Thursday, September 17, 2009

Kinky Health Insurance Reform

In addition to a public plan that covers the basic health care needs of everyone and anyone, Kinky Care also slaps the insurance industry upside the head and directs them back to the risk-sharing purpose of insurance. Although I am opposed to the reforms that turn the insurance industry into a cost-sharing bastard child, the insurance industry is in serious need of reform.

Critics point to insurance companies refusal to cover pre-existing conditions as a problem, but I am fine with the insurance company refusing to insure pre-existing conditions. However, I am opposed to denying legitimate claims in order to cut costs. The denial of claims or cancellation of insurance after a claim is made is referred to as rescission. Rescissions are not necessarily evil because they does have a proper role in combating fraud. If an applicant lies about a pre-existing condition and then makes a claim resulting from that pre-existing condition, then a denial of claim and rescission is proper. Combating fraud helps to hold down the cost of honest customers and the right to rescind a policy is cheaper than requiring a verifiable, complete medical history from each applicant. However, denying a claim due to an honest mistake by the customer should be forbidden. So, how can you tell the difference between an honest mistake and a fraudulent application? First, a rescission can only occur when the claim is related to the error in the paperwork. If you forgot to mention a broken leg when you were a child and make a claim for a heart attack, the insurance company must honor the claim. Second, the rescission must occur within a reasonable amount of time -- I'd choose two years. Even if you have a family history of heart disease that you covered up, if you don't make a claim or if they don't catch you for two years, then you are free and clear. The third issue is intent and this is the hardest to determine. Did the applicant make an honest mistake or was he trying to cover something up? You have a heart attack after 6 months and the insurance company finds out that your estranged father was on medication for high blood pressure. That would be one for the courts or arbitration panel to decide.
An associated reform covers changes in premiums. Even if insurance is not rescinded, premiums could still rise after a customer has a serious illness. The term of an insurance contract and the allowable increases in premiums must be laid out in the initial contract. If you want a ten-year contract with premium increases restricted to 5% per year, then you could get it. A year-to-year contract would also be available with the knowledge that the customer is taking on the risk of premium increases.

The final major reform is the allowance of interstate competition and the removal of federal antitrust exemptions. Insurance companies are currently protected from federal antitrust laws under the 1945 McCarran-Ferguson Act. The supposed reasoning for this exemption is that they are regulated under separate state regulations with a prohibition against interstate competition. This results in individual state markets that are dominated by a single insurance company. Rates among states vary widely largely based on regulations that restrict risk-based premiums or require mandates that customers may not want. A twenty-five year old who doesn't want coverage for mental health care would be charged the same as a sixty-year old who wants his Viagra covered under a state mandate. Moves to repeal the antitrust exemption and to allow interstate competition are already underway and will hopefully pass regardless of the final health care reform.

Health Insurance (as opposed to Health Care) Reform

Alot of the venom regarding health care in the US has been directed at the insurance industry. Nancy Pelosi singled them out as the top villain, town-hall protestors are labeled as industry shills, and the primary evidence of the failure of the current system is the number of uninsured people in the US. In fact, the overall health care reform drive is largely a matter of health insurance reform. But health insurance is not health care and was never meant to be. The purpose of insurance is to spread risk among a large number of people. Unfortunately, the insurance industry seems to have moved away from that goal and I want to institute policies that direct the industry back towards their original purpose. Reformers, however, want to turn the insurance industry into something it was never meant to be.
The principle idea behind insurance is that bad things will happen to some people, but not to everyone. If there are ten people and each one of them has a 10% chance of having an accident that will cost $100,000, then each person has an expected cost of $10,000 and the insurance company will charge each person $10,000 (plus some profit) for coverage. If some people choose not to buy insurance, then that won't affect the expected cost of the remaining individuals. The main point is that insurance should charge each person their expected cost plus profit and each person has the right to either buy insurance or not to buy insurance.
Reformers want to turn insurance from risk-sharing to cost-sharing. Under cost sharing, people are no longer charged an amount based on their own level of risk, they are charged an amount based on the collective level of risk. Suppose you had ten people again and one person had a 91% chance of having an accident while the other nine had a 1% chance. Risk-sharing Insurance would charge the nine people $1,000 (plus profit) each and the other person $91,000 (plus profit). Cost-sharing Insurance would still charge each person $10,000. If one of the nine refuses to buy insurance, insurance would have to charge the remaining nine $11,000 each (expected costs are now $99,000 divided by nine people). If another person drops out, the premium would by $12,250 (98,000 divided by 8). The expected costs would be divided among fewer and fewer people until the one person has a premium of $91,000 that he can't afford and the other nine have no insurace.
In order for cost-sharing to work, everyone must be required to buy insurance with the low-risk people effectively subsidizing the costs of the high-risk people. That is why the reformers push three primary reforms: mandates that force everyone to buy insurance (or pay a fine), guaranteed issue which says that insurance companies can't refuse high-risk individuals, and community rating which means that everyone is charged the same regardless of their level of risk. These changes would be accompanied by subsidies that help poor people pay for insurance and taxes that force wealthy people to pay for those subsidies.
The primary healthcare reform proposals being debated result in redistributions from the wealthy to the poor through taxes and subsidies and from low-risk individuals to high-risk individuals (from the healthy to the sick) in the form of individual mandates, community ratings, and guaranteed issue. As far as I'm concerned, there isn't a lick of difference if this is done through a single-payer system, a public option, co-ops, exchanges, or reform of private insurance. I can understand some people supporting this type of reform. It might even be better than what we currently have. But it still isn't the best system and I don't support it.
The fundamental characteristic that a health care policy has to have in order for me to support it is the existence of different levels of quality of care with the customer paying more for higher levels of quality.

