Wednesday, June 24, 2009

Trouble Indemnity 4


One of the most unusual, and most troublesome, aspects of our current health insurance system is that, for many Americans, health insurance is provided through our employer. This causes many problems. If you lose your job, you will eventually lose your health insurance coverage (the COBRE program provides limited extension). If workers are satisfied with their current insurance, it is likely to make them hesitate before changing jobs, particularly if they are in a period in which they are receiving benefits for ongoing health problems. It means that workers often have few choices as employers prefer to negotiate “one size fits all” packages with insurers. Natural diversity among consumers puts a great deal of competitive pressure on automobile insurance companies to innovate, to compete on rates, and to discover what customers prefer in terms of non-price attributes such as service. This competitive force is largely not in play in the health insurance market.

How did we get to this point? The starting point would be my last post on adverse selection. One alternative for insurers to avoid problems of adverse selection is to provide group insurance at group insurance rates to a large collection of customers who, on average, are unlikely to exhibit enough adverse selection to make the group plan unprofitable to the insurer. The move towards group insurance began with fraternal organizations and then picked up steam with Blue Cross and Blue Shield programs in the 1930s.

Recall that Double Indemnity was released in 1944 (

Neff: Back in my office there was a phone message from Mrs. Dietrichson about the renewals. She didn’t want me to come tomorrow evening. She wanted me to come Thursday afternoon at three-thirty instead. I had a lot of stuff lined up for that Thursday afternoon, including a trip down to Santa Monica to see a couple of live prospects about some group insurance.

The transforming event in group insurance in the United States was World War II. The Roosevelt administration imposed wage and price controls throughout the economy. Expanding defense plants had difficulty attracting workers form other cities, and they could not compete on wages. So, some of the companies began advertising “fringe benefits” such as group health insurance, and were, for whatever reason, able to avoid prosecution under the wage controls. As these fringe benefits became more common, they were awarded the various tax exemptions they now enjoy (and thus are distinct from wages for tax purposes).

John McCain proposed moving shifting the tax exemption for health insurance from the employer to the employee (either as a tax deduction or as a refundable tax credit). The incentives to engage in careful consideration of what would be an individual’s optimal insurance policy would likewise move to the employee. If individuals owned their policies, they could take them with them if they changed jobs. Recall that the Obama campaign launched a blistering advertising campaign against the McCain plan calling it a tax increase. (It did increase taxes on firms, but it offset them with tax reductions for individuals). Now, advisers to the Obama administration and to the Congress admit that the idea of increasing the tax on employers is being seriously considered (that is, at least the tax increase part of the McCain plan).

I believe that there are a lot of advantages to plans similar to those proposed by Sen. McCain. I see the biggest difficulty in the McCain-type plans being in retaining group insurance pools so as to avoid adverse selection problems. As I have discussed with students interested in market-based reforms of health insurance, a big problem is what to do, during such a transition, with people who are obviously high-risk or even very sick.

A series of polls over the past couple of days have shown that somewhere in the range of 70 – 90 percent of Americans are happy with their current health insurance. Christianity is neither majoritarianism nor utilitarianism, so this is not a mandate to do nothing. But it is a signal that the size of the “crisis” we are supposedly fixing may not be as large as advertised, and it is also a signal about utilizing all of our virtues of wisdom and prudence in how to proceed.

So, what would I do if I could design the new health insurance legislation? I would follow with something like the McCain plan, relying on greater competition and flexibility in private health insurance plans. I would restrict the ability of state governments to mandate special provisions that many individuals don’t want. I would have the government (federal or states) playing some kind of role to deal with high-risk individuals in a manner similar to what some states do with regards to automobile insurance. For people whose current medical condition makes obtaining health insurance a non-starter, there are a couple of choices. These people could be folded into the various state Medicaid programs, or the government could act as an assigned risk agent, conducting a random process to assign high-risk individuals to existing pools.

