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.

PART 1: INCOMPLETE CONTRACTING AND THE THIRD-PARTY PAYER PROBLEM

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 www.imsdb.com