A big debate over the Presidents plan to reinvent America's sickly health care industry is taking place on a t.v, newspaper, or website near you. His plan has been lovingly nicknamed Obamacare by its biggest fans and is an attempt to get you insured whether you like it or not. The economic logic behind it all is that insurance always works better when risk can be spread over a large group. Similar to economies, insurance structures depend on young healthy productive people, the kinds that places in demographic crises like Japan are running out of. The U.S isn't as sprightly as it once was either.
When an insurance company decides to enter a market, they try to calculate what is basically a sick to healthy person ratio. The best case scenario for a health insurance company would be a nation of hypochondriac marathon runners. Our paranoid athletes would quickly buy the insurance polices because they think sickness is around the next turn but lead extremely healthy lives and never actually receive anything from the insurance company except bills and maybe some peace of mind (yup, you can buy that too). This results in a happy health insurance company that gets plenty of premiums and never has to pay out. Unfortunately for health insurance companies most of us are more risk-tolerant and less fit than our hypothetical population so they have to deal with two major problems, namely adverse selection and asymmetrical information.
Lets look at another market as George Akerloff did in his seminal paper on "The Market for Lemons" to better understand what complicates health insurance and insurance in general. The Market for Lemons is a story that anyone who has bought a used car can relate to. It explains everything from the slimy connotation of a used car salesman to the existence of that darned car fox.
In Akerloff's assessment he points out that in the market for used cars an inherent problem exists between seller and buyer. While the buyer might get to test drive the car and even have a mechanic check it out, the seller still knows the true value of the car with more clarity. This is textbook asymmetrical information. Websites like carfax.com attempt to minimize this problem for used cars as do companies like yelp for businesses, glassdoor for jobs and pretty much any other service that attempts to "reveal" the truth about a product. When asymmetrical information exists, human beings tend to be shmucks, or what a more sophisticated, less honest, economist would call, commit "rent-seeking behavior". This explains the image of the used car salesman. They know more than their customers about the product and therefore are put into a position where they can manipulate the buyers perceived value of it (just so happens to always be in the up direction).
Akerloff establishes that in the hunt for a used car, the buyer is always at a disadvantage because he has to buy from a self-interested entity that can say more certainly than you what the car is worth. Furthermore, no one out there is doing you any favors and telling you the car is worth less than it is. So now we have a market (start to think in general, not just cars) of people basically over-stating the value of a product, and more importantly a consumer who knows it. This leaves us with a bunch of people who need used cars but don't trust the ticket price. In fact, not only do they not trust it but they know for a fact it definitely isn't a bargain because why would anyone sell something for less than its worth. What they don't know is just how exaggerated the price is and that's why you should never pay the asking price, even for a hot dog in NYC.
The next step of the analysis is where it gets really interesting. People smarten up and no one wants to buy used cars because at best they will get a fair deal and much more likely be scammed. What Akerloff's paper is so famous for pointing out is that a very important, often over-looked victim of asymmetrical information are the honest sellers of good used cars. Anyone who is trying to sell a good used car can't get what its worth because the buyers market is jaded; they just wont trust the price. So if you had a used car and you knew it was worth $800 but because everyone you tried to sell it to figured you were lying like everyone else and would only pay $600, what do you do? You keep the car and hopefully fall back in love with it or something like that. This is the result of asymmetrical information that economists refer to as adverse selection. Basically when a market is broken because one party has a knowledge advantage over the other, the parties who "play by the rules" will be forced out of the game. This in turn increases the ratio of cheaters in the market, worsening the trust problem, and further removing more honest players, until the point where only "lemons" are left. In Akerloff's analysis, literally no good (by good I mean accurately valued) used cars can be sold or bought even if everyone has good used cars and everyone wants to buy them for what they're worth.
What fun, back to Obamacare. Just like a used car salesman knows his car better than you, you know how often you have cravings for Big Mac's or unprotected sex (asymmetrical information wink wink) Insurance companies care very much about what or who you will put in your body because they pay for whatever it or they give you, whether it be diabetes or an STD. Just like our jaded car-buyers, insurance companies know you have every reason to lie to them about how healthy you are (the value of the product). Like yelp or carfax, preliminary screens and mountains of paperwork are a way for the insurance company to find out a little bit more about what they're getting into.
Next up insurance companies look at their policy holders as a whole, or the market they intend on serving, and determine their pricing structures. Like our used car debacle, health care companies don't believe you and for their own safety have to err on the side of expensive coverage. Can you guess what happens next? Healthy people no longer are getting a fair deal for their insurance so they opt out of it. In order to have a viable business, insurance companies need a large base of healthy people who won't be collecting anytime soon. The elderly, sick, or your extremely lazy pizza loving college roomate, realize that at almost any cost insurance will be worth it to them so they aren't budging. This is the equivalent of all the "lemons" staying on the market because there's a lot of leeway when selling a piece of garbage. As healthy people drop out, and the not-so-healthy stay in, the ever important sick:healthy ratio churns out higher and higher premiums. Now even moderately healthy people are like screw it, ill go to webmd.com. All you're left with is sick people, and since sick people don't make any money for insurance companies, all the insurance CEO's decide to chase their true passions of basket weaving and interpretive dance. Now you have a bunch of people who want to sell insurance, a bunch of people who want to buy it, but no market for it!
The biggest difference between used cars and health insurance is that many countries feel some obligation to provide for their people and even argue health care is a basic human right. While that might be a stretch, in the end, its in everyone's interest to see that our population stays relatively healthy if not to enjoy life, at least to produce. Obama wants to make insurance mandatory to salvage a shrinking market that is essential to the prosperity of our nation. Opponents of Obamacare want American citizens to maintain the right to spend their money how they choose. Both sides are pro-consumer, and both sides make sense. What everyone can agree on is that the current system is unsustainable and malfunctioning. The evidence is in America's ranking on health indices as well as our high number of uninsured. It's frightening to see more and more American companies take on more of their employee's health insurance risks to avoid premiums, only to be crippled by a catastrophic health event (think premature baby, chronic illness, organ transplants). In economic times like these, the last thing we want is our small businesses gambling their existence on their employee's lifestyles.
Of course it isn't black and white, that's just the politics talking. Technology has a huge part to play in the solution through lowering medical costs, allowing insurance companies to better assess peoples health, and reducing administrative costs across the board through electronic file sharing and the likes. A lot of progress is yet to be made with employee incentives, like credits to go to the gym, quit smoking, and who knows what else in the future. The health problem is so interesting because it's so obvious, and the paths to improvement are as plentiful as the glaring deficiencies. I'm not sure what Akerloff would say but I know he wouldn't be to proud of us if we didn't take his findings and run with them. Then run some more.
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