At the outset, I’ll stipulate that I am no expert in health care but that my biases are strongly against the expansion of government entitlements in this or other areas. Discount my meanderings as you see fit. My understanding, however, is that a large part of the problem in health care costs comes in the way in which we price the system. We pay for services rather than outcomes. [...]]]> One of the joys of being a contracts prof is that you get to teach Hawkins v. McGee, the hairy-hand case of Paper Chase fame. Reading this week’s Economist briefing on health care has got me thinking about the meaning of the holding in that case for the current health care debates.

At the outset, I’ll stipulate that I am no expert in health care but that my biases are strongly against the expansion of government entitlements in this or other areas. Discount my meanderings as you see fit. My understanding, however, is that a large part of the problem in health care costs comes in the way in which we price the system. We pay for services rather than outcomes. This creates an incentive for providers to create a system structured around providing expensive procedures rather than providing positive health outcomes. I wonder, however, if Hawkins v. McGee doesn’t provide a way forward.

The case is normally presented as being about the proper measure of damages. Hawkins had a badly burned hand, and McGee promised that if he could perform an experimental skin graft Hawkin’s hand would be a “one hundred percent good hand.” The operation was a horrible failure, leaving Hawkins with a maimed and hairy hand. The court awarded expectation damages, namely the difference between what was promised — a good hand — and what was delivered — a maimed and hairy hand. (It turns out that a hand wasn’t worth much in New Hampshire in 1929; Hawkins got a couple of hundred bucks.) The case is odd because it presents what would ordinarily be a malpractice claim as a contract claim precisely because McGee did more than simply promise to perform services for a fee. He promised an outcome.

Suppose that we replaced the ordinary healthcare contract with the Hawkins v. McGee contract, namely that hospitals promised to deliver healthcare outcomes rather than healthcare services. First, it would align the incentives of health care providers much more closely with patients. Second, it would inject a lot of uncertainty into health care providers liabilities. After all, in many cases they will not be able to deliver particular outcomes, causing a breach of their contracts. This second issue could be controlled in two ways. First, health care providers could specify the amount they would pay in the event of unsuccessful treatment in a liquidated damages clause. Provided the courts enforced these clauses, they would diminish the unpredictability of payouts. Second, and perhaps more importantly, a fee-for-outcome contract would create a powerful incentive for healthcare providers to actuarialize the effectiveness of treatments, carefully compiling data on how likely successful outcomes actually are.

Were this contract adopted, going to the doctor would involve the purchase of a very different bundle of rights. Rather than buying services on the advice of a conflicted expert advisor, one would in effect purchase a form of insurance. In return for a fee, you would be promised a favorable outcome or the payment of some sum of money. The hospitals would then, in effect, be in the position of making bets on the effectiveness of their own treatments, bets that would become more profitable the better the outcomes were.

[M]aterial available on the Web shows that people who have specific illnesses or use certain drugs can’t buy coverage.

”This is absolutely the standard way of doing business,” said Santiago Leon, a health insurance broker in Miami. Being denied for preexisting conditions is well known, but when a person sees the usually confidential list of automatic denials for himself, “that’s a eureka moment. That shows you how harsh the system is.” . . . .

Searching the Web, The Miami Herald found underwriting guidelines for Coventry Health Care, which owns Vista; Wellpoint; [...]]]> For the millions of people losing their jobs and having to obtain health insurance on their own, they are in for quite some difficulty if they have a pre-existing condition. According to the Miami Herald:

[M]aterial available on the Web shows that people who have specific illnesses or use certain drugs can’t buy coverage.

”This is absolutely the standard way of doing business,” said Santiago Leon, a health insurance broker in Miami. Being denied for preexisting conditions is well known, but when a person sees the usually confidential list of automatic denials for himself, “that’s a eureka moment. That shows you how harsh the system is.” . . . .

Searching the Web, The Miami Herald found underwriting guidelines for Coventry Health Care, which owns Vista; Wellpoint; Assurant Health; and Blue Cross Blue Shield of Nebraska.

Among the health problems that the guides say should be rejected: diabetes, hepatitis C, multiple sclerosis, schizophrenia, quadriplegia, Parkinson’s disease and AIDS/HIV.

