Nate says “One of These Things is Not Like the Other”
Yesterday, over at FiveThirtyEight Nate Silver sternly questions George F. Will’s latest column. In doing so, Nate commits an error that is made frequently in the healthcare debate. Saying profoundly that healthcare is “different”:
I’m a big believer in the profit motive in 99 percent of all cases. If the government decided to open a non-profit hamburger stand, I doubt that it would compete successfully against Five Guys. If it tried to open a non-profit airline, I doubt that it could offer the same value as JetBlue. Insert joke about General Motors and/or the Post Office here. The point is, I think the profit motive is generally well worth it in terms of the incentives it creates to cut costs, develop new products, improve customer service, and so forth.
But health insurance is not like those things.
I’ll agree that it’s different, but only that it’s artificially so. We made it that way. We created this monster. And therefore we can destroy it.
So exactly why are FiveGuys and JetBlue different than health insurance? Nate’s explanation:
Insurance exists because of the decreasing marginal utility of income: most people would rather have a 100% chance of paying $300 a month than a 1% chance of paying $30,000 a month. In fact, our hypothetical customer — let’s call him Frederick, after George F. Will’s middle name — might very well accept a 100% chance of paying $400 a month rather than take 1% chance of having to pay $30,000, which he might not be able to afford. This is true even though Frederick will lose $100 on this deal in an average month.
There’s nothing wrong with this arrangement — the customer has improved his marginal utility and the insurance company has made $100. It’s a win-win.
He starts out fine, giving a clear textbook-style example of risk aversion. But then takes a turn I was not expecting from a Chicago-trained academic:
The thing is, though, that the insurer hasn’t had to work particularly hard for his $100. He hasn’t had to figure out how to cook up tastier fries or save you a few bucks off the cost of your next flight to Orlando. All he has to do is to have a bunch of money pooled together, such that he has a different marginal utility curve than you do. He has the luxury to accept the risk of unlikely outcomes, particularly if he can hedge his position by making the same deal with other customers, most of whom won’t wind up requiring an angioplasty or cataract surgery, even if Frederick does.
The insurer hasn’t worked hard? Tell me you have a real argument, please. The insurer innovated. He created this neat thing called a risk-pool and combined it with the law of large numbers to give consumers something of value. That value is then worth something in the market. This innovation clearly filled a need for this world of risk averse people. Who cares if the insurer “didn’t work hard” to create it. If consumers are being provided with a service they clearly demand, then what’s the problem?
There is a local car washing facility up the street from my house, where I go and I pay to wash my own car. I never see the owner there and he has never so much as lifted a finger in my general direction, yet he makes money from the building he set up to provide such a service. Is he evil?
Banking is eerily similar to insurance pools. Are bankers evil too? Wait. Don’t answer that one.
Health insurance is different, I’ll admit it again. But Nate never really offers a sufficient reason why.
Now, what’s supposed to happen in the free market is that another company will come in and offer Frederick a better deal: they’ll offer him the same coverage for $350 a month, accepting a smaller profit, and Frederick will happily take the deal. There are at least a couple of reasons, however, why this may not be happening in the insurance industry. The first is that Frederick might not realize he’s paying $400 every month for insurance. That’s because if he’s like the majority of Americans, he’s getting his insurance through his work, and except when the HR lady gave him a shiny brochure on his first day at the office, he’s probably never thought very much about what this insurance is costing him in terms of foregone salary. This is particularly so because health insurance benefits, unlike other types of income, aren’t taxed, and so Fredrick is less cognizant of them if show up on his paycheck at all. Not only, then, is the free market maxim of perfect information violated, but it’s violated in such a way that creates artificial profits for the insurance industry: the government is effectively subsidizing every dollar that Frederick’s company is willing to spend on his insurance benefit.
The profits the insurance industry is making, of course — profits artificially boosted by an enormous backdoor tax subsidy — don’t seem to be buying the customer much of anything in terms of improved service or cost savings. On the contrary, health care costs are rising by as much as 9-10 percent per year, without any concomitant increase in the level of service. If JetBlue were raising the cost of its fares by 10 percent per year, they’d be out of business.
The reason the insurers are staying in business, though, is because barriers to entry in the health insurance industry are in practice quite high. Insurers benefit from pooling risk. The larger the pool, the better in terms of the insurer’s ability to hedge its risk and build negotiating leverage with its providers. That makes it very difficult for a Five Guys or a JetBlue type of start-up to compete: they’ll have trouble getting together enough customers to pool their risk adequately, and even if they do, they won’t have as much negotiating leverage as the big guys. Health care providers may demand a better deal or refuse to accept them. As such, they’ll never get off the ground.
So health insurance is different because it’s subsidized? And that it has barriers to entry? The payment system is confusing and masks the true costs? These are not arguments that health insurance is intrinsically different than burgers or plane tickets. The government could set up a subsidy for cows and lower the price of ground beef, the government could set up a Civil Aeronautics Board and block airline entry, and I know employers who allow workers to keep their airline miles even when the company reimburses the ticket. Thats a benefit that could otherwise be paid in cash. So that’s not it either.
Health insurance is different because of the third party-payer system. When I buy a burger, I eat it. When I want to fly, I buy a plane ticket. Direct costs come out of my pockets and the direct benefits accrue solely to me. We buy health insurance hoping we don’t have to use it. But what does it get us? Health insurance has become a method of carte-blanching our way to consuming health care services. The users of insurance dictate the cost structure. We’re not paying for the tests, our insurer is, so we get them. Every one of them the insurer agrees to.
Imagine if I paid Five Guys $7-8 bucks to get in door and then they let me in the kitchen and build my own burger. I’d make one-heck of a burger before I left. Oh and don’t forget about the fries, I’m taking a cart load of those home too. Five Guys would close shop within days.
The key difference here is that the people who get the benefits of health care don’t face the costs of their choices. And no one spends my money more prudently than I do. Milton Friedman wrote the same thing in 2001, so I don’t claim this to be original thought here, but his wisdom is no less true today:
Two simple observations are key to explaining both the high level of spending on medical care and the dissatisfaction with that spending. The first is that most payments to physicians or hospitals or other caregivers for medical care are made not by the patient but by a third party—an insurance company or employer or governmental body. The second is that nobody spends somebody else’s money as wisely or as frugally as he spends his own.
What we need to control health care costs is a system where individuals pay their own way for most routine health care services and prescriptions. But then the government insures everyone with a lower-premium catastrophic health insurance plan.
Tags: 538, healthcare, Nate Silver
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