providers. We all lose.

Out of Pocket Payments

When patients select health care goods and services, but third parties pay for them, patients have a tendency to purchase too much health care. Doctors and hospitals are happy to oblige. Not surprisingly, third-party payers impose burdensome controls, such as formularies and prior authorization, to limit such purchases. These controls impose added costs on the system and put roadblocks in the way of doctors who are trying to provide good medical care.

A technique for good decision-making is to put decisions in the hands of those who will receive the benefits of good outcomes and pay the costs for bad outcomes, aligning incentives with dominion. One solution would be to eliminate third-party controls by taking decisions away from third parties and putting them in the hands of those who already have an incentive to limit low-value purchases: the direct consumers. Small copayments (a fixed payment) and even coinsurance (a percentage payment) do not fully incentivize the patient to choose medical services wisely. The only way to eliminate the controls imposed by third-party payers is to eliminate the payers themselves and to have consumers—in this case, patients—pay 100 percent from their own pocket.

But that’s too extreme. We consumers want protection against such risks and that’s why we buy insurance.

The in-between solution, which we often saw when people paid their own money for individual, non-subsidized insurance, is catastrophic insurance: customers bear high out-of-pocket costs for initial expenditures, which causes them to make wise purchases, and insurers pay 100 percent of the costs after a high deductible. Today, catastrophic health insurance is available only to those under 30 and those facing certain types of hardships.10

Event-Based Health Insurance 

Probably the best solution is insurance that covers health events. With this type of insurance, first suggested in 1992 by health economist Susan Feigenbaum,11 if you were to get appendicitis, for example, you would be paid a lump sum, perhaps $35,000, an estimate of the median cost for treating appendicitis—mainly the appendectomy—in your geographic area. The money would go to you, not a doctor, hospital, or drug company. Any insurance company in the world that can run numbers and set odds could provide this event-based insurance.

“For too long, health insurance has been focused on the repair and not the event. It’s time to rectify that.”

With a flush bank account, or the guarantee that the money is coming, you could decide where, when, how, and even whether to be treated. If there were two hospitals near you, you could compare them and choose the one with the best quality and/or price. This insurance plan would have a minimal deductible, perhaps $1,000, to dissuade you from filing claims for insignificant problems, such as needing an aspirin for a headache. Does this type of insurance look familiar? It should. This is how casualty auto insurance works. If you slide your car into a tree and dent some sheet metal, your insurance company will pay you the estimated cost of the repair. Then, you can choose to skip the repair and pocket the money, use the money to fix the fender only, or supplement that amount and have your whole car painted. The insurance company won’t know or even care which path you take because its involvement is related to your collision event, not your fender repair. For too long, health insurance has been focused on the repair and not the event. It’s time to rectify that.

Appendicitis is an acute health issue and the lump-sum payment would happen once. What if you developed a chronic condition, such as Parkinson’s disease, diabetes, asthma, or multiple sclerosis? In this case, you would regularly consult your physician, who would update your diagnosis and prognosis. Your insurance company would then pay you an annual, quarterly, or even monthly amount for that health event. Here’s the important point: that insurance company forever “owns” your Parkinson’s disease, which first appeared during the time it covered you, regardless of whether you later cancel that policy or become insured by a different company.

This type of insurance completely obviates the problem of pre-existing conditions, at least for those who buy insurance early. If you are insured when the problem is first discovered, that insurance company forever owns it and, therefore, owes you for that health condition. If you weren’t insured, you were “self-insured,” and you are responsible for any health conditions that arise. Children could be covered under their parents’ plan.

Moving to this type of insurance system would require the well established practice of medical underwriting to determine the baseline risk with any given individual, and it would expose those of us with pre-existing conditions to a potentially difficult transition period. Logically, you can’t get insurance for a medical condition that’s already happened. For this reason, care-based insurance—what we currently have—will always be necessary for some segment of the market.