For cancer, the key is how patients have been doing in remission. Wellpoint, a national insurer, rejects applicants who have had breast or prostate cancer within the past five years. With other types of cancer, 10 years must have passed. Assurant Health, based in Milwaukee, rejects most patients whose cancer has not been in remission for at least eight years.

Other reasons for automatic denial by various companies: alcohol-related problems of people who have not been abstinent for at least six years, chronic bronchitis, severe migraines, and a cardiac pacemaker installed within the last two years.

Some insurers will automatically reject applicants who are using certain prescription drugs. Wellpoint denies anyone who within the past year has taken Abilify and Zyprexa for mental disorders as well as Neupogen, which is used to treat the side effects of chemotherapy. Vista lists the anticoagulant Warfarin and the pain medication Oxycontin. Both companies list insulin.

The article also discusses how the insurers use database companies to gather data about people’s medical conditions and prescription drug use:

To make sure that applicants are not lying, insurers hire a data-gathering service — Medical Information Bureau, Milliman’s Intelliscript or Ingenix Medpoint.

Intelliscript and Medpoint do computerized searches of a person’s drug use, gleaned from pharmacy benefits managers and other databases.

The difficulty is that if a person has a disease, then it may be nearly impossible for that person to obtain health insurance. My advice: (1) stay employed; (2) don’t get ill. Otherwise, you’re basically out of luck.

Originally, of course, there weren’t insurance companies. Rather, individual merchants and speculators would meet informally at Lloyd’s Coffee House in London. Suppose that there was a merchant with a ship that was about to make a voyage to America that he wished to insure against loss due to the perils of the sea. He would arrive at Lloyd’s with a written contract promising to pay him so much in the event that his ship went [...]]]> Of late I’ve been reading Niall Ferguson’s The Ascent of Money: A Financial History of the World, and I’ve been struck again at how similar the rise of the modern CDS market is with the rise of maritime insurance at Lloyd’s Coffee House in the early 18th century.

Originally, of course, there weren’t insurance companies. Rather, individual merchants and speculators would meet informally at Lloyd’s Coffee House in London. Suppose that there was a merchant with a ship that was about to make a voyage to America that he wished to insure against loss due to the perils of the sea. He would arrive at Lloyd’s with a written contract promising to pay him so much in the event that his ship went down. He would also arrive with money — or at least the willingness to pay it. He would then circulate through the coffee house, looking for those who were willing to sign the contract. Suppose that the contract promised to pay out 5,000 pounds in the event that the ship went down. Some people would sign for one pound of liability, some for 100 pounds, some for 1,000 pounds. Each underwriter would, of course, be paid by the merchant for their signature in proportion to the amount of liability that the underwriter took on. In the end, the merchant would have an insurance contract on his ship signed by a pool of investors who in aggregate were paid less than the insured value of the ship. Of course, while he was at Lloyd’s the merchant might pick up a bit of money by signing on as an underwriter on another merchant’s insurance contract. Before too long there were people who made their living (or at least tried to) entirely with in Lloyd’s Coffee House.

Thus maritime insurance started out much like the modern CDS market. It was an entirely over the counter trade. (Literally!) There were no reserve requirements for underwriters, there was a lot of speculation by those who didn’t have a clear idea of the risks they were taking on, as well as underwriting by experienced market participants who probably had a very good idea about the perils of the sea. And of course, there was an endemic problem of counter party risk. If an underwriter turned out to be insolvent in the event that a ship did sink off Cape Hatteras, there wasn’t much that the hapless owner could do. There was, I suppose, the consolation of debtor’s prison and the knowledge that you could drive welshing underwriters and their children into a Little-Dorrit-esque existence.

There was a two fold response to the wild world of Lloyd’s. On one side, the common law courts reacted with skepticism if not outright hostility to the contracts written in the smokey coffee rooms. There was a persistent suspicion that these contracts were little more than gambling devices, something disreputable that ought to be suppressed or limited. On the other side, the regulars at Lloyd’s realized that they needed to clean up the insurance market. The result was a system of trading within an association to which one could not gain access unless certain basic proofs of reliability were met. In the end, pay-as-you-go was replaced with insurance based on an insurance pool and investment proceeds, which gradually reduced the problem of counter party risk in insurance. (Although it far from eliminated it.)

