Purging Healthcare of Unnatural Acts

Purging Healthcare of Unnatural Acts


Everyone knows (or should know) that forcing a commercial health insurer to write for an individual a health insurance policy at a premium that falls short of the insurer’s best ex ante estimate of the cost of health care that individual will require is to force that insurer into what economists might call an unnatural act.

Remarkably, countries that rely on competing private health insurers to operate their universal, national health insurance systems all do just that. They allow each insurer to set the premium for a government-mandated , comprehensive benefit package, but require that each insurer “community-rate” that premium by charging the company’s individual customers that same premium, regardless of their health status and even age (with the exception of children).

American economists wonder why these countries do that, given that in the economist’s eyes community-rated health insurance premiums are “inefficient,” as economists define that term in their intra-professional dictionary. 

The Affordable Care Act of 2010 (ACA, otherwise known as “ObamaCare”) also mandates private insurers to quote community-rated premiums on the electronic market places created by the ACA, allowing adjustments only for age and whether or not an applicant smokes. But within age bands and smoker-status, insurers must charge the same premium to individual applicants regardless of their health status.

As fellow economist Mark V. Pauly points out in an illuminating two-part interview with Saurabh Jha, M.D., published earlier on this blog, aside from the “inefficiency” of that policy, it has some untoward but eminently predictable consequences. It happens when healthier people disobey the mandate to purchase insurance, leaving the risk pools of those insured in the ACA market places with sicker and sicker individuals, thus driving up the community-rated premiums. As Pauly points out at length, a weakly enforced mandate on individuals to be insured can become the Achilles heel of community rating.   

Every actuary or economist who instructs students on this point probably therefore opines that, ideally, for the sake of economic “efficiency” and to overcome the untoward side effects of community-rated premiums, one would like to allow insurers to peg the premium charged an individual applicant on the best actuarial estimates of likely future outlays for that individual, that is, to charge individuals so-called “actuarially fair” premiums and publicly subsidize those applicants faced with very high premiums. The word “fair” here signifies that chronically healthy individuals are not asked to cross-subsidize chronically sick people through the premiums they pay, which many Americans consider fair. General taxpayers pay those subsidies.

Alas, thinking about the administrative steps needed to translate our profession’s normative dicta into workable operations in the trenches has never been our profession’s strong suit. Not surprisingly, then, not much is said about that crucial step in the Jha-Pauly interview. But we can muse about what life in those trenches might turn out to be. After all, we do have some idea of how a market for individually purchased health insurance that is based on risk rated (actuarially fair) premiums works, because that is how the pre-ACA market for individual and small-group policies worked in this country.

As Pauly acknowledges, the administrative costs of such a system are high. It is so because every applicant must submit to the insurer a very detailed description of his or her health status and those submissions must then be converted into customized, risk-rated premiums. That information, of course, could be conveniently harvested by hackers.

Pauly cites some estimates of the administrative costs of risk-rating in individual insurance markets; but they strike me as low.  A clearer picture can be had from the horse’s mouth, so to speak, namely the Council for Affordable Health Insurance which represents insurance carriers active in the individual and small group market.  On the third page of a letter dated May 7, 2010, addressed to the National Association of Insurance Commissioners (NAIC), the Council noted inter alia that pre-ACA

“The NAIC standards for individual market loss ratios vary between 55%-65%, depending on the type of plan. In fact, most guaranteed renewable plan loss ratios are set by the states at 60% or less.”

What the Council calls “market loss ratios” is otherwise known as the “medical loss ratio” (MLR). It represents the fraction of the premium that insurers lose on procuring actual health care for their insured. The remaining fraction (1- the MLR) goes for marketing, administration and the insurer’s profits. Thus an MLR of “60% or less” implies that 40% or more of the premium does not buy health care, but goes for marketing, administration and profits. It takes a certain fortitude on the part of private health insurers to acknowledge that huge spillage into overhead so openly.