I think the hardest question I wrestle with is whether the government ought to require people to purchase health insurance. I’m more comfortable with such a requirement in automobile insurance because a) it only applies to liability insurance, that is, with regard to our harm to others, and b) many states have an opt-out provision based upon a driver’s ability to demonstrate that he has enough capital that could be attached in a successful tort suit. Reason a) does not apply in health insurance. Here is the moral question I will put on the table for people to think about. Suppose a reform such as I have outlined, together with Medicare and Medicaid, makes health insurance practically available, for purposes of this discussion, to everyone. Consider the following admittedly extreme case. Mr. X makes $170,000 per year in a self employment situation. He could purchase a catastrophic expense private health insurance policy for a couple of hundred dollars per month. He chooses not to, because he spends all of his paycheck on expensive cars, clothes, and entertainment. This means that he has no savings. One day, he realizes that he has developed a debilitating, perhaps even fatal disease that eliminates his ability to earn an income, but this disease can be cured for $1,000,000 in health care expenses.

As Christians, how should we answer the following questions? Should he be treated, or should he be turned away? If he is to be treated, who should pay for it? Is there anything that should be required from Mr. X in return? If the decision is to treat him, what incentive do any of us have to act any differently than Mr. X.

This hypothetical is not as far-fetched as it seems, because currently there are many people in the United States who choose not to purchase health insurance even though it is available to them. (Although few of these non-insurers are in the extreme situation I created for this example, not all of them are by any measure “poor”). Eventually, I suppose that if Mr. X lives long enough and is destitute for long enough he might pass the eligibility screens for the taxpayers to pay his treatment through Medicaid. After all, he has paid taxes to his state government. Is that fair? What if everyone behaved the same way as Mr. X?

One answer to these questions that doesn't involve the government is, as Doug has been discussing in his previous posts, a Christian sense of obligation, based upon love of neighbors. I think of my grandfather who, in the midst of about 10 years of unemployment during the Great Depression, had to deal with medical bills for my grandmother who died from a lingering bout of cancer somewhere around 1940. My grandfather and I used to get into lively political discussions; his beliefs were somewhere between those of a liberal Democrat and a conservative socialist. He was a Christian (a member of the Church of the Nazarene) and quite literally a card-carrying member of the AFL-CIO (somewhere in my files I have his card). I am sure that if he were alive today he would be lecturing me on the need for a single payer, government operated health care monopoly. But one of the things he was proudest of was that he worked out a repayment plan with my grandmothers' doctors, never accepted a penny of governments handouts, and clearly remembered the very date on which he paid off the last of those bills, about 15 years after my grandmother died.

Friday, June 19, 2009


This post was intended to provoke thought about how easily we slip into a cost-benefit paradigm versus having a moral absolute against certain actions. Alas, the document is saved to another computer . . . my article will have to wait. But, the essence is that rather than say an action is wrong on the basis that it violates codes of behavior we weigh the wrongness of the action against the benefit that emerges. So, actions like torture which slice away chunks of dignity and humanity from another person is not refused on the basis of a moral absolute; instead, the costs of degrading another person's humanity is said to be worth it if the benefit of the torture was important information that saved lives. Perhaps this happens to an economist more than others since we so frequently use the cost-benefit framework, but, I wonder if others engage in similar thought processes everyday. As you will see in the longer post I do not have a good response to these larger questions, so if that is unsatisfactory perhaps you shouldn't read the next post . . . they are questions I am struggling to answer myself.

For this post though I found a John Stossel video that is approximately eight minutes long about "free-loaders", or the homeless you see with signs on the side of the road. This video emphasized the notion of assymmetric obligation that was the subject of my blog post two weeks earlier. Does conditioning charity on work deepen the dignity and respect of the relationship between the recipient and giver? Or, do requirements of work negate the gift as a gift at all? I would be interested in your comments. While many homeless go to shelters that do not obligate their efforts towards chores, some (in the Stossel video) discovered that the obligation to work instilled a sense of purpose and in fact deepen the relationship between the giver.