I actually think that there are some important lessons to be learned from Lloyd’s. First, over the long term I think that it is pretty clear that the insurance-as-gambling meme turned out to be a legal dead end. Judicial hostility toward insurance contracts injected legal uncertainty into the mix of other risks, but did little or nothing to deal with the underlying problems of counter-party risk and proper risk assessment. These problems, it turned out, were solved despite legal hostility rather than because of it. Second, a completely decentralized market of spot contracts in pure risk allocation doesn’t work horribly well. Regulating the capital requirements of players in the game (or at least insuring their transparency) is absolutely necessary. Better yet is a clearing house system that eliminates counter party risk through asset pooling and the ruthless exclusion of unreliable or undercapitalized players. Not surprisingly, the commercially sophisticated parties at Lloyd’s did both of these things long before the courts and parliament managed to sort out a sensible attitude toward insurance. I suspect that the same will be true of the CDS market.

Nearly 30% of the total nursing-home population is receiving antipsychotic drugs. . . . In a practice known as “off label” use of prescription drugs, patients can get these powerful medicines whether they are psychotic or not.

Federal and some state regulators are pushing back, questioning the use of antipsychotic drugs and citing nursing homes for using them in ways that violate federal rules. New York has increased its focus [...]]]> The market has done a characteristically fantastic job of “trimming the fat” at nursing homes–i.e., squeezing out more profit by providing less care. One may wonder, how do the residents of such homes get taken care of when staff are fired and other corners are cut? The WSJ reports on one solution: drug them.

Nearly 30% of the total nursing-home population is receiving antipsychotic drugs. . . . In a practice known as “off label” use of prescription drugs, patients can get these powerful medicines whether they are psychotic or not.

Federal and some state regulators are pushing back, questioning the use of antipsychotic drugs and citing nursing homes for using them in ways that violate federal rules. New York has increased its focus on antipsychotics in nursing homes, training inspectors to spot signs of medication abuse.

Meanwhile, some employees are finding their health increasingly managed by their employers. “Employers Tell Workers To Get Healthy or Pay Up” is the headline, and here are some of the pressures:

Employees at some companies who are overweight, smoke, or have high cholesterol, for instance, and who don’t participate in supplementary wellness programs, will pay more for health insurance. In extreme cases, employees’ insurance deductibles could rise by $2,000.

What I wonder is: will the same people who are so distressed by the possibility of government-mandated purchase of health insurance also rise up against the corporate imposition of health standards? Or is paternalism perfectly fine when it’s a product of the market?

Finally, I highly recommend Frederick Crews’s piece on the increasing pressures to conform one’s personality to a sanguine norm. Observing some trends I noted in a review of a book on the pathologization of shyness, Crews notes that we are entering a world “in which convictions, perceived needs, and choices regarding health care are manufactured along with the products that will match them.” Here’s one part of a fascinating review:

[E]pisodic sadness has always been a socially approved means of adjusting to misfortune and that much is lost, both medically and culturally, when it is misread as a depressive disorder. Yet [DSM-III] has propagated that very blunder by failing to clarify the difference between environmentally prompted moods—those responding to stress or hardship—and dysfunctional states persisting long after the causes of stress have abated. In no sense, however, can that indictment be confined to just one disorder. The Loss of Sadness [a book reviewed by Crews] implies that nearly every nonpsychotic complaint is subject to overdiagnosis unless contextual factors—familial, cultural, relational, financial—are weighed in the balance.

As I have suggested in Technology, Competition, and Values, we cannot ignore how “financial factors” play into our pathologization of certain ways of thinking, feeling, and acting. If Medicaid were funded adequately, perhaps we could properly pay the number of staff necessary to treat elderly nursing home residents as people in need of care, not sedation. Perhaps a universal health care system would excuse employers from the terrible choice the market forces on them: avoid sick workers or face a competitive disadvantage vis a vis the companies that do. And finally, perhaps a society with less pressure to “sell oneself” would give the shy, the sad, and the anxious a little breathing room to explore many alternative routes to well-being.

Image Credit: Wikipedia, Bentham’s Panopticon.