It is hard to imagine that any other country would tolerate so large a leakage of the premium into overhead. While economists would nevertheless call such a market “efficient,” as the profession defines that term, there is no reason why non-economists should take the economists word for it. Indeed, it can be doubted that non-economists would apply that felicitous term to any health insurance system that burns up to 40% or even more of the premium the insured pay just on marketing, administration and profit efficient, if the insured were aware of it. 

We also know from the pre-ACA days that millions of Americans then were denied insurance coverage outright by private insurance over preexisting conditions. Eliminating that problem by mandating “guaranteed issue” was one of the major goals of the ACA. Estimates of the percentage of applicants denied coverage in pre-ACA days vary. Some estimates put the number at 1 out of 7 (i.e., 14%). Other sources quote much higher figures. In an Issue Brief, the Kaiser Family Foundation provides a table with numbers, by state, of “declinable conditions.” It is worth citing here at length from Jonathan Cohn’s “ObamaCare’s New Paperwork Is Simpler than Private Insurers”:

“If you want to know which conditions attract scrutiny, you can consult a Blue Cross Michigan underwriting guide. The list of “unacceptable medical conditions,” which you’ll find on page 23, starts out like this: “Abnormal pap (unless there have been 2 subsequent normal ones), Addison’s disease, Adrenal gland disorders, AIDS, ARC (AIDS related complex), HIV+, Alcohol abuse or alcoholism (unless 12+ years since recovery), Amyotrophic lateral sclerosis (ALS), Alzheimer’s disease, Aneurysm, Angina pectoris, Aplastic anemia, Arteriosclerotic heart disease, Atrial fibrillation or flutter, Ascites, Autism and Aspergers syndrome, Autoimmune diseases.” Highlights later in the alphabet include Cancer, Congenital Disorders, Heart Murmurs, Lupus, Parkinson’s Disease, and, of course, Pregnancy.”

What would happen to those denied coverage by insurance companies in the scheme envisaged by Pauly? Would they be assigned to a high risk pool?

Unfortunately, while we do know a lot about the modus operandi of a classic, medically-underwritten (risk rated) market for individually purchased health insurance, there is no experience in the U.S. on how to link such a market to the system of public subsidies that Pauly calls for in the Jha-Pauly interview. How exactly would this work?

Relevant variables here presumably would be, on the one hand, the insured’s “disposable income” and, on the other, the risk-rated health-insurance premiums quoted that individual by competing insurers. “Disposable income” would have to be carefully defined for this purpose. Is it just available money income after taxes and transfers? Or should it be the latter figure minus required outlays for other necessities, such as food, housing, clothing, fuel for transportation to and from work, etc.? Besides that question, a series of others come to mind, to wit:

  1. For what benefit package would the premiums be quoted? Who would specify that package? What might be excluded from the package? Would there be lifetime limits on coverage or annual limits on specific services (e.g., prescription drugs)?
  2. What would happen if the specified benefit package underlying the public subsidy were shallow and the insured got severely ill, facing unaffordable medical bills for clinically beneficial products (e.g., drugs) and services not covered by the policy? Who would pay those bills? Would the cost of such care be shifted to paying patients through higher prices? Or would the insured simply be denied those clinically beneficial products and services, at the risk of avoidable, premature death or chronic illness?
  3. Would premiums be reset annually, in light of changes in the insured’s changing health status?
  4. Could an insurer cancel a policy ex post if the applicant had inadvertently or deliberately concealed a particular medical condition from the insurer when applying for coverage?
  5. What would be the risk-based premium on which any subsidy would be based? Would it be the lowest one quoted in the relevant market area? And what would that area be?
  6. Would the insured’s out-of-pocket cost for the coverage be linked to his or her disposable income, as it is under ObamaCare?
  7. Who would manage the market place in which individual policies are sold, or would the market return to pre-ACA operations, managed solely by an uncoordinated net of insurance brokers?
  8. Who would pay the brokers’ commissions, the insurance companies, setting up an evident conflict of interest, or the insured, as it should be.
  9. Would people denied coverage by insurers in this free market be enrolled in a high risk pool? If so, what would be its design parameters – the benefit package, the premium charged the individual, the magnitude of public subsidies, and so on?