Even though my number of observations is small I know someone that was homeless in Tallahassee told me he didn't want to go to the Haven of Rest because they required him to wake up and look for work. It is absolutely true that some are not able to work, but, I do not believe the Stossel is video is a complete distortion (which is why I put up a link). Some able bodied men and women simply do not want to be obligated to anyone.

Tuesday, June 16, 2009

Trouble Indemnity 3


Night Watchman: How’s the insurance business, Mr. Neff?

Neff: Okay.

Night watchman: They wouldn’t ever sell me any. They say I’ve got something loose in my heart. I say it’s rheumatism.

Neff (Scarcely listening): Uh-huh.

Night watchman looks around at him, turns away again, and the elevator stops.

Night Watchman (Surly): Twelve. *

The insurance industry lives and dies by numbers and probabilities. They are making a bet you and I won’t die in the next 90 days, won’t run our car into a tree, won’t have a house fire. In order to survive, they need to know how likely each of those is. In what have to be two of the only movie scenes that make insurance actuarial statistics seem really cool, in Double Indemnity Barton Keyes (Edward G. Robinson) first recites an ode to claims adjusters:

“To me a claims man is a surgeon, and that desk is an operating table, and those pencils are scalpels and bone chisels. And those papers are not just forms and statistics and claims for compensation. They’re alive with drama, with twisted hopes and crooked dreams. A claims man, Walter, is a doctor and a blood-hound and a cop and a judge and a jury and a father confessor all in one.” **

Keyes later rattles off (by my count) twenty-eight different actuarial categories of suicide (“suicide by poison, subdivided by type of poison, such as corrosive, irritant, systemic…”) and then concludes “Of all the cases on record there’s not a single case of suicide by leap from the rear end of a moving train.”

A crucial economic problem behind all of these numbers is that individuals may have differences in how likely they are to generate a claim. The differences are typically unobservable ( a driver's inherent skill and care in driving) but perhaps correlated across the population with things we can observe (look at what happens to the automobile insurance rates of young men when they get married). Or, they could be directly observable (a person's accident record). And, depending on the particulars of how a policy is crafted and priced, the actual probabilities of a claim of the people who buy the policy maybe higher than that of the general population. This is called the adverse selection problem, and it’s why the Night Watchman couldn’t buy life insurance (at least not at a price he was willing to pay). It isn’t just in the movies. Dealing with the adverse selection problem is a responsibility of being a good steward of resources if you are in that business. And, I think it’s one of the thorniest problems in the health insurance debate.

As I’ve followed the discussion of different proposals on health insurance, I keep seeing the adverse selection popping up like Whack-A-Mole. In proposals to move to more competition in health insurance, making the market look more like other kinds of insurance, a question that can’t be avoided is the following: “If we re-boot the nation’s health care system to a more-market oriented approach, what do we do with the people who are already sick? Who will sell them insurance (or otherwise pay for their medical needs)?” As Christians we have an explicit Biblical mandate to worry about this problem.

One historical solution to adverse selection has been group ratings. The insurance company sells to an entire category of customers large enough that there is little adverse selection relative to representative groups in the population (or at least the level of adverse is manageable). But this is one of the historical forces behind why we have employer-based health care. (It’s not by any means the only such reason, as I’ll discuss in the next installment). On the other hand, health care economist Scott Harrington argues that one of the reasons that the Obama administration’s “public option” will inevitably produce something close to a single-payer government monopoly is “the fixation of many reform proponents on attempting to ensure that no person's premiums or coverage terms will be related to health status.” If health status plays no role in setting premiums, we have abandoned the idea of health “insurance” and simply have a system of bureaucratically rationed socialized health care.

To me, the trick, economically, politically, and as a matter of Christian morality, is to come up with some system that is informed by our successes and failures in how we deal with similar problems in areas like bad drivers in automobile insurance and special geographical conditions (flooding, hurricanes, earthquakes, wildfires) in homeowners’ insurance. This could involve using some of the same institutions. Or, it could involve Christians thinking outside of the 20/21st century box, and returning to ideas of private cooperative religious institutions that once flourished in the United States.