Wednesday, September 16, 2009

The Laffer Curve

Much has been made about President Obama’s efforts to raise taxes on high income individuals in order to fund additional spending programs such as health care, energy, and the stimulus. Critics cry class warfare and complain that the wealthy shouldn’t be punished in order to provide a welfare state. Defenders say that the rich can afford higher taxes without any big impact on their well-being. The bigger concern to me, and one that isn’t getting the attention that it deserves, is this – it won’t work.
Raising tax rates on high income individuals will not raise as much money as expected and may raise even less money than before. The idea behind this is known as the Laffer Curve and it basically argues that work effort is a declining function of tax rates and that there is some tax rate that maximizes the amount of revenue collected. At low tax rates, people work but the government gets very little tax revenue. As tax rates rise, people will work less so that tax revenues will still rise but at a decreasing rate. At some point, tax revenues will begin to fall as the reduced work effort dominates the higher tax rate. At extremely high tax rates, people won’t work and no money will be collected. If you wish to draw it, the Laffer Curve looks just like an arch.
There is some tax rate that would maximize total taxes, but people disagree on what that rate is. Keynesian economists (Democrats) tend to believe that we are below that point so that higher tax rates lead to higher tax revenues. Meanwhile, supply-side economists (Republicans) tend to believe that we are beyond that point so that raising tax rates actually reduces tax revenues.
In reality, the revenue maximizing tax rate depends on income and you can make a strong argument that high income people should be taxed at lower rates than middle class people. The determining factor is whether or not people have a substitute for working. High income people include business owners, professionals, doctors, lawyers, … and anyone in the highest income levels probably has some control over their career and how much they work. They have the option of taking more vacation, retiring earlier, sheltering income, deferring income, or take some other action that reduces the amount of tax revenue that the government takes in. Any reduction in the amount of work done by these people, and therefore their income, will result in lower tax revenues. Meanwhile, middle class people have less flexibility in their job. Employers expect 40 hours per week with two weeks of vacation – no more, no less. Low income people actually have greater flexibility too in that they can receive state support or work in informal (and untaxed) jobs instead of working in a traditional job.
It is politically infeasible to have lower tax rates on high income people, so the government really needs to determine the tax rate that maximizes tax revenues for this group and then set tax rates for middle and lower income people either equal to or below that rate. So, what rate maximizes tax revenues for high income workers? I honestly don’t know, but I have a feeling we are probably already close to that rate. The highest marginal Federal Tax rates are set to go up to 39% plus state and local income taxes and sales taxes means that we’re probably already at about 50%. I really don’t think that higher rates will lead to higher revenues.

Not everyone agrees with this. Tax rates have been significantly higher than they are today – as high as 91% under Eisenhower – and the economy did just fine. Indeed, there is very little correlation between economic growth and the highest marginal tax rate. There are two reasons for this. First, tax rates should affect the level of income, not the growth rate. When tax rates change, there may be short term effects on growth as people change their work habits, but once these habits are set, there is no reason that the growth rate should be affected. Second, changes in tax rates will only affect a small percentage of tax payers. If you raise tax rates on the highest 2% of workers, then they may cut their effort, but it won’t have a huge impact on the overall economy.
Again, some people disagree and say that the tax cuts just help the rich get richer. As proof of this giveaway they point to the increase in income inequality since the 1950s when tax rates were 91%. In actuality, their argument is self-contradictory and shows the Laffer effect. When tax rates go down on the highest income individuals, they have greater incentives to work and invest which causes their income to go up. Lower tax rates lead to higher before tax incomes. Conversely, higher tax rates lead to lower pre tax incomes. As far as the effect on tax receipts goes, it depends on the strength of that relationship. If an increase in the tax rate from 40% to 50% causes income to fall from $100,000 to $80,000, then tax receipts are unchanged. A smaller impact on income, say a decline to $90,000, would result in higher tax receipts while larger declines in incomes would lead to lower tax receipts. Overall, I think that higher tax rates will do very little to raise revenue, but it might reduce income inequality. This might be a worthwhile objective, but it won’t pay for additional programs.