Others undoubtedly can think of yet other questions; but let these suffice.

Probably because of the complexity of operating a risk-rated private health insurance system supported by public subsidies, few nations operating universal health insurance systems have adopted that approach. In fact, I cannot think of any.

Switzerland, Germany and the Netherlands, for example, all rely on a system of competing private health insurance carriers. Unlike the U.S., they do not have government-run health insurance programs at all. Competing private insurers can quote different premiums for the same, government-specified benefit package, which tends to be quite comprehensive. But unwilling to subject their citizens to the complexity and vagaries on risk-rated health insurance markets, these countries mandate that the premiums quoted by competing insurers be strictly community rated, even with respect to age. Somehow these countries have been able to make this work for decades, without the collapse of their health insurance markets. If we Americans were not as insular and proud as we are, we might explore how these countries manage to do that and learn from it.

We would discover that somehow these nations make the mandate to be insured stick to the point of garnishing the wages of individuals disobeying the mandate to be insured. Perhaps these nations also succeed in persuading young and healthy people that they, too, might fall very ill at some time in the future. One can then view community rating as the analog of a call option on a stock. In this case, it is a call option on a low premium in case one falls seriously ill, the price of the option being the overpayment relative to actuarial costs when healthy.

In the U.S., we consider it unacceptable for government to force individuals to purchase from a private vendor a product they do not wish to buy. To many Americans this makes sense – hence the strong opposition to the individual mandate to be insured – ironically much favored by Republicans during the 1990s but now decried by them. The mandate to be insured has been a major rallying point for those who oppose ObamaCare.

One way to overcome that problem might be to abandon the mandate altogether, but to offer individuals a deal they are less likely to refuse. In his “Averting a Health Care Backlash,” for example, Paul Starr as early as 2009 counseled the Obama Administration to let individuals opt out of the mandate to be insured, but to allow them back into ObamaCare only after 5 years. 

I would have been much rougher. In a blog post entitled “Rugged Individualism vs. Social Solidarity,” published in The New York Times, I proposed that individuals opting out of a system built on social solidarity, with community-rated premiums, should never be allowed to rejoin it later, aside from some very special circumstances. It would be a deal fewer people would refuse. Rugged individuals who turn their back on social solidarity can be asked tough it out on their own when misfortune strikes, rather than rediscovering in those calamitous moments the beneficence of the community. Unfortunately, too many of them follow the mantra “when the going gets tough, the tough run to the government,” as can be seen every time a hurricane wreaks havoc on some area or uninsured rugged individuals fall seriously ill or have a serious accidents, when they expect the best available health care, even if they cannot pay for it. A forgiving nation has always enabled this behavior.

Starr’s and my approach can be viewed as market approaches, albeit ones structured to contain a so-called “nudge” to obtain coverage.

Uwe Reinhardt is a professor of political economy at Princeton University.

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31 Comments on "Purging Healthcare of Unnatural Acts"

Mar 4, 2017

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Feb 5, 2017

We have to consider moving to a life long annuity for healthcare. Setting a yearly “risk” based rate based upon age has failed.

If a 65 year old had all payments for health insurance credited to an annuity account starting from birth then with compound interest there would be between 1 to 2 million dollars credited to that person at age 65. The vast majority of people will die before they ever need that much care. With this system there should be plenty to take care of the small percentage that do need a lot of care.

Ben Carson proposed this but his plan fell down when he wanted the risk pools to be for each “family”. Let’s get everyone in to 1 big risk pool and let’s not throw our premium payments out every single year. By the time you get to 65 you’ve paid hundred of thousands of dollars in premiums, those dollars should count for something.

