Debunking the idealized world of market-based health insurance
Three myths surrounding market-based health insurance
By Abdo Yazbeck, Economic Advisor for USAID’s Health Finance and Governance Project
In the early 1960s, the brilliant Nobel Prize winner (1972) economist Kenneth Arrow, showed that due to asymmetric information, health care markets do not necessarily bring about socially optimal solutions. Many years later, another Nobel prize winning economist (2001), Joseph Stiglitz, formalized the asymmetric information work building on Arrow’s construct. Two Nobel winning economists and overwhelming empirical evidence of health insurance market failures, however, have not deterred some ideological policy advisors and politicians from pushing market-based solutions in health financing. Terms like “competition” and “individual choices” are used to create a mythical world where the invisible hand solves all problems. Reality, however, has a strong empirical bias so if you find yourself confronted by some of the following myths about this important topic, stand your ground.
Two Nobel winning economists and overwhelming empirical evidence of health insurance market failures, however, have not deterred some ideological policy advisors and politicians from pushing market-based solutions in health financing.
Whether it is in the context of community-based health insurance, expanding existing health insurance arrangements, or building from life-insurance models, the words “voluntary” and “health insurance” should not co-exist in the same sentence. The math is simple and powerful. The 10–60 principle refers to an empirical reality observed in vastly diverse large populations like the United States or rural China. It is the empirical fact that at any point of time, usually measured in a year, 10 percent of the population will end up using over 60% of the resources spent on health care. This means that for insurance to function, you cannot have a large share of the remaining 90% who feel that they may not be part of the unlucky 10% deciding to opt out because the system is voluntary. If enough healthy people opt out leaving only those with high risk, the premiums balloon and the market fails — fondly known in the insurance industry as the death spiral.
…the words “voluntary” and “health insurance” should not co-exist in the same sentence.
In well-functioning markets, competition is a way the market imposes pressure for lowering cost of production and improving quality of services. If a producer does not improve the product and lower the cost, they will lose out to those that do. The 10–60 empirical principle in health expenditure changes the dynamic of competition in health insurance. For a health insurer to survive and thrive economically the best way to lower costs is to avoid individuals that are in the 10 percent that will cost the most. Competition in health insurance is not about lowering the cost of producing good health, it is about reducing the insurer’s costs (medical claims) and that is done in ways that can defeat the purpose of health insurance: life-long expenditure limits, excluding pre-existing conditions and other ways to cream skim the healthiest individuals, using the individual’s medical history to price the insurance so the 10% pay more (medical underwriting), high copayments and deductibles so individuals do not seek care are among the many ways used by insurance systems to manage risk. Even if regulation prohibits or limits these practices, health insurers will do what they can to manage risk and minimize costs.
Competition in health insurance is…about reducing the insurer’s costs (medical claims) and that is done in ways that can defeat the purpose of health insurance…
While in a well-functioning labor market with a high percentage of formal sector jobs, collection for payroll taxes for health insurance purposes is relatively easy and efficient, payroll-based health insurance creates a number of larger challenges. First, in countries with a sizable informal sector, high payroll taxes discourage informal employers and employees from entering the formal economy as they prefer not to pay. Second, even with well-functioning labor markets, increasing payroll taxes increases the cost of labor and makes the country less competitive for exports and foreign investment compared with countries that finance health care through other sources. Third, employment-based insurance adds to the inflexibility of labor as worker with pre-existing conditions are less likely to try to change jobs or take risks to start new companies, and labor inflexibility is detrimental to economies.
…increasing payroll taxes increases the cost of labor and makes the country less competitive for exports and foreign investment…
Abdo Yazbeck is the Economics Advisor for USAID’s Health Financing and Governance (HFG) Project. He has over 25 years working as a health economist for HFG and at the World Bank. He has authored/edited seven books, including “Africa’s Demographic Transition: Dividend or Disaster,” “Better Health Systems for India’s Poor,” “Learning from Economic Downturns” and “Attacking Inequality in the Health Sector.” He has a Ph.D. in Health and Labor Economics.
HFG is a five-year project funded by the U.S. Agency for International Development under Cooperative Agreement No: AID-OAA-A-12–00080. The HFG project is led by Abt Associates in collaboration with Avenir Health, Broad Branch Associates, Development Alternatives Inc., Johns Hopkins Bloomberg School of Public Health, Results for Development Institute, RTI International, and Training Resources Group, Inc. The views expressed within this publication do not necessarily reflect the views of the U.S. Agency for International Development or the U.S. Government.
