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FROM THE FIELDHow And Why The Health Insurance System Will Collapse
The advocates of defined-contribution health plans extol the virtues of consumer-driven health care, consumer choice, and empowered consumers as solutions to the problems—particularly the rapidly growing costs—of employer-sponsored health benefits. This paper argues that the widespread use of defined-contribution plans, with more consumer choice and more knowledgeable consumers, will lead to the erosion of the social contract on which health insurance must be based, with healthier employees subsidizing the care of older and sicker ones, and a death spiral of adverse selection. If unchecked by government intervention, these trends will lead to the collapse of employer-sponsored health insurance.
Insurance is a way of spreading risk. It works if the many subsidize the few. People whose houses do not burn down pay for the losses of those whose houses go up in flames. People with insurance whose cars do not crash pay for the repair or replacement of the crashed cars. In health insurance, the healthy pay for the care needed by the sick. The health insurance industry, and especially employer-sponsored insurance, is buzzing with words and phrases such as "consumerism," "empowerment," and "choice." There are reports that "this year has seen a surge in employer interest in offering consumer-directed health plans...particularly now that the Internal Revenue Service has provided clear guidelines for establishing such plans" and that "this trend is expected to accelerate."1 According to Helen Darling, "We are moving from a defined benefits model to a much more consumer-driven and more substantially consumer-financed model."2 Proponents of this trend toward defined-contribution plans (while using the words rather loosely) talk about the empowerment of consumers, because consumers can choose the health plan best suited to their own needs. This trend toward more "consumer-driven" health insurance sounds wonderful. We like to have choices. One size does not fit all. Choice promotes competition between health plans and therefore improvements in quality and efficiency and better prices. Choice and competition are all-American marketplace values. So surely consumer-driven health care must be good. It is particularly popular with many Republican legislators, who want to promote this model for both employer-sponsored insurance and Medicare. But words can deceive, particularly words that sound good and are used to sell us something. During the Cold War the names of many communist-front organizations included the word "peace." Organizations using the word "freedom" are often conservative organizations working for lower taxes or less regulation. In health care, several organizations using the word "quality" were set up by drug companies, insurers, or physicians to fight government-funded health insurance and to protect their incomes and profits. So we should be careful before we assume that "choice" in health insurance or "consumer-driven" health plans are a good thing. Voltaire wrote that the Holy Roman Empire was not holy, not Roman, and not an empire. But it sounded great.
The fundamental problem with the current trend toward consumer choice of health plans is that we know our health status and can make a reasonably good estimate of how likely we are to need much health care in the next year. We don’t know if our houses will burn down or if we will crash our cars, so we willingly buy insurance to protect ourselves against something that we know may happen but is unlikely. For these types of insurance we recognize and accept that the fortunate majority pays to subsidize the unfortunate minority. But insurance doesn’t work if informed buyers can predict the future. If we had a better idea of whether or not our houses would burn down, we would buy more or less insurance. And of course the insurers would want to insure the good risks but not those whose houses were likely to catch fire.
When it comes to our health status, we are (compared with our "fire status") reasonably well-informed. We know if we need regular drugs for high blood pressure, high cholesterol, or arthritis or if we are diabetic. We know if we have been diagnosed with cancer or our spouse with Alzheimer’s disease and that it will be expensive to treat these diseases. We know that as we get older the chances of getting many diseases increase. So, if we are likely to need expensive care, we will choose health plans with generous benefits even if they cost a bit more—and so will millions of other older, sicker people. Assumptions of the young and healthy. The young and the healthy, on the other hand, will assume, rightly, that their chances of needing expensive medical care are much lower. If they behave rationally, they will choose plans with coverage for "catastrophic" or unexpected accidents or diseases but not for the routine care of chronic conditions or diseases that mainly affect older people. If people with choices behave this way—and people in general are rational economic animals, so they should—the young and healthy will no longer subsidize the cost of care for the old and sick. It would be as if those whose houses do not burn down stopped paying for the losses of those whose houses did—what insurers call "adverse selection."
There are three reasons why this seems likely to happen. I have mentioned one, the trend toward defined-contribution health plans, with consumers being given more choices of different plans. Another reason is that consumers (insured workers), while still woefully ignorant about the benefits and costs of various plans, are becoming "more knowledgeable about medical care and are getting smarter every day" and better able, therefore, to choose the plans that are better for them.3 A third reason is that employers and insurers (which offer "consumer-directed" plans) are encouraging consumer choice. To make the trend away from more generous traditional health plans to defined-contribution plans more palatable, they are touting the benefits of choice and are urging employees to "choose the plan that’s best for you." This adds some sugar to the otherwise bitter pill of increased out-of-pocket costs associated with these plans, as consumers are encouraged to make " ‘cost-conscious’ choices about medical decisions."4 If efforts to substitute defined-contribution plans are successful, and there is no obvious reason why they should not be, they will destroy the social contract on which health insurance must depend: the willingness of those who do not need much health care to pay for those who do.
Some in the insurance industry believe that these problems can be avoided through risk adjustment—with insurers covering older and higher-risk members receiving higher premiums from the employer than those with younger, lower-risk members receive. Unfortunately, current risk-adjustment mechanisms are crude at best, and it will be many years before we know whether or not we can risk-adjust effectively for the employed population.5 Sadly, it is likely that insurers (with the help of their consultants) will game the system, finding new ways to attract and recruit good risks, so that risk adjustment slows but does not prevent the death spiral of adverse selection.6 Just as accountants will find new tax loopholes, so consultants will find new ways to skim the cream.7 Examples of health insurance markets that began to unravel because of adverse selection in the 1980s and 1990s include the coverage of mental health care in the Federal Employees Health Benefits Program (FEHBP) and the New York State and New Jersey individual insurance markets.8 The most relevant example may be the Australian system, in which young Australians did not opt in to subsidize health care for the old. In these cases, governments intervened to prevent the systems’collapse. If the employer health insurance market begins to unravel because of adverse selection and defined contribution, presumably the government would intervene to prevent its collapse. But that intervention might necessitate abandoning much of the "consumer-driven, choose what’s best for you" ethic that is so popular with the advocates of a defined-contribution approach to health insurance. For many years Syms, the New York retailer, has successfully used the advertising slogan that "an educated consumer is our best customer." In health insurance, an educated consumer with a choice of a broad range of health plans would be our worst nightmare—leading to a death spiral of adverse selection and the collapse of employer-sponsored health insurance, which is not exactly the outcome employers and insurers have in mind.
Humphrey Taylor is chairman of the Harris Poll at Harris Interactive in New York City.
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Assumptions of older persons.