Feb 3, 2017

Dr Reinhardt asks pointedly why other nations can have community rating yet their insurance markets do not fall apart.

Here are some reasons that come to mind:

1. In most of these states, health insurance is part of what let’s call Social Security.
The premium is more like a tax. Note that in the USA, Social Security has about a 99% taxpayer compliance rate.
These nations do NOT make health insurance a personal choice, allowing you to gamble that this year you will not need coverage.

2. In most of these states, all employers pay into health insurance/Social Security. There is not large pockets of businesses that avoid paying for benefits, indeed who base their business plan on avoiding benefits.

3. The risk adjustment plans in these nations are complex and mature and well-funded. I once read that for every health insurance premium in Holland and Germany, risk adjustment adds another 30% to the total paid in.

Compare this to the pathetic reinsurance fee that was part of the ACA. For 2014-2016, all health insurance plans had to pay $63 per participant (the fee varied) into a reinsurance plan for large claims in the ACA.

Even at this low level, the right wingers called this a bailout of insurance companies.

The essence of a fee like this is to charge taxpayers as a whole some tax money, so that insurers in the individual market can afford to offer guaranteed issue.

We would have to get used to much larger transfers in order for Pauly’s idea of subsidies to actually work.

Feb 1, 2017

The costs may be half of ours but the government controls the money
Do you think any government has the ability to set aside funds for a specific purpose as an insurer does?
The obvious answer is no so the inability to maintain reserves means it is impossible to address medical trend or a spike in claims
Which means a government run system is unaccountable and unsustainable
Unless, of course, one believes a government can create money out of thin air and get away with it
There is only one Entity able to create something out of nothing.
I will give you a hint – it is not a sovereign government that has its own currency

Feb 1, 2017

“The obvious answer is no”

No, the obvious answer is it doesn’t need to, a government doesn’t need a reserve, but could institute one. Do we put aside reserves for war – I’d like to see the war account reserve?

Seems most universal coverage countries are able to manage – however not perfect. Insurance and economists are not the answer, that’s what’s obvious.

Feb 1, 2017

Community rating is effective in at least 2 situations
1. Where the deductible is high enough that age and health are irrelevant such as $60,000
The chance of a 20 year old incurring $60,000 of bills is the same as an 85 year old, more or less
2. Account based plans like HSAs that build to $60,000
Community rated in the sense that assuming one earns one percent in a savings account, the person who puts in twice of another will have double the benefits
Of. course at a one percent return, assuming one puts $140 a month in an HSA, it may take 30-40 years to reach $60,000, depending on claims
If one puts $140 a month into a Health Matching Account, he will reach $60,000 in 161 months, assuming no claims
He puts in $22,540 to accumulate to $60,000, almost a 3 to 1 return

Barry Carol
Feb 1, 2017

Don — Your numbers don’t compute. To accumulate $60,000 in 161 months by saving $140 per month would require an investment return of 1.078% PER MONTH which equates to 12.937% per year. Such returns are just not available from safe low risk investments in the current extremely low interest rate environment. At 8.333 basis points per month (1% per year equivalent), 161 payments of $140 each would build to $24,111 assuming no claims.

For a health matching account to reach $60K after 161 payments of $140 each, the implied investment return is 12.937% per year. I don’t see how any insurance company could possibly make that work.

Feb 1, 2017

When we developed the monthly crediting, we did not go to Goldman Sachs
We worked with a premier actuarial firm for 5 years
That is because returns are based on claims experience
To learn more you can go to nationalprosperity.com and click on HMA
If you want to set up a 30 minute go to meeting, call 877-850-8532
Before our meeting you will need to sign a non disclosure agreement as our product is patent protected

Feb 1, 2017

“Community rating is effective in at least 2 situations”

There is 3 situations. Every other industrialized country in the world with universal coverage where their costs are about half the U.S.