Friday, September 4, 2009

A brief overview of Kinky Economics

On this blog I will outline my views on public policy. The basic principles of Kinky Economics are that everyone deserves a basic quality of life while minimizing the restrictions on people who desire a better life. I also sometimes refer to this philosophy as the barbed wire safety net, it can save your life, but it's not meant to be comfortable. The actual name of Kinky Economics comes from the idea of a kinked Aggregate Demand curve for those of you with a familiarity with Keynesian economics. I am currently focusing on the health care debate due to the current national debate. However, I will sprinkle in some other blog posts at times. It is my objective to pull this together into a book, so you will at times see periods where I focus on taxes, the environment, welfare, regulation, and other topics. I look forward to any comments you may have.

A brief overview of KinkyCare

How should health care be reformed? Well, the Kinky Economist has a plan that provides for both universal health care and the best damn health care that money can buy. Anyone can get health insurance for free through the government. This public plan would be modeled on the VA system where the government owns the hospitals and the doctors and nurses are employees of the government, so members would not be able to choose their own doctor. Employment in the system could be worked into programs for medical school. For example, tuition is free at military academies such as West Point, but students are required to give four years of duty after graduation. The GI Bill will pay for college for soldiers after they leave the service. The federal government could pay for medical school with a requirement that the doctors work in the system after graduation.

The plan would focus on preventative care where annual check-ups are not only free, but you could get paid for a healthy lifestyle. So much of our health care costs, especially diabetes, heart disease, and respiratory problems, are driven by behaviors such as obesity, inactivity, and smoking. By focusing on wellness, these costs can be avoided (although healthier lifestyles do result in higher costs due to increased life expectancy and chronic diseases in old age).

Chronic and catastrophic health care would be rationed by Quality Adjusted Life Years (QALYs). For instance, the government may pay up to $40,000 for treatment that extends a patients life by one year, so the cost per QALY would be $40,000. Yes, health care will be rationed -- it is already rationed. Every scarce resource is rationed. If you don't want the plug pulled on Grandma. then pay for her health care. You shouldn't demand that other people to pick up the tab if you're not willing to pay the costs. If QALYs are used to ration health care, then how much are we willing to pay to save a life? More accurately, how much are we willing to make someone else pay to save a stranger's life? The budget for health care must be limited to a percentage of the total government budget. Once a fixed dollar value has been created, the cost per QALY will depend on how many people are in the government plan and how much health care they need. The government plan is meant for the poor and the sick, not the healthy and the wealthy. If more people get their own insurance, then the available funds can be spread among fewer participants resulting in higher costs per QALY. The plan can also accept contributions from donors that would increase the cost per QALY.

Another focus of the plan is positive externalities of health care. The plan could require patients to be immunized resulting in a reduced likelihood that other people will get sick. The plan could strongly encourage organ donation to help save other lives. The plan could be used for research on new medical techniques and drugs. All of these characteristics result in social benefits.

The final focus of the plan is cost containment. Treatments would be based on comparative effectiveness so that costly, ineffective treatments are avoided. Medical malpractice costs would be eliminated or at least drastically reduced by not allowing patients to sue or instituting a program to resolve these disputes. Generic drugs would be prescribed instead of brand names in order to lower pharmaceutical costs. Finally, the plan would use it's size to negotiate better terms for prescription drugs, medical equipment, and other purchases.

The public plan is not for everyone and most Americans can and should get their own insurance, just as they do today. However, the health care system does have flaws and room for improvements. The primary downfall of the plans that seem to be bandied about is the insistance on a single level of health care resulting in either reduced levels of care and/or higher costs. By recognizing that everyone deserves basic health care but not necessarily Cadillac care, I believe that the KinkyCare framework has the best potential to improve health care coverage and results.

Is US Health Care Broken?

One of the arguments made by proponents of health care reform is that the US system of health care is clearly broken because we pay so much more than other countries for health care and have worse results. Indeed, the overall statistics bear this out. We spend twice as much per capita and have lower life expectancies and higher infant mortality rates. Is this not proof of the need for change? Perhaps not if we look at individual results instead of averages. Suppose both Rich and Joe are dying. It would cost $100,000 in medical costs to extend Rich's life by one year while it would only take $50,000 to extend Joe's life by two years. From an overall statistical perspective, it would make more sense to save Joe's life. But what if Rich has $100,000 and Joe is broke. Rich might prefer to spend his money to save has own life, and the only way to save Joe is to forcibly take Rich's money from him through taxes in order to pay for Joe's treatments. While this might benefit Joe, Rich is now dead and out $50,000.
So, is this reflective of our current situation? Evidence indicates that this does play a role. While our overall spending is high and our overall results are low, if the results are broken down into subgroups the picture changes. Life Expectancy of Whites and Asian-Americans are inline with European and Asian averages while the life expectancy of African-Americans is lower than the life expectancy of other ethnic groups in the US, it is higher than the life expectancy in African nations, although this is not necessarily a fair comparison.
This is the health care debate in a nutshell. Many people I know and respect believe that health care should not be determined by how much money a person has and that it is fair and preferable that health care should be allocated on the basis of need while the costs of those resources should be borne by the people who can pay. Such a system would indeed lower costs and improve overall results. I would take the opposing view that it is an individual's right to allocate their wealth in a manner of their own choosing.