* ) Screenplay by Billy Wilder and Raymond Chandler, based on the novel by James M. Cain. Available at

** ) As a mea culpa, economists (among others) should admit that we missed the fact that mortgage documents tell stories of real drama of real people, and that 1000 banks each owning 1/1000 th of 1000 mortgages does not create the same incentives as 1000 banks each owning one mortgage.

Sunday, June 14, 2009

We Interrupt This Movie....

The national debate over the Obama administration’s proposals for what seems intended to be, in effect, the transformation of the U.S. health care network into a British style single-payer socialized insurance system is really heating up. I had intended my next post to continue on some of the economic basics of health insurance with one of the most important economic problems: adverse selection. However, along the way Sue and I watched the DVD of Gran Torino and I just had to say something about it.

A problem with discussing Gran Torino is that it’s hard to talk about without spoiling the action for those who haven’t seen it. But, here’s a movie about life, death, sin, the consequences of sin, confession, redemption, transformation, the Sermon on the Mount, the parable of the Good Samaritan, Dirty Harry in retirement, appropriate lawn care, muscle cars, barbers, and a dog [and, a warning, language that risks offending just about anyone].

Presbyterians seem inclined to believe that it is written in the Gospels that all Bible studies must have one chapter in each of 13 weeks. Even if that is true, a Bible study based on Gran Torino could go the distance.

If those who haven’t seen the movie want to jump ship here, let me note just one example. How does the difference in Walt’s first and second response to the neighborhood problems speak to the debate as to whether Christian peacemaking is or is not pacifism? I argue that Walt’s transformation illustrates that the “use of force” is not at all the key issue: “force” (yes, I will argue actual physical force by one person directed against another) is an integral part of both of Walt’s plans. The difference was what was in Walt’s heart, and whose agenda he was following. Walt’s first response was a classic example of the fact that even if we thoroughly believe that we want to do good, if we put our own will and reason at the center of what defining what is “good,” we will miss God’s mark.

There are at least 12 other great discussions for Christians to be had from Gran Torino.

Next up from me, a return to “Trouble Indemnity,” adverse selection, and the case of the irritated elevator operator.

Friday, June 12, 2009

Pattern of this World

"Do not conform any longer to the pattern of this world, but be transformed by the renewing of your mind. Then you will be able to test and approve what God's will is -his good, pleasing and perfect will." Romans 12:2

Famous economist Alfred Marshall said, "Economics is the study of ordinary life." Beyond the commonly held view that economists focus on the stock market (which you certainly know is not true if you've been reading this blog), economics has the privilege to work with humans and the way they associate, group, and make decisions. But, there is also great difficulty in explaining human behavior. Let me explain.

When a hard scientist holds out a rock from their body and lets go, the rock falls. The rock always falls, it is governed by the law of gravity. Unlike the rock, which has no choice, humans are not dominated by the law written on their hearts (Jeremiah 31). Instead we have free will. Therefore, human behavior is much more nuanced and difficult to explain by any positive theory. I will describe what that means in a bit.

Lately I have been reading a book titled "Deep Economy" by Bill McKibben. His book is very provocative and will be the subject of future blog posts, but, he absolutely bludgeons economists on their promotion of the individual. Quoting English critic Richard Douthwaite in his book, "[Economists] are forced to ignore the possibility that irrationality, prejudice, love, community solidarity, idealism, upbringing, . . . [lots of other good things economists are forced to ignore] because if they abandoned their twin simplifying assumptions of rationality and pure self interest . . . the world would remain so complicated they would have nothing to say about it." Ouch! But, this is not a new commentary, other social scientists are appalled that economists use the model of self interest to predict human behavior. But, this is key, I think they are confusing normative and positive theories.

Normative theory explains what should be done. Positive theory explains what will happen.

