Insurance, the Market and those pesky wowsers (Doc Holliday)

Now that my work has lightened up, I too will part a few shots at government and wowsers.

Health care puts forward a number of dilemmas for economists and policy makers. In this posting, I will consider the incentives and distortions that have arisen from government intervention in the provision of health insurance. I will also put forward a solution.

In any laissez faire insurance market, insurers charge insurance premiums that reflect the risk that people impose on the pool of insurance premiums. This is true for all insurance markets that I can think of - cars, houses, luxury boats, personal property. If you are 18 years old and park your Subaru WRX in Broadmeadows overnight, you pay the price!

Unfortunately, this doesn't occur in health. Instead, in every developed country that I can think of, everyone pays the average (pool) price - not the marginal cost. This is not because of a decision by health insurances but because of government regulation. The objective of community rating regulation as it is called, is to ensure that even the poorest can access affordable health care. Its effect is to smear insurance costs so that the rich and healthy subsidise the poor and the sick.

Community rating regulation appeared first in countries where private health insurance was the norm. But it also operates in the government-run single payer schemes (consider the National Health Service in the UK, Medicare in Australia and Canada). In these schemes, the costs of health insurance are smeared across tax-payers, not those seeking insurance. (The medicare levy surcharge is an exception, but this is only effective when we consider the role of Australia's Lifetime health cover rating system).

However, this has some rather unintended consequences (hello hello!). One is that it removes any incentive for individuals to adopt healthy life-styles. Why drink green tea and ride a bike to work if you know that someone else is paying for your healthcare?

In a laissez faire market, there would be a variety of insurance companies each offering slightly different products. Some might offer health-management organisation type contracts: you agree to change your behaviours (eg give up smoking) in return for discount insurance. (Funnily enough, the earliest health insurance schemes (organised by many religious and charitable organisations) at the turn of the 20th century did offer just that.)

But under community regulation, no one has an incentive to change their behaviour. This is a problem for both private health insurance schemes (as in US, Switzerland and Greece) and single-payer schemes (UK, Canada and Australia). In bid to protect the insurance pool against the threat of smoking and drinking geriatrics, wowsers step up to the plate to start issuing edicts: that shalt stop drinking, smoking, and growing old etc. The number of regulations that Roy posted are indeed scary. But in a dysfunctional market without marginal prices, the number of regulations can not but grow as bureaucrats scramble to change behaviour. Any market in which there are no prices will grow increasingly dysfunctional as successive layers of regulation are introduced to control it.

Is there a role for the market? I believe there is, and Australia already gives us an example. Some years ago (in 2000 I think), Australia introduced Lifetime health cover (LHC). It was introduced by the Howard Government in response to the adverse selection taking place as healthy people opted out of private health insurance to be covered by Medicare. LHC in effect penalises people incrementally the longer they remain privately uninsured. It acts like a second-best market price for private health insurance (PHI). The older and more likely you are to get sick, the more private health insurance will cost, so join up when

you're young. It doesn't give you the same incentive to change your lifestyles as an actuarially fair premium but its close. But it did influence PHI membership dramatically. It also demonstrates that people are sensitive to market prices - even for health insurance.

Back to my dilemmas for economists and policy makers. How do we get a healthcare system that is offers all the economic efficiencies that is currently lacking yet addresses the equity concerns of providing care for the poorest in the community? The obvious response is to introduce a voucher-type system. Governments provide individuals a voucher (it may be means-tested) to be spent on health insurance. The amount given to the individual reflects their risk-rating (so high risk individuals get paid more). Individuals can get to keep some of that voucher if they can demonstrate a reduction in their risk-rating (credited back to a Medicare Savings Account for use on a rainy, sick day). Individuals can use that voucher money to purchase private health insurance from any number of competing health insurers on the market.

There is another dilemma in health care that needs addressing - market power of medical professionals (doctors and surgeons). But that is for another posting.

regards

Doc Holliday.