Recently, the nonprofit group Alabama Patients First has stirred controversy with commercials criticizing Blue Cross and Blue Shield of Alabama. Such a controversy naturally prompts examination of the economics of health insurance.
Insurance is a complex transaction. How much will be paid can never be precisely described when making a contract, especially given new drugs and treatments in the healthcare industry. Insurers must deny some claims to ensure the availability of funds to pay legitimate claims.
But employer payment of health insurance worsens this situation because the employer basically pays the medical bills of the employees and their dependents. Thus, the employer has a financial interest in denying claims that employees would like covered.
The Customer is Always Right?
The customer for employer-provided health insurance is the employer, not the employee. Unlike auto or home insurance companies, which compete vigorously for our individual business, most employer coverage involves a group contract between the employer and insurer.
Employers choose coverage details. Employee preferences matter in this because for-profit businesses will not want to spend a lot of money on coverage employees do not value. But employee influence is indirect and weak, as evidenced by the few coverage options typically available, and employer choices do not reflect consumer preferences as accurately as in other markets.
The third-party payment inherent in insurance further weakens alignment with consumer preferences. The buyer and seller are the first two parties in a transaction. The insurer, the third party, pays for procedures and drugs individuals cannot afford themselves, doing so without charity or tax dollars.
Employer-paid health insurance also increases the cost of hiring in America, encouraging the offshoring of jobs. Furthermore, work-based health insurance makes Medicare for retirees inevitable.
The Endurance of Employer-provided Insurance
Given these problems, why does employer payment persist? One reason is taxes. Employer paid benefits avoid income taxes, allowing $1,000 for health insurance to go further than $1,000 in salary. Yet taxes are not decisive because the law could allow purchase of individual health insurance using pre-tax income.
Adverse selection, which arises when one party knows something the other does not, provides a more fundamental reason. The less informed party can easily overpay and consequently not participate in otherwise valuable exchanges. For health insurance, the information involves health status. We can assume that most people are healthy, but that some are in poor health. The healthy thus have few medical bills and are insurable for a low premium, while those in poor health have much higher medical bills, a fact causing insurers to want to charge them more. Thus, individual coverage sold for a premium reflecting average medical cost will be attractive to the unhealthy but will overcharge the healthy. The insurer ends up insuring the unhealthy and losing money.
Is There a Way Out?
One solution to this issue involves insurance consisting of some in good health and others in poor health, as is the case with the employees of a business. Group insurance costs less per person than individual insurance. But while this is nice, we also lose a lot from not purchasing health insurance for ourselves.
No magic wand exists to reduce the real resources required to train doctors, develop pharmaceuticals, and produce new medical devices. But we can keep costs from being higher than necessary.
Insurance necessarily increases costs through third-party payment. If insurance covers 100% of hospital stays, patients will choose to stay an extra night. The increased costs drive up premiums.
Individuals – not employers – shopping for their own insurance would likely select policies controlling these costs. People would also learn more about their preferences regarding coverage by making the decisions employers currently make. Tailored coverage should avoid paying for coverage the patient does not value more than the cost.
Economic theory also offers some insights on these preferences. For example, modest, regular expenses like checkups are not worth insuring because of moral hazard cost inflation. People should want big expenses – which threaten bankruptcy – fully covered. And people would not choose policies allowing for thousands of dollars in surprise billing.
Economist Thomas Sowell observes that there are no solutions in life, only tradeoffs. That said, allowing individual Americans, not their employers, make more of the decisions regarding insurance tradeoffs would make healthcare more affordable and valuable.
Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University. The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.
