Perils of a “Lightly Regulated” Insurance Market
posted by Frank Pasquale
I’ve addressed the “ostrich economics” of Gregory Mankiw on this blog before. Mankiw’s “Pitfalls of a Public Option” is yet another contribution to the genre. Mankiw argues that no public option in insurance is necessary, since “We don’t need government-run grocery stores or government-run gas stations to ensure that Americans can buy food and fuel at reasonable prices.” Paul Krugman’s response:
Economists have known for 45 years — ever since Kenneth Arrow’s seminal paper — that the standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough. To act all wide-eyed and innocent about these problems at this late date is either remarkably ignorant or simply disingenuous.
Krugman actually understates just how unconventional the economics of health care can be. Given these divergences from standard market models, Brad Delong may well be right to say that even Friedrich Hayek could approve the idea of a public plan: it’s a way “to use the market as an institutional discovery mechanism.”
Of course, most modern-day Hayekists are more likely to take Mankiw’s view than Delong’s; namely, that “private insurers, lightly regulated to ensure that the market works well, would offer Americans the best health care at the best prices.” We have a sense of how concentrated the private insurance industry and providers are. What exactly does “light regulation” look like in that context?
One clue can be found in Reed Abelson’s excellent article in today’s NYT, Insured, but Bankrupted by Health Crises. The story of the Yurdins conveys just how risky such a market can be:
[M]any . . . people . . . have coverage so meager that a medical crisis means financial calamity. One of them is Lawrence Yurdin, a 64-year-old computer security specialist. Although the brochure on his Aetna policy seemed to indicate it covered up to $150,000 a year in hospital care, the fine print excluded nearly all of the treatment he received at an Austin, Tex., hospital. . . .
At St. David’s Medical Center in Austin, where he went for two separate heart procedures last year, the hospital’s admitting office looked at Mr. Yurdin’s coverage and talked to Aetna. St. David’s estimated that his share of the payments would be only a few thousand dollars per procedure.
He and the hospital say they were surprised to eventually learn that the $150,000 hospital coverage in the Aetna policy was mainly for room and board. Coverage was capped at $10,000 for “other hospital services,” which turned out to include nearly all routine hospital care — the expenses incurred in the operating room, for example, and the cost of any medication he received.
In other words, even the hospital couldn’t understand (or anticipate) the tactics of Aetna. I wonder if Mankiw disapproves of Aetna’s approach here–or if he’d like to see Gotcha Capitalism further extended into the health industry.
Before ditching the public plan option, politicians should think hard about what the world of health care will look like without it. Jon Cohn provides a projection:
Fast forward a few years to the first day that [a weak] reform bill–signed with much fanfare in the Rose Garden, with a beaming bipartisan coterie–takes effect. The bill’s crown jewel is not the public option, but a “national insurance exchange,” a benefit clearinghouse that is supposed to sign up private insurers to provide choices to people without workplace insurance. These choices vary based on the region you live in, to reflect the plans in the local market.
In many markets, however, the choices turn out to be roughly as limited as they are today, when the dominant insurer enrolls at least half of privately insured people in 16 states and at least a third in 38 states. The national insurance exchange is meant to create greater competition, but for most of the country, the choice is basically between WellPoint and UnitedHealth–gargantuan for-profit insurers each about the size of Medicare. Yes, there is more than one choice in most areas, but not choices that meaningfully differ from each other, or from what is on offer today. . . .
Not surprisingly, the premiums that most plans offer within the exchange are just as high as they are today. Without a public plan offering coverage that, estimates project, would be around 25 percent cheaper, the private plans in many markets are free to gouge consumers without much concern about losing business. And without pressure on these plans to control costs, they aren’t about to cut back their administrative waste or high profits or excessive executive salaries, much less bargain aggressively with drug companies and hospitals demanding ever higher prices.
Not a pretty picture.
July 1, 2009 at 6:59 am
Posted in: Health Law
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Responses (6)
jimbino - July 1, 2009 at 8:31 am
Please explain how your public plan will cover me and other American tourists and expatriates who are overseas. Neither Medicare nor Medicaid does that now.
geoff - July 1, 2009 at 9:38 am
Frank: Mentioning the words “adverse selection” and “moral hazard,” waving your hands, and then pronouncing heavy government regulation as the solution to these “problems” is not an argument. Can you explain why the public option or other government interventions will help? In what way are these interventions targeted at Krugman’s proposed problems? And even if they are, what makes you think they will actually work? Arrow’s article simply doesn’t say what Krugman says it says, but it is certainly true that AS and MH are issues for insurers. Duh. These are not foreign to “free market economics,” nor are they dynamics that the neo-classical model can’t handle; in fact, the neo-classical model invented the economics to understand them.