Care-Based Health Insurance

With an event-based insurance market, there will always be people who, for whatever reason, were not insured with event-based insurance when their condition was diagnosed, leaving them to pay for expensive treatments. Care-based insurance—the type of health insurance we are familiar with—could cover this subset of people, and a national market could be used to find the optimal combination of coverage and price. It would be expensive, as those without pre-existing conditions move to the cheaper event-based insurance. So public and private organizations could selectively target these patients with subsidies to defray their costs. Since only those with documented need would be targeted, the subsidies and interventions for this limited segment of the market could be lower, and less distortionary, than those that preceded and are currently a part of the Affordable Care Act. Subsidies are distortionary when they induce people to make poor choices, such as when customers purchase a subsidized item that they would never have purchased without the subsidy, because the overall costs were greater than the overall benefits.

The long-term goal should be to move everyone to an event-based health insurance system, the benefits of which are manifold: lower prices, better care, better patient control over health care choices, lower administrative expenses, more portability, more security, more transparency of prices, wider access to medical professionals, wiser shoppers, a better market for insurance, better health outcomes, and less financial risk.

Effects on the Supply Side

One of the benefits of the above reforms, as noted, is that it would cause consumers to be much more cost-conscious. That awareness of costs will, itself, cause positive changes in supply. One of the best illustrations of this is the evolution in eye surgery over the last few decades—a corner of the health care market that is largely free of government and commercial third-party interference. The original surgical procedure, called radial keratotomy (RK), relied on the skill of the surgeon to make large cuts in the cornea, required a six-week recovery, and originally cost about $8,000 ($18,600 in 2018 dollars).12 Today, LASIK has largely replaced RK for those who are eligible. According to George Mason University economist Alex Tabarrok, in 1998, the average price of LASIK laser eye surgery was approximately $4,400. Just six years later, the price had fallen to $2,700, a 38-percent reduction.13 Adjusted for inflation, the price had fallen by over half, a result we are used to seeing in computers but rarely in medical procedures.

This discussion of the supply side, though, just scratches the surface. In a future article, we will lay out reforms, all consistent with classical liberal principles, that would increase the supply of medical care and bring down its price without hurting quality and even, in many cases, such as with LASIK, enhancing quality.


For far too long, most of us, including many health economists, have thought and written as if health care and health insurance were special. In some ways they are. But the same principles that have made auto insurance work so well—there is no auto repair cost explosion—can be applied to health insurance to make health insurance and health care better and more affordable.

Ronald Reagan famously said, “There are no easy answers, but there are simple answers.” This is true in health care also.


Bernie Sanders, “Medicare for All: Leaving No One Behind,” 2016 presidential campaign.
David Montero, “Nevada governor vetoes Medicaid-for-all bill”, Los Angeles Times, 17 June 2017.
Mike Magee, “‘Medicaid-For-All’ vs. ‘Medicare-For-All’,” HealthCommentary, 16 August 2016.

Michael F. Cannon, “Is Obamacare Harming Quality? (Part I)”, Health Affairs, 4 January 2018


Joseph W. Stubbs, “Does prevention improve health care outcomes and lower costs?”, 5 July 2010.

Lori Montgomery, “Expanding Preventive Care May Add to Costs, CBO Says”, Washington Post, 8 August 2009.

Katherine Baicker, et al, “The Oregon Experiment — Effects of Medicaid on Clinical Outcomes”, New England Journal of Medicine, 2 May 2013.


Robert Book and Paul Howard, “Yes, It Was The ‘Affordable’ Care Act That Increased Premiums”, Forbes, 22 March 2017.

Lara Hoffmans, “They Unblinded Me With Science”, Forbes, 23 March 2012.

Alex Tabarrok, “Seeing is believing (in the free market)”, Marginal Revolution, 23 November 2004.


*Charles L. Hooper is president of Objective Insights, a company that consults for pharmaceutical and biotech companies.

For more articles by Charles L. Hooper, see the Archive.


*David R. Henderson is a research fellow with Stanford University’s Hoover Institution and an emeritus professor of economics at the Graduate School of Business and Public Policy at the Naval Postgraduate School in Monterey, California. He blogs at EconLog.

For more articles by David R. Henderson, see the Archive.