Copays, Premiums, and Risk-Pooling ... Oh, My! (First in a series on healthcare reform)

At the risk of causing eyes weary with healthcare reform to glaze over, I am starting an essay series to suggest various measures to improve the current U.S. healthcare system. The measures I describe include global changes, as well as tweaks, or modifications to the current system. Nothing I suggest is necessarily original -- the changes are discussed elsewhere in great detail -- but my blog offers an opportunity to have a discussion with those not steeped in the details of healthcare financing.

I have decided to make the essay much more manageable for readers by addressing one weakness and solution per day.

I have been a healthcare consultant for 15 years, with experience tracking the financing of patient care, medical technologies, drugs, biologicals, and advanced procedures for treating patients. Doing so has afforded me a birds-eye view of how the U.S. healthcare system intersects with patients, physicians, hospitals, and health insurance companies.

An earlier essay discussed the inherent problems with the so-called "public option," whereby the government will offer a health insurance plan to "compete" with private-sector insurance companies. An astute reader commented that, while he felt my piece was effective in identifying the structural flaws with the public option, I did offer any solutions of my own. (In other words, it is very easy to criticize without presenting alternatives.)

As everyone knows, President Barack Obama (here, here, here) and others have derided the free market for "failing" Americans in health care. That is, quite simply, false at best, and a lie at worst. The federal government has infiltrated itself into the health insurance market so deeply that it publishes approximately ten thousand pages of rules and regulations annually, just for Medicare and Medicaid. That does not even include regulations for private insurers, as well as legislation and regulations the state governments lard onto the insurance market.

So, the reader will understand if my recommendations to improve the healthcare system do not draw on anything Obama says; in fact, most of my suggestions run counter to anything he has said or believes. So, with that framework understood, let's jump right in.

The first measure needing reform is the tax structure of health insurance.

Tax Structure

Problem

The tax structure of health insurance is one of its most distorting features. A series of federal rules, enacted shortly after World War II and culminating in an IRS decision in 1954, resulted in employer-sponsored health insurance not being taxable income (and, therefore, payable with pretax income). However, health insurance purchased elsewhere (e.g., self-purchased) must be paid with after-tax dollars.

Predictably, the vast majority of Americans now receive health insurance through their employer. (David Blumenthal, MD, summarizes succinctly the origins of employer-sponsored health insurance in his 2006 New England Journal of Medicine article "Employer-Sponsored Health Insurance in the United States — Origins and Implications" located here.)

This tax preference for employers has several pernicious consequences. First, it means that health insurance provided by employers is much cheaper than health insurance purchased by an individual for himself and/or his family. As a result, simply having health insurance tends to tether employees to their jobs -- even if the job is less than desirable -- out of fear of being without coverage. This "job anchor" prevents many individuals from pursuing a better job (however, one defines "better," whether it be a higher salary, shorter commute, improved quality of life, etc.)

The second implication of employer-sponsored health insurance is that it constrains salaries. If a new employee already has health coverage from a spouse, he or she may not need to participate in the employer's health insurance plan -- thus saving the employer thousands (or tens of thousands) of dollars a year in insurance premiums. However, that economic benefit -- through no strategem on the employer's part -- accrues 100 percent to the employer. In other words, the employee does not participate in the economic benefits of forsaking health insurance, in the form of a higher salary or other benefits.

Solution

Removing the tax deductibility of employer-sponsored health insurance would help equalize insurance costs between employers and individuals. A likely result is that many employers would no longer provide health insurance as part of the benefit package.

Despite probable knee-jerk reactions about the horror of this possibility, this is not a bad development: As prospective employees start negotiating for jobs in the "new normal," and realize benefit packages no longer include health insurance, they should begin demanding higher salaries and/or other benefits (i.e., subsidized transportation costs, subsidized tuition, etc.) to compensate.

The provision of employer-sponsored health insurance was originally offered because the federal government placed a cap on salaries -- leading employers to search for other job benefits -- so the process of salaries increasing to compensate for the lack of health insurance is simply a reversal of earlier employment decisions.

Ultimately, shifting health insurance provision to individuals is a better arrangement, because employers do not (cannot, actually) offer employees the full range of health insurance options available, for the employee to select the plan that best meets his or his family's needs. Rather, in an effort to keep insurance premiums as low as possible -- while still offering employees a modicum of choice -- most employers allow employees either an HMO (health-maintenance organization) or PPO (preferred-provider organization) option.

Employees could use the resultant higher salaries to select from a much greater range of health insurance plans -- and the plans would not be linked to employment status (or lack thereof).

Granted, employers would still have a cost advantage due to pooling (i.e., large employers could "pool" together a number of employees, thus spreading out risk to reduce premiums). However, individuals would still be able to join risk pools, and benefit from the same premium-reducing activity. As a matter of fact, individuals could join pools structured around commonalities that may result in greater cohesiveness than employers, and potentially greater loyalty to insurance companies. These advantages might well result in lower premiums for pools that involve "families of families" and other cooperative arrangements, especially given the disloyalty that employers and insurance companies have toward one another. (Employers change health insurance companies approximately every two years.)