Why Health Insurance Doesn't Work

'The state's largest for-profit health insurer is asking California physicians to look for conditions it can use to cancel their new patients' medical coverage," said the first line of an expose in the Los Angeles Times earlier this month. The subject was Blue Cross' practice of enlisting doctors to help them deny the claims of sick individuals.

What's strange, however, is that everyone acted like the insurer was doing something wrong. Gov. Arnold Schwarzenegger accused them of asking doctors to "rat out the patients." Hillary Clinton gave the company a similar lashing, in the same tone of moral outrage used by most of those quoted in the article. Within a few days, the policy was ended.

But Blue Cross officials weren't doing anything wrong. They were doing exactly what we've asked them to do: They were following the incentives of the modern insurance market.

It's a common complaint that health insurers don't actually offer "insurance." As generally defined, insurance is a form of risk management that individuals use to protect themselves against unpredictable loss -- a car accident, say, or a house fire. Health insurance, by contrast, is a form of risk pooling that individuals use to smooth out lifetime healthcare costs. Heath insurance does not insure us against risks so much as it insulates us against costs. We pay regular premiums so we don't have to directly pay for irregular care.

Not all of us, however, make this deal with insurers. About 50 million Americans are uninsured, and tens of millions more are underinsured. There's no law that says we all must have insurance or that insurance companies must agree to cover us. Given that, it's natural that insurers -- which are, after all, for-profit companies, not government agencies or public trusts -- turn their attention to making deals with the most profitable among us and avoiding deals (or finding ways to break contracts) with the least profitable.

That's exactly what we would expect them to do. We are using them to minimize our risk, and they are selective about us to minimize theirs. So is it any surprise that they compete over which of them can be the most sophisticated about cherry-picking the healthy from the unhealthy (stories abound of insurers in offices with a "broken elevator," so only those who can walk 10 flights of stairs can apply) and which is the most adept at canceling policies once they become unprofitable?

This is the competition within our insurance industry, and it is not good for us. That can be a bit counterintuitive in a country like ours, where all competition is thought to benefit the consumer. But just as competition among drug dealers does not aid the neighborhood, competition among insurers does not aid the ill. It might if they were competing to deliver better care to the sick, rather than trying to figure out how to avoid delivering any care to the sick at all. But they're not.

Indeed, their inattention to actual care is startling. For instance, the U.S., for all its technological advancement, has among the lowest adoption of cost-saving, care-improving health information technology in the world. That is the fault, in part, of our insurers, who have not forced its adoption among care providers.

In the current system, insurance companies add negative value -- which is to say, they make healthcare worse, not better. And here's why: It is actually against their interest for insurers to compete on giving us the best care. It's not simply that they're not doing it, but given the structure of the marketplace, they shouldn't do it.

Imagine that Insurer X works with its providers to develop the best diabetes protocols in the country. And it begins advertising this fact. What happens on Day Two? It's flooded with individuals suffering from diabetes, or individuals who fear they will one day be suffering from diabetes. These people, in the current system, are a bad deal. Not only is it nearly impossible to insure them at a profit, but pooling their costs (which is what insurers do, after all) raises premiums for all the insurer's other customers.

Over time, that encourages healthy folks contracting with that insurer to quit the pool and go find a cheaper deal with an insurer that caters to healthier individuals, which forces the insurer to raise premiums yet again, driving out more healthy folks, which forces it to raise premiums again, which drives out more healthy folks, and so on. It's what industry experts call an insurance death spiral, and it ends with the collapse of the insurer.

Given those incentives, insurers cannot be expected to compete on the basis of better care, because if they encouraged better care, all that would happen is they would attract worse deals. Which is why, in the current system, insurers make things worse.

But it doesn't have to be that way. If insurers existed in a market in which they had to compete on delivering better care, rather than competing on developing better techniques to deny care, we'd be far better off.

Here are the principles such a market would require:

1) Universality: Insurers cannot compete effectively unless everyone is in the pool. If the healthy can leave -- if they can decide insurance is a bad deal until they get a little sicker and a little older -- then insurers simply will have to compete to attract the healthiest, which means offering the lowest costs, which means insuring the fewest sick people. The system has to be universal.

2) An end to cherry-picking: Insurers cannot be allowed, before offering insurance, to use demographic sub-slicing to cherry-pick the market. That means no more judging individuals based on preexisting histories, no more use of complex formulas around age and income and race and region in an effort to identify those who might someday get sick. Insurers should have to offer insurance to anyone who wants it for the same price. No exceptions.

3) Risk adjustment: Merely having everyone in the system won't be enough, nor will forcing insurers to do away with their most delicate cherry-picking tools. Insurers will just become sophisticated at advertising on G4 Tech TV, in snowboarding magazines and in Whole Foods -- in places, in other words, where the young and the healthy gather. So on top of the universal system and the community rating, you need risk adjustment, which means either that insurers are reimbursed more for taking on sicker patients, or (my preferred method, and the one used in Germany) insurers with particularly healthy pools pay into a central fund that redistributes to insurers with less healthy pools. At the end of the day, it has to be as profitable for an insurer to insure a sick person as a healthy one.

4) Benefit floors: There has to be a minimum level of comprehensiveness below which insurance plans cannot dip. Otherwise, they'll just sell the healthy on plans that don't cover anything and so are very cheap. That's just another way of pulling in the healthy and keeping out the sick. Creating a floor ends their ability to segment the market by offering less value.

5) Information transparency: Quick: If you wanted to buy some health insurance, where would you go? How would you compare plans? There needs to be a single place, or a set of them, where individuals can shop for insurance. This is hard stuff to find and harder yet to understand, and real effort needs to go into constructing an easily accessible marketplace that customers can effectively navigate. And within that space, it needs to be easy for individuals to compare insurers on plan comprehensiveness, price, outcomes, etc.

That means we need a marketplace where folks can go to shop for insurers, and they need to have standardized comparisons or nonpartisan rating authorities providing information they can use.

It's not impossible to imagine a scenario in which insurers actually compete to offer better service; in which the marketplace really does work to the consumers' benefit. That could take a million different forms, from personalized care coordinators to electronic records to online access to your health information to negotiated discounts on gym memberships.

But none of this will happen as long as insurers operate in a perverse market in which their incentives are to make the system, and our care, worse.

Reform is necessary, not just for our sakes but so the insurers actually can be better, rather than continuing to act as whipping boys for frustrated politicians.

This article originally appeared in theLos Angeles Times.

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