To be certain, there are some economists that believe everybody should act in their own self interest, but, they are a minority. Otherwise I believe many economists think people ought to act in an other regarding manner. Economists simply use self interest to explain human behavior because the model of self interest is more frequently correct in explaining what people will do than any other model. Self interest is hands down the best positive theory available to the social sciences.

Then economists have uncovered the chief pattern of this world: self interest. Since we are admonished by Paul not to conform to the pattern of this world where does that leave us? To consider others better than ourselves (Phillippians 2:3). To do unto others as we would have them do unto us (Luke 6:31). Finally, if we refuse to conform to our own self interest we are promised the ability to discern God's will! That means that if we yield to God our own way the precious gift of life in the spirit will be able to take hold.

Tuesday, June 9, 2009

Trouble Indemnity 2


The concept of “moral hazard” in any insurance situation is easy to describe. Moral hazard is a possibility when the insured person and/or beneficiary can, after the signing of the insurance contract, engage in undetectable actions that make a loss more likely (or have a higher payout). A classic extreme case is the driver who doesn’t lock his car because it is insured for theft.

The entire plot of Double Indemnity is one giant moral hazard scheme. Phyllis and Walter take action to increase the probability that the Pacific All Risk company pays off on Phyllis’ policy on her husband. But, before Walter gets involved in the web of murder, notice what his friend Barton Keyes says to him about the problem of insurance salesmen who don’t pay attention to the problem of moral hazard:

KEYES: I get darn sick of picking up after a gang of fast-talking salesmen dumb enough to sell life insurance to a guy that sleeps in bed with a rattlesnake.

It’s a major source of controversy as to how much of a problem moral hazard is in health insurance. Yes, people smoke cigarettes, drink to excess, overeat junk food while lying in front of the TV, take drugs, engage in unsafe sexual practices, and jump out of helicopters on skis, just to name a few things. Less obviously, people avoid unpleasant diagnostic tests such as prostate exams and colonoscopies. The question for economists is whether any of this is moral hazard. Do people do more of these bad things (or fewer of these good things) because they have health insurance? This blog is not the place to answer that question, but there are many empirical studies that attempt to address them.

In the United States, one of the purported advantages of HMOs is that because of the more informal and more frequent contact between the HMO and the patient, the managed care system is in a better position to promote so-called preventive care, that is, an antidote to moral hazard. For example, my HMO will pay a part of my gym membership. Again, we would need to turn to more extensive statistical analysis to investigate whether these effects were more than anecdotal. But as long as we are dealing with anecdotal comments, never forget the immortal words of Mickey Mantle: “If I had known I was going to live this long, I would have taken better care of myself.”

** If anyone knows any annuity actuaries, I’ve always been fascinated by the concept of moral hazard in annuities. Because the annuitant is paid benefits because he is still alive, his moral hazard is to quit smoking, eat healthy, and run marathons well past the age of 80. The moral hazard of the insurer is to hope that he ruins his health to an early grave. A frequent comedic version of this in the movies is the elderly person with an annuitant right to live in a house or apartment that someone else wants.

Friday, June 5, 2009

Assymmetric Obligation

Remember the kindergarten cut-outs? “Fold along the line of symmetry,” the teacher instructed. We did and it was good –as long as we used the stencil and cut along the lines. Otherwise we would be asymmetric with two sides that are different either in proportion or design.

Symmetry seems to produce a feeling of equilibrium and beauty we value in our art and architecture. But, relationships are not often symmetric, especially in the Kingdom of God. We are instructed in Luke, "If you love those who love you, what credit is that to you? Even "sinners" love those who love them. And if you do good for those who do good for you, what credit is that to you? Even sinners do that . . ." In fact, the very nature of Agape love is that it moves first! Agape always advances. Like the Father that saw his son still a long way up, lifted his robe, and sprinted in an unroyal race to greet his son the Kingdom of God is not symmetric. He did not move in perfect rhythm with his son, but went the extra mile to greet him. This love is graceful, committed, and full of unmerited favor -not symmetric.

