A few months ago, a Xerox benefits official indicated that the company was considering a dramatic plan to convert its health insurance plans to a defined-contribution program in which employees would be given money to purchase their own health care coverage. In response to a flurry of phone calls from employees worried that they would somehow lose their health benefits, the company then said that such changes were five to seven years off, and would only occur if the group insurance system failed to reform itself in ways pleasing to workers and owners. According to Wharton professor of health care systems and economics
In their new book, Pooling Health Insurance Risks, published by the American Enterprise Institute for Public Policy Research, Pauly and Wharton doctoral candidate Bradley Herring take an in-depth look at the relationship between premiums and expected medical expenses across the three major sources of private health insurance in the U. S.: large employment-based group insurance, small group insurance, and individual nongroup insurance which is sold like homeowner’s or auto insurance. They expose some common misconceptions about how these insurance markets work, showing that employment-based insurance ultimately may not be as performing as well–nor individual insurance performing as poorly–as is generally believed. By helping policymakers better understand the present functioning of these markets, their findings could have a significant impact on the future of health insurance in America.
The authors examined the three types of insurance in terms of their extent of "risk pooling" (all policyholders pay the same premium regardless of their level of expected expense) as opposed to "risk segmentation" (setting people’s premiums proportional to their estimated health risk.) The issue of risk pooling vs. segmentation is quite controversial, as it calls up policy questions such as: should (and do) premiums vary according to indicators of health risk? Should the young and the healthy subsidize the old and the not-so-healthy? Should public subsidies to insurance vary according to economic status and risk?
The type of insurance currently held by most Americans and favored by public policy is employment-based, which receives a tax subsidy in excess of $100 billion a year. And the conventional wisdom in insurance-market analysis gives high marks to this type of insurance, asserting that it manages to pool risk almost completely across all customers. Individual insurance, on the other hand–held by only 7% of Americans with private health insurance–gets the worst grade for supposedly seeking out low-risk customers and gouging or avoiding those considered high-risk. But Pauly and Herring’s research turned up surprisingly counter-intuitive information. "While this ranking may still be correct," the authors say, "our results suggest that the appearances which give rise to these judgments may be quite deceiving."
First of all, is it in fact true that individual nongroup insurers segment risks? "The fear with some policymakers is that the individual insurance market is simply unfair, in that it risk-rates high-risk individuals by making them pay much more," says Herring. "We discovered that there really is not such a strong relationship between individual risk and the premiums these people pay." While sellers certainly try to segment risks, buyers apparently shop around enough to find themselves decent deals. People holding individual insurance whose anticipated medical expenses are twice the average pay premiums only about 20 to 40% higher than other individual insurance customers. Most importantly, buyers frequently choose policies with guaranteed renewability, even where that feature is not required by law. The result: in this market, premiums paid by those with chronic conditions are not consistently greater than those paid by the healthy. What’s more, according to the authors, "no conclusive statistical evidence exists that ordinary Americans seeking insurance in the nongroup market are differentially deterred from obtaining coverage because they are higher-than-average risks."
What about the accepted notion that employment-based group insurance pools risk almost completely? Even in large groups, higher-risk individuals do pay somewhat more–either through higher premiums or lower wages–because they exhibit some "determinants of expected expense." What determinants? Age, for one. "Workers receive lower raises over their careers for seniority in firms where they obtain insurance than in firms where they do not. Thus, through lower wages, older workers effectively pay more for their insurance." In addition, Pauly cites some evidence that location (for example, paying a higher premium because your firm happens to base you in New York where doctors and hospitals are expensive, rather than in Iowa), and gender (one recent study shows that the wages of insured women tend to be lower in states that require maternity benefits,) may also play a role in the rates employees pay.
Moreover, the authors found that high-risk, low-wage employees in small groups were less likely to obtain insurance than others. With employment-based insurance there is, of course, also a freedom of choice issue: "There’s currently this managed care backlash where employees just don’t seem to be that happy with what their employers are offering," says Herring.
So, is individual health insurance currently the best choice for almost all Americans? Not now, say Pauly and Herring. It’s too expensive–not because sellers are trying to hike premiums for high-risks, but because of the steep administrative costs. People at all risk levels are being charged premiums that are too high relative to the benefits they get back. "This high loading arises because this market, like all customized markets (and like its analogues in automobile and homeowners insurance) is very expensive to administer." Unfortunately, faced with these high prices and the absence of a tax-subsidy for individual insurance, say the authors, the people with the greatest need of insurance assistance are the ones who are the most often discouraged from buying it. They often tend to rely on free care, if necessary, instead.
Pauly and Herring offer some guidance for altering both public policy and private behavior in the area of health insurance. First, they assert that not only does the tax subsidy to employment-based health insurance lead to excessive levels of insurance coverage, but in its current form it is also inequitable. This is because it favors those with higher incomes and those currently employed in groups. Pauly and Herring suggest at least directing the tax subsidy towards the individual market as well, and perhaps also working to lower its administrative costs. Rather than focus on fears of risk-segmentation, the authors suggest that political energy should be directed towards the nongroup market’s major problems: high loading costs, lack of persistence in purchasing, and mistaken choices.
Will large-group employment-based coverage continue to be the norm for most Americans in the foreseeable future? Perhaps for most Americans, but individual insurance may be gaining ground. Says Pauly: "[Presidential candidate] Bush recently proposed helping the uninsured by giving them credits or subsidies. A lot of those people would probably take that credit and go buy in the private market." Herring adds, "If suddenly we have some kind of policy change with the goal of getting more people insured, most likely there’s going to be an increased reliance on the individual market. So understanding what’s currently happening to those insured in this market is an important issue."