Frank - July 1, 2009 at 11:04 am
Geoff: My last several posts in the health law archive have addressed why a public option is necessary:
http://www.concurringopinions.com/archives/category/health-law
I doubt that regulation without a public option can work.
Even if Krugman is wrong about Arrow, the following two pieces describe several shortcomings of neo-classical approaches to health care, including modish CDHC programs:
http://www.milbank.org/quarterly/8503feat.html
http://ideas.repec.org/a/cup/hecopl/v4y2009i01p99-114_00.html
Finally, I think we should reflect on how the situation described by Joseph White in the Milbank piece came about. Thomas Greaney of SLU has convincingly argued that failures of antitrust enforcement have contributed a great deal to larger failures of the health insurance market:
http://www.concurringopinions.com/archives/2009/05/an-antitrust-angle-on-the-public-plan.html
So the ultimate result of laissez-faire, anti-antitrust rhetoric here is to necessitate greater public involvement in a failed health insurance market. . . . just as free market fundamentalism may well have been behind the banking collapse that’s spurred the greatest increase in financial regulation since the 1930s. Ah, the cunning of history.
Frank Pasquale - July 1, 2009 at 11:09 am
PS: It does look like DeLong tried to stretch Hayek’s theory a bridge too far:
http://www.qando.net/details.aspx?Entry=5176
JP - July 1, 2009 at 11:58 am
Part of the problem is that nobody is talking about the same thing.
Mankiw was addressing the President’s call for a public option that operates competitively without government subsidy. Such a proposal doesn’t address adverse selection, moral hazard, or any of the other numerous possible causes of market failure present in the health insurance market.
Frank, you have previously clarified that you support a subsidized public option. Mankiw argues that a subsidized public option only makes sense if it is really just a step toward single-payer health insurance. (BTW, I am interested in your perspective on this claim.) He then goes on to make the standard arguments against single-payer.
Krugman hasn’t clarified anything. It is quite possible that he supports either a subsidized or unsubsidized public option simply as a stalking horse for single payer, which he has advocated before. Krugman’s criticism of Mankiw is simply a non sequitur.
Dan Culley - July 3, 2009 at 7:06 pm
I don’t see how you can mock the suggestion that we should try “light regulation,” purportedly on the basis that the health insurance and health provision industries have high barriers to entry, when most of the barriers to entry in these sectors are government created.
State insurance regulations are responsible for the fractured, single-state insurance markets that we currently have. An easy way to lower the market shares of the dominant insurance companies in each state would be to preempt state insurance regulation and replace it with uniform national rules. Insurers that look big relative to state markets do not look big in a single national market.
Similarly, in most states, entry in to the hospital services market requires a “certificate of need,” and they are rarely granted, no doubt because of regulatory capture. Rather than proposing a government-sponsored health plan, maybe we should try allowing entry first? Just as with insurers, it’s not as if the same hospitals are dominant everywhere, and successful ones could easily surmount the relatively modest market barriers to entry if government ones were removed.
Moreover, there is no reason to believe that the public plan would behave any differently than current private plans. You provide a nice sob story about fine print in a private plan. (Somehow assuming that “light regulation” cannot include regulations to curb false or misleading contracting practices…) But I see no explanation of why the public plan would have any different incentives. “Not for profit” universities should provide ample evidence that simply giving something a public mission does not magically create incentives for good behavior. With a limited budget and a fear of political criticism, the public plan would try to save money by reducing coverage in the least transparent way possible, to avoid politically unpopular cuts.
And finally, no analysis of the health care market is complete without acknowledging that Medicare regulations essentially drive the entire pricing model for hospitals. This blocks innovative pricing structures that could start to address moral hazard.
These regulations do a lot of harm to patients. How about we give the free market a chance?
Simply throwing around market failure words is not an argument. And spending time pointing out how “laissez faire” people are does not contribute much to the discussion. Have you even asked Mankiw what he envisions as “light regulation”?
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