Health Risk is a Matter of Life and Death

Health insurance premiums tend to be high for individual policies because of adverse selection and moral hazard.

Mr. Usinowisc left his job as an environmental engineer at the research firm Battlelle Memorial Institute to start a consulting business in 2001. He had to add his wife (who was treated for ovarian cancer three years earlier) as his business’ employee to get health insurance coverage. In Ohio, state law requires insurers to grant policies to small businesses with at least 2 employees regardless of health conditions. The policy that he bought cost $1000 a month in premiums with $5000 annual deductible. In 2002, he went back to work at Battelle partly because of his wife’s mounting health bills. Now his family health insurance cost about $150 a month in total premiums. The same health conditions, but almost 7 times difference in total premiums.

The big premium difference between individual and group health insurance is a logical result of risk pooling. In a large insurance pool, the insurer does not have to know the exact risk of an individual because the premiums collected from the less risky will be enough to cover the more risky. But if health insurance is not universally mandated, only those who are high risk would tend to buy coverage. Such adversely selected pool will likely have very high claims requiring very high premiums to cover them. These higher premiums will in turn adversely select the even more risky. In the worst case scenario, no individual health coverage will be offered.

Auto insurance is less expensive to buy partly because basic liability coverage is universally mandated. Such a large insurance pool averages out the risk characteristics of individual drivers. Auto insurance is also less expensive because there is a built-in cap in the damage claims. If a car is badly damaged and the repair cost exceeds the book value of the car, the insurer can just pay out the book value of the car. But in health insurance there is no equivalent book value for a patient. The insurer must pay for what is medically necessary (see Supply-chain Births) which could cost many times more than the present value of the future earnings of the patient. And what is medically necessary can keep expanding as new drugs and new medical procedures are adopted. In a sense, the absence of a coverage cap amounts to a moral hazard since the insured has no incentive to refuse even futile treatment (see Dying for Money). Such moral hazard is quite common whenever third-party payment is involved.

To contain escalating health costs, many employers are moving from traditional defined-benefits health coverage to defined-contribution health coverage. In particular, the employer pays a fixed contribution to a health savings account tied to a high-deductible catastrophic health insurance policy. Since whatever left unspent in the account can be rolled over for future use, employees may be more careful about wasting his account balance. But once the high-deductible is met, the moral hazard of unrestrained treatment takes hold again. And the problem of adverse selection still remains for people whose employers do not have any defined-contribution health plan. Even with tax credits or deductible, the healthy are likely to pass on buying any high-deductible plan. So even high-deductible health plans would be too expensive for the health-risky to afford.