Brief aside: I do believe that God desires a symmetric relationship with us like the lover is Song of Songs says, "I am my lovers and he is mine." He desires for us to feel completely loved and for our hearts to be in complete desire to be like His heart. That is why he is always telling us such things as "Be holy as I am holy" and "Be merciful as I am merciful".

But, I often wonder what Agape looks like for our political system. Does this seemingly personal command to practice Agape love transfer to a collective voting process with government programs? Our system transfers money, goods, and services without requirement to those in need. In contrast, many earlier Christian charities required minute tasks such as wood chopping, whitewashing walls, or sewing garments in order to receive charity. Essentially, if these charities knew that work was not available for the alms asker they put them to work.
Those who refused the tasks, "gained classification as "Unworthy, Not Entitled to Relief" [or] "those who prefer to live on alms . . .". Does the requirement for some work disqualify the lodging, food, etc. from charity or agape love? Or, does the requirement deepen the respect and dignity both parties have for each other?

Since the human response to love is not always gratitude that leads to action we can not live in the ideal world. The ideal world being that each person so motivated by the love they have been shown demonstrates their appreciation by asking what part they can perform. Instead we seem to be forced into obligating those people to work or continually giving money without placing any obligation to the taxpayer placed on the recipient. The latter has turned into entitlement which is certainly undesirable because people cease to view the help as charity. The former may be undesirable because organizing mass amounts of people to work would also cost money and again there is the question of whether it is really charitable. Are the least of these able bodied men and women?

Fundamentally this comes down to a question a very bright friend of mine asked me, "Doug, do you believe you can systemitize the Kingdom of God." My reply, "I'm not sure, but I don't think you can." Then, I do not think agape love is for the government but for people. Surely, this is one of the most interesting experiments: Place a self interested human, with free-will, in the world, show him/her the message of truth and see if they can learn how to love.

Tuesday, June 2, 2009

Trouble Indemnity: Christians and Health Insurance Part 1.

The U.S. Congress is already beginning the debate on radical transformations of our nation's health insurance and health care markets (I will argue that the two terms are not synonymous). Many Christians are following this debate. Some have already made up their minds about what constitutes a faithful response, but I suspect that there are many who are still uncertain. In this and a few subsequent posts, I am going to outline four economic points that are important special considerations in the debate over health insurance: 1) incomplete contracting and the third-party-payer problem, 2) moral hazard, 3) adverse selection, and 4) “how we got here.” To keep things a little bit more lively, I will repeatedly reference examples from what is arguably the greatest movie ever made about the insurance business, Double Indemnity (Paramount, 1944). The story/screenplay are the combined work of three of our greatest storytellers: James M. Cain, Billy Wilder, and Raymond Chandler *. In this classic American thriller, insurance salesman Walter Neff and bored housewife Phyllis Dietrichson conspire to murder Phyllis’ husband and collect a handsome insurance payment, all the while staying out of the way of crack insurance investigator Barton Keyes.


When I sign a contract to buy a car, the approximately simultaneous transfer of money and the car fulfills the basic contract. An insurance contract is different. When I buy insurance, money and the policy obligation change hands, but the agreement is in reference to some risky future event which, if it occurs, will require the seller (the insurance company) to compensate me. The simplest of these contracts include life insurance (if I die, my beneficiaries receive the contracted amount) or an annuity (if I am still alive, I receive my monthly annuity check). Notice that in these cases the conditions of fulfilling the contract are relatively unambiguous and easy to monitor (although some desperate people attempt true fraud). I am either dead or alive, and the amount of payment is specified in the policy.

Sometimes, however, there is ambiguity as to whether or not the conditions triggering the payment have been met, or what the payment should be under those circumstances.

NEFF: Look, baby. There’s a clause in every accident policy, a little something called double indemnity. The insurance companies put it in as a sort of come-on for the customers. It means they pay double on certain accidents, the kind that almost never happen. Like, for instance, if a guy got killed on a train, they’d pay a hundred thousand instead of fifty.

