There are two primary reasons that an individual mandate is supported in health reform, not just by Democrats, but by many Republicans as well. The first one is the notion that the only legitimate way to pay for a health care service is through insurance. And the other is that the uninsured are a bunch of “free riders” who sponge off the rest of us by consuming but not paying for health care services. So our premiums go up in the form of a “hidden tax.”

These arguments sound compelling – until you dig a bit deeper.

Insurance is the best, in fact, the only way to pay.

Insurance generally has been used as financial protection against unexpected and rare occurrences. It is typically a two-party contract that pays a benefit when a loss occurs. This is true for auto, homeowners, life, and virtually any other kind of insurance you can think of.

But health insurance has become something entirely different, thanks to my former employers at Blue Cross. In fact Blue Cross insisted for many years that it was NOT “insurance” but “prepaid health care.” Because of Blue Cross market domination in the 1930s and 1940s commercial carriers ended up replicating the Blue Cross model.

Today, all health insurance is a combination of “insurance” for adverse events and “prepaid health care” for services that are low cost and predictable.

The object of this coverage is to pay for health care services. There is nothing wonderful or magical about having a health insurance policy in itself. The reason to have it is to pay for the services you consume and the bills you incur.

But there are many ways to pay for those services. If I need a service that costs $2,000 I can slap down my insurance card on the counter and the insurance company will pay the bill. But I could also slap down my credit card and my bank will pay the bill.

The only difference is how the insurance company or the bank gets the money to pay the $2,000. In the case of the insurance company, it can pay the $2,000 because I (or my employer) have been giving it $100 a month for the previous 20 months. If the bank pays the bill, I (or my employer) will pay off the debt by sending the bank $100/month for the next 20 months. The only difference is pre-payment versus post-payment.

So the question becomes which is the more efficient way to finance the $2,000? The bank will charge me interest (possibly 8%). But the insurance company also has a charge in the form of a loss ratio (also in the time value of the money it has been holding.) So, how does the insurance company load compare to the interest rate the bank charges? If the loss ratio is 93%, (7% load) it is probably a good deal, but if it is 80% (20% load), it is not such a good deal.

Free Riders

Let’s first remember “free riding” is at most a trivial problem, amounting to something like 2 percent of all health spending in the United States. But the “solutions” that have been proposed are massively intrusive on the lives and freedoms of 100% of Americans.

Consider —

n     It is not the uninsured clogging hospital ERs, but the fully insured, especially those on Medicaid.

n     There is indeed a “cost-shift” to the insured from uncompensated care, but it pales compared to the cost shift from underpayment by Medicare and Medicaid.

n     The “cost-shift” would still have to be paid out in the form of subsidies in any event. Money is not saved.

n     The uninsured do in fact pay for a large portion of their own consumption, and would pay an even larger share if they were charged at the PPO rate for services (or Medicare +25%).

Consider also —

n     Getting rid of “free ridership” means massive policing of the insurance status of 100% of Americans — this means substantial administrative costs added to the system.

n     It also involves massive subsidies, including to those who are not currently subsidized, and penalties for those who are not.

Consider finally —

n     There is not yet a proposal that would end “free ridership.” All of the current proposals will continue a large number of people who are uninsured and getting free services, including illegal immigrants and people who simply don’t pay their bills. For all of the contortions and intrusions, the current proposals would at best reduce the problem, not solve it.

My conclusion — The issue of free ridership is a lot of Sturm und Drang about very little. Our time would be better spent on helping reduce the problem with a series of steps to make coverage more attractive and more affordable and prices more realistic for people who self-pay.

Policy makers operate on the assumption that having insurance (pre-paid health care) is inherently a Good Thing and superior to not having insurance and post-paying for the exact same service. Why? If I can pay for the same services at a lower cost, why is that a bad thing? If the goal is to pay for health care services, we should be interested in finding the most efficient way to get that done. In some cases it may be through insurance coverage, but in other cases it may be through bank financing. Neither is more virtuous than the other.