The free market can provide health security.

• Author: Cochrane, John H.
• Position: Medicine & Health

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NONE OF US HAS health insurance, really. If you develop a long-term condition such as heart disease or cancer, and then lose your job or get divorced, you can lose your health insurance. You now have a preexisting condition, and insurance will be enormously expensive--if it is available at all. This happens to real people. A significant and expensive health problem is a common root cause of catastrophic economic descents in the U.S. Many people stick with bad jobs or bad marriages just to keep their health insurance.

Free markets can solve this problem and provide lifelong, portable health security, while enhancing consumer choice and competition. "Heath-status insurance" is the key. If you are diagnosed with a long-term, expensive condition, a health-status insurance policy will give you the resources to pay higher medical insurance premiums. Health-status insurance covers the risk of premium reclassification, just as medical insurance covers the risk of medical expenses. With health-status insurance, you always can obtain medical insurance, no matter how sick you get, with no change in out-of-pocket costs. With health-status insurance, medical insurers would be allowed to charge sick people more than healthy people, and to compete intensely for all customers. Individuals would have complete freedom to change jobs, move, or alter medical insurers. Rigorous competition would allow us to obtain better medical care at lower cost.

Most regulations and policy proposals aimed at improving long-term insurance--including those advanced by Pres. Barack Obama--limit competition and consumer choice by banning risk-based premiums, forcing insurers to take all comers, strengthening employer-based or other forced pooling mechanisms, or introducing national health insurance.

The individual health insurance market already is moving in the direction of health-status insurance. To let health-status insurance emerge fully, we must remove the legal and regulatory pressure to provide employer-based group insurance over individual insurance and regulations limiting risk-based pricing and competition among health insurers.

The lack of secure, long-term, portable health insurance is the greatest single problem with our current health care system. Solving this problem is a central goal of every health care reform proposal from all parts of the political spectrum. There are plenty of other difficulties with our health sector: the uninsured; hospitals' hotel-minibar pricing policies; poor information; the drudgery of useless paperwork; cost recovery of new medicines; optimal copayment levels; and so on. Yet, all of these are fairly clear problems, each limited in its reach, with fairly clear remedies. The lack of long-term insurance, by contrast, seems a harder nut to crack and, unlike, say, the plight of the uninsured, it is a problem that faces each of us directly.

Free and competitive markets are the best way to spur innovation, provide better service, and reduce costs. So far, however, many people have thought that competition undermines long-term insurance, leading to the extensively regulated market we now face and to proposals for further regulation. Health-status insurance lets us break out of this dilemma, as it can provide completely portable, lifetime health insurance and great individual freedom of choice in a deregulated, competitive, and, hence, efficient and innovative market.

Market-based lifetime health insurance has two components: medical insurance and health-status insurance. Medical insurance covers your medical expenses in the current year, minus deductibles and copayments. Health-status insurance covers the risk that your medical insurance premiums will rise. If you get a long-term condition that moves you into a more expensive medical insurance premium category, health-status insurance pays you a lump sum large enough to cover your higher medical insurance premiums, with no change in out-of-pocket expenses.

Why can't medical insurers just charge everyone the same premium? In a competitive market, medical insurers must charge sick people higher premiums, and charge healthy people lower premiums. If an insurer charged everyone the same price, then a competitor could woo away healthy low-cost customers, and the original insurer would go out of business. Furthermore, the main reason insurance companies refuse coverage, deny coverage for preexisting conditions, or, more subtly, avoid or mistreat people with long-term expensive conditions is that they cannot charge those people enough to cover their costs. If medical insurers can charge enough, they will compete for the business of every customer, even the sickest. Freely risk-rated, competitive medical insurance gives everyone access, albeit at a cost. It leaves people vulnerable to the financial risk of large premium increases, but health-stares insurance would fill that gap.

The combination of health-slims insurance and competitive, freely priced medical insurance solves the central problem of our current health insurance market: the lack of real, long-term, portable health security. With health-slams insurance, you always can get medical insurance, no matter if you get sick, change or lose jobs, move, divorce, take some time out of the labor force, or even let your medical insurance lapse. The lump-sum payment from the health-slims insurer means you always can pay your medical insurance premiums.

Health-status insurance also would give each of us much greater freedom and choice. No matter how sick you become, you would be free to change medical insurers. You could afford the higher premiums a new medical insurer will demand, just as you could afford the higher premiums your current insurer will require. You would not depend on the good treatment of one insurer, the vagaries of one group, the link to one employer, or the bureaucratic decisions of a single government-provided plan.

Best of all, when every consumer is free to switch insurers at any time, medical insurance companies will compete for everyone's business. They will compete for the business of expensive, high-risk customers, rather than try to get rid of them or "contain their costs." They also can compete for the business of people who currently are healthy, as such competition will not undermine the implicit cross-subsidy to people with preexisting conditions. Constant competition for every consumer will have the same dramatic effects on cost, quality, and innovation in health care as it does in every other industry.

In sum, health-status insurance simultaneously can give us complete and portable long-term insurance, great individual choice, and cost-containment beyond the dreams of any health policy planner--and it does not cost consumers anything. The combined health-status and medical insurance premiums are the same as those of a lifetime individual insurance contract, and the same in present-value terms as those of a (hypothetical) successful group or pooling program, even before we factor in cost savings from greater competition.

Suppose that a healthy 25-year-old male will incur $2,000 worth of medical expenses in a year, on average. A competitive medical insurance market will offer him insurance with a $2,000 premium, plus administrative costs and profit. Suppose that, along with potential short-term illnesses, he has a one percent chance of developing a chronic condition that will raise his average medical expenses to $10,000 per year. If he develops this condition, a competitive medical insurance market still will cover him in following years, but his annual medical insurance premium must rise to $10,000, plus costs and profit. This is a large financial setback.

To be covered over the long term, then, he needs a lump-sum payment large enough to cover $8,000 per year in additional medical insurance premiums. At a five percent interest rate, that sum is $148,370. The premium for health-status insurance is one percent of that value, $1,483.70, plus administrative costs and profit. In sum, he pays $2,000 for one year of medical insurance, plus $1,483.70 for health-status insurance...