Barry Carol
Feb 1, 2017

Aside from the culture of solidarity in Europe vs. the culture of individualism in the United States, the other big difference between the U.S. and Switzerland, Germany and Netherlands is that the European health insurance systems were in place for decades and the U.S. would require a radical change in the status quo to replicate one of those three European systems. That radical change would create lots of winners and losers and the losers, especially unions with very comprehensive coverage with most or all of the premium nominally paid by the employer, would vigorously oppose any changes. Maybe we could implement a radical change in the health insurance system for people just entering the workforce today, but I don’t think we could do it for the entire population.

Feb 1, 2017


You have prompted an admirable collection of comments, very thoughtful. I believe it is safe to say that a large enterprise that invests in quality over time will have an easier time managing its costs (and profits). For the quality issue, I think there is an assumption that our nation’s healthcare is very good. No doubt there are isolated sections where it is outstanding, especially if you know how to access it. There is really no consensus as to exactly why the increased cost of our nation’s healthcare is annually higher than our nation’s economic growth. AND, there is no consensus for why the over-all quality of our nation’s healthcare industry can be succinctly characterized by its ‘worsening’ maternal mortality 30 years in a row.

I suggest that if we can’t rapidly change the our nation’s healthcare that 50% of our citizens may need during their life-time, we won’t be able to solve its cost problem for 100% of our citizens. MacDorman et al reported their Original Research in the September 2016 edition of Obstetrics & Gynecology titled “Recent Increases in the U.S. Maternal Mortality Rate” and Sub-Titled “Disentangling Trends From Measurement Issues.” Our maternal mortality ratio for 2014 was 23.8 per 100,000 Births OR 952 deaths. The best 10 out of the 50 Developed Nations had a maternal mortality ratio that averaged “5”. This means that 800 women may have died that year because they lived in the wrong nation.
Basically, our nation does not have the means to establish equitably available and ecologically accessible Primary Healthcare for each citizen, community by community. Each person and their extended family must experience the importance of timely and responsive Primary Healthcare in order to transfer it to any maternal healthcare. A means to promote the level of social capital within every community would be necessary to augment its ‘common good’ for all citizens. The local priorities and values already exist in every community. We need only to find a means to mobilize and focus it.
A similar strategy has already produced an agriculture industry within our nation that is the most efficient and productive among the nations of the world, by a wide margin. It started when the Smith Lever Act was passed by Congress in “1914.”

William Palmer MD
Feb 1, 2017

We should try running it as a public good somewhere….say Hawaii or Puerto Rico. It would be paid for in the same way we pay for Congress or for the military: this year’s grants compared and hammered out with last year’s, voted by Congress, paid by the taxpayer, driven by medical need.

No billing. No billing apparatus. No fee schedules. No insurers. No competing systems: no Medicare, Medicaid, VA, Champus.

Docs, nurses, employees, administrators all on salary. Big Pharma and durable equipment firms must face monopsonic purchasing and foreign acquisition if these sources are competitive.

We must include mental health, drug rehab, long term care, and important dentistry together in universal financial budgets so that we finally become aware of synoptic societal needs.

If we find infinite demand, we may have to develop treatment priority theory. In general, we should focus on illnesses that may kill, or might disable, or might bankrupt a patient if that patient were forced to seek treatment outside the public good system.

Barry Carol
Feb 1, 2017

I think you would find near infinite demand as people go to the doctor for every sniffle just to seek reassurance rather than give the problem a reasonable chance to resolve itself. I also don’t think Americans are prepared to accept explicit rationing. Long term care alone would bring people out of the woodwork by the hundreds of thousands and possibly millions who are currently caring for loved ones at no cost to taxpayers but at considerable personal financial and emotional sacrifice.

Separately, a Canadian primary care doctor once told me that patients in Canada think nothing of cancelling appointments at the last minute or just not showing up because they know that no payment is due at the time or service. Those same doctors must also use billing codes to get paid so there is still some need for claims administration and physician documentation..

