Squaring the Circle on Health Care

Republicans have put themselves in an impossible position on health care.

Unless you’ve been living deep in a cave underneath the rock which knocked you into a coma when it fell, you’ll have heard about the health care debate. In 2009 the Democrats passed the Affordable Care Act (also known as Obamacare). The Republican party united in opposition to the law and spent the subsequent seven years vowing to repeal and replace the law with something non-specifically better. They focused their pitch in particular on spending less and reducing regulation.

Having won control of Congress and the White House in no small part on the strength of those promises, and particularly its crusade against the individual mandate, the party has turned its attention to following through. As readers might know, it has been a fiasco.

In part this is because promising to deliver more while spending less is the policy equivalent of selling door-to-door Flex Belts.

In other part, however, this is because health insurance doesn’t behave like a normal consumer market. Deregulating this market may not be possible at all, because many of the traditional rules of competition don’t work quite the same way they do elsewhere.

A traditional market responds to sympathetic incentives. Say I provide a widget that consumers buy. The relationship is sympathetic because I make my money by providing a product that consumers want. This relationship helps make markets self-regulating (to an extent) by encouraging competitors to pursue customer satisfaction.

Health insurance companies do care about their reputations, but they have four critical differences.*

First, health insurance is a coercive product. A consumer’s alternative to buying insurance is to risk untreated sickness, injury and death, functionally eliminating the walk away point for anyone who isn’t 25, healthy and convinced they’re going to stay that way.

Second, nobody actually wants the product that they buy. They purchase health insurance, but what they actually want is health care when sick.

Third, an insurer makes its money by not providing that desired service. By definition almost everyone who files a claim will cost the company more than they paid in premiums (otherwise consumers would simply pay for health care out of pocket). Thus, an insurer needs customers but not consumers.

Finally, providing coverage and collecting premiums are unrelated activities. Customers purchase health insurance when they’re healthy and collect on it when they’re sick. By the time a someone files a claim for the care they want, the premiums have been long paid and that customer has become a liability.

In sum: A customer pays for insurance as a way of securing in advance the health care they want. An insurance company pays for health care to convince consumers to buy the insurance they want to sell.

This creates an adverse incentive because the relationship actually has two points of interaction, both of which leave one party unhappy: The insured purchases insurance, paying money but getting an I.O.U. Then the insurer supplies medical care, losing money and getting a long-term liability.

If I supply widgets, we can theoretically strike a bargain you value the widget you get more than the money you paid and I value that price more than the product supplied. Here the two parties’ interests never truly align.

Assuming rational market actors, the insurance company will work hard to collect as many premiums and deny as many claims as it can, because that approach maximizes profits. Under this system only group purchasers can effectively bargain on behalf of sick members, because only they can leverage the profits from their healthy members.

This is the crux of the problem that Republicans have made for themselves. They have promised to deliver a more efficient health care sector through deregulation, but that may not be possible. Left to its own devices, the health insurance industry will make most individual customers unhappy, not because of good guys and bad guys but because the industry and its customers want different things.

All of the things people hated about health insurance pre-2009 were a result of the industry functioning as designed.

Health insurance is not a normal marketplace. It is a market of captive consumers and one in which the interests of the buyers and sellers sharply diverge. Successfully deregulating this industry may not just be difficult. It may be impossible.

*Health care is different for many reasons, but we will focus on four here.