What ultimately tripped up Walter and Phyllis was that theirs was not a simple life insurance policy; it was an accident insurance policy. As such, the Pacific All Risk Insurance Company did not have to pay if they believed that the death was not an accident. And Barton Keyes did not believe for a minute that this was an accident. Following his lead, Pacific All Risk refused to pay. Pacific All Risk and Phyllis disagreed as to whether the conditions requiring the payment had been met.

Any of us who has automobile or homeowners' insurance faces this problem. If there is any ambiguity or incompleteness in a loss situation our interests as policy holders (first party) differ from those of the repair shop (second party) or the insurance company (the third-party payer). Most of us have had experience or know about typical examples. If our car is damaged, we believe that repairing the car involves choosing our preferred paint shop and using original manufacturer replacement parts. The insurance company, the third-party payer, will want to use independent parts and their own “in house” paint shop.

Despite the annoyances that these incomplete contracts can cause in automobile or homeowners’ insurance, the range of dispute is relatively bounded. If a tree falls on my car, it is not credible to believe that it was worth nothing. Likewise, regardless of what ever kind of emotional attachment I have to my car, it’s easy to find an upper bound of liability: the current retail price of an equivalent brand new car. Virtually all of the disputes over the inability to write all-encompassing, unambiguous policies will be within these bounds.

The problem with health insurance is that there are no such natural bounds. What is the responsibility of my health insurance company to pay for surgery, drugs, hospitals, doctor bills, and so forth if I come down with a serious disease…one that threatens my life or my ability to continue in my daily activities? Is the insurance company obligated to pay for continually more and more expensive (perhaps highly risky) treatments until I return to exactly my previous condition of health? Unless the policy simply requires pre-arranged lump-sum payments ($250 for bronchitis, for example) there is likely no simple upper bound reference amount (such as the value of the new car) that all parties can agree upon after such a medical emergency. The situation in the 1930s may have been different. But following the advent of modern miracle drugs and surgeries, the range of possible contracting disputes in health insurance is daunting. There are two traditional approaches to answering this inherent problem in health insurance.

In an indemnity system, the gatekeeper is a health professional that both sides ex ante agree can authorize approved expenditures. At its simplest extreme, in an indemnity system if a licensed physician prescribes the treatment, the insurance company will pay for it. Indemnity insurance companies are not going to leave themselves exposed to payments almost without limits except those limits chosen by the person being paid, so indemnity systems are disciplined by deductibles, co-payments, and lifetime aggregate payment limits. (When I have been covered by an indemnity system, I tended to worry about physicians prescribing unnecessary or needlessly expensive procedures or drugs).

In a managed care system, the third-party payer problem is addressed by giving the payer (for example, the HMO or the bureaucracy of a socialized medical insurance system such as that in Great Britain) the authority to decide what treatments it will or will not pay for. Both Americans covered by HMOs and people living in Britain under their National Health Service are aware of what it means to have the managed care gatekeeper say: “This treatment is too expensive given the probabilities of success; we will not pay for it.” (When I have been covered by an HMO, I tended to worry about the plan paying for less treatment than I desire). What is the discipline on the managed care gatekeepers? In a market system, such as with automobile insurance, customers can evaluate competing gatekeepers and vote with their pocketbooks. That is why automobile insurance companies advertise not only low rates but also how easy they are for policy-holders to deal with. In a single-payer socialized system, the discipline is often political. It's easy to Google the British press and read about how the news media and members of parliament react when some drugs or medical treatments are denied by the NHS.

My point in this blog is to argue that in our current world of miracle drugs and surgeries, the very idea of asking someone other than the patient to foot the bill for the medical expenses faces unavoidable contracting problems. Different systems attempt to deal with this problem in different ways, but in any system the institution footing the bill (an indemnity company, an HMO, a charity, a government) will be unable to operate with unbounded and ambiguous contractual liabilities. Nothing that Congress can do will change that for any system that asks for payments to be made by someone other than the patient.

NEXT INSTALLMENT: Phyllis and Walter’s sinister plot.

* the script is available on