Feb 1, 2017

I agree with community rating and a strong mandate, but the government’s obligation is not to cast the mandated into the pit of unaffordable extortion from the “system”. We have seen how the deductibles and premiums for ACA mandated policies make no sense to the incomes of people needing health care and who get no subsidy. As well we have allowed insurance to separate the ACA group from their other groups, so the risk pool is smaller, distorted and expensive – given the weak mandate.

Get the damn costs under control and enforce a strong mandate and get the risk pools much much larger. That’s why Medicare for all is a good solution, 300 million in the risk pool, and cost control, and premiums through taxes and possibly a VAT tax for those not reporting.

Otherwise go to the German system, cost control and all.

Jan 31, 2017

After a cogent introduction and development, I find the conclusion of this article incoherent.

If it is agreed that community rating is inefficient, why even pursue it? By what magic will it work next time? What evidence is there that compelling citizens into participating will somehow make it viable?

To make this proposal simply on the basis of the alleged success of community rating in 3 radically different European countries is imprudent, to say the least (or perhaps not serious).


I like Dr. Gropper’s “confusopoly” term.
A couple of clear ideas/quotes from the Pauly interview to keep in mind:
“I’d advise him to stick to the Ryan plan. I’d advise that he minimizes rent-seeking and keeps the hand of regulation light and graceful.”
“maintain guaranteed renewability in the individual market and extend the renewability to the people with employer-sponsored insurance, so that they can be covered if they lose their jobs, or move to new jobs.”…over time this would greatly reduce the high risk problem in insurance.
…..and we need to keep in mind most everyone agrees somewhere around 30% of care is of zero net health benefit….economic waste every single year. And that waste is much worse in states that have added all kinds of mandates….We know how to greatly reduce that source of waste and others!

Barry Carol
Feb 1, 2017

I would sometimes hear corporate executives complain to groups of investors that they thought half of their advertising dollars were wasted. The problem was that they didn’t know which half.

If you can figure out a way that allows doctors and patients to identify the wasted portion of health services in real time and then get the elimination of that waste incorporated into the standard of care that will be accepted by trial lawyers who bring malpractice suits, we might be able to make some progress in reducing waste in healthcare. Until then, I’m not optimistic and I’m not holding my breath.


It is not complicated. Patients figure it out immediately! [It remains a mystery how little people figure things out without legions of policy experts]. Costs immediately go down 14% when in corporate plans one enrolls in a high deductible plan linked to health savings accounts. [No, this isn’t mean…the companies usually make a contribution to the HSA].

The research that shows this was conducted by Rand and only had a tiny sample of 800,000 families in multiple states. No one wants to pay attention to this…..too many parties have an interest in keeping the funds flowing.

Barry Carol
Feb 2, 2017

The bottom line is that taking care of the outliers as you call them is very expensive which makes it hard because nobody wants to pay for them at the federal, state or individual level. Taking care of the healthy is easy and cheap as long as they don’t have help to pay for the sick..

Feb 2, 2017

Taking care of the healthy or the unknown high risk patient (outlier) means that more high risk patients are managed appropriately.


The overuse/harmful use/wasteful use of health care is about 30% (Hadler has said it may be close to 50%)…..this is a huge pile of funds that if tapped allow us to fund policy that takes care of the least healthy. And the Rand study shows a way to immediately begin reducing the overuse without harmful outcomes. It has already been happening as seen in the slow down in health care inflation that began with the introduction in the employer world of these types of plans.

Feb 1, 2017

Paul, you have consistently shown the way. People have a tendency to try to solve the healthcare dilemma starting with the outliers when if they started with the general population many of the problems of the outliers would be reduced before even getting to the outliers.

15% is a lot, but my guess is that we could save double to triple that if we would stop trying to overcomplicate things and move to a truer marketplace.


Thanks Allan. I feel like a broken record citing the large Rand study. Good point re the focus on outliers as a way to do nothing or a way to advocate for another layer of regulation/mandate/etc on physicians and patients….their preferred approach.