The American Spectator

The Right Prescription

One of the most common rejoinders to those who advocate a free market health care system is: how would private enterprise cover those with chronic illnesses?

This is a valid concern. After all, under the current system, a profit-seeking insurance company does not have an incentive to take on a chronically ill patient whose medical costs will exceed any monthly premiums that the company could charge.

But John H. Cochrane, the Myron S. Scholes professor of finance at the University of Chicago's Booth School of Business, thinks he has the answer.

Speaking informally to reporters at a luncheon sponsored by the Cato Institute this week, Cochrane explained his proposal, which was presented in detail in a recent paper he wrote for the think tank.

In his view, the biggest problem with the current employer-based health care system is the issue of portability, because it affects everybody, whether or not they have insurance. The horror stories of those who lose their jobs and health care coverage, get diagnosed with cancer, surrender their homes, and declare bankruptcy permeate the media and provide the emotional force behind the drive for government-run health care.

Liberal policy analysts have proposed solving the problem by passing laws requiring that insurers grant coverage to anybody who applies and that they charge everybody the same premiums, regardless of risk factors or preexisting conditions.

However, when those ideas have been tried at the state level, the results have been disastrous -- the artificially low premiums for the sick drive up the cost of insurance for the healthy. The higher cost deters healthy individuals from buying or maintaining their coverage, and there is a mass exodus of insurers from the state because they don't want to be left with only the sickest patients. The liberal policy solution to this problem, which is caused by state intervention, is yet more government intervention in the form of a mandate requiring that all individuals purchase health insurance or face a fine.

Cochrane's alternative solution is the creation of insurance policies that would protect individuals against a hike in premiums they would incur if they were diagnosed with a disease that moves them into a higher risk category.

While such health status insurance policies could be crafted in a variety of ways, one model Cochrane suggests would be to have the health status insurer provide lump sum payments that would be used to cover the cost of the higher premiums. To prevent fraud in the form of fake diagnoses, the payment could be made into an account that could only be used for medical expenses.

The major advantage of the idea is that it would create a competitive market in which insurers would actually chase after sick patients because they'll be able to charge them higher premiums. It would also lower the cost of insurance for healthier individuals who would no longer have to subsidize the sick indirectly.

Under such a system, if individuals have lapses in their insurance, lose their jobs, or face financial setbacks, as long as they maintain their cheaper health status insurance, they'll have the ability to purchase insurance should they get stricken with a disease.

Cochrane argues that health status insurance wouldn't cost people any more than they pay for coverage right now, because today insurance companies are required to renew the polices of anybody they currently insure, and the risk that those customers might get sick in the future is built into the cost of the policies. Cochrane is suggesting that insurers sever those two elements, allowing people to maintain separate health status insurance policies.

Another advantage of such an approach is that right now, insurance policies are short-term contracts. With people moving from job to job and changing coverage so often, insurers have less motivation to encourage healthier habits among beneficiaries. However, health status insurance policies would be issued for the long term, meaning that companies would want to provide incentives for healthier living, perhaps translating into lower premiums for non-smokers and those who remain trim.

During the lunch, Cochrane addressed some of the potential challenges to implementing and sustaining such a system. The most pressing is: what do we do with the millions of Americans who already have preexisting conditions? In response, he acknowledged that there would have to be a role for government during the transition process to finance accounts to subsidize health insurance for those who are afflicted. "If we can get to a system that would be Nirvana, then I would be willing to support lump sum payments to individuals in order to get there," Cochrane said.

The other complication is posed by the development of genetic testing, which could lead health status insurers to discriminate against people based on their family history as they now do against those with chronic diseases. However, Cochrane argues that this problem would be minor in comparison, because the price of a policy based on calculating the probability that somebody might get cancer is a lot cheaper than the price once there is a certainty that the person has cancer.

While Cochrane's proposal is mostly conceptual at this stage, the key point, he said, is that there are ways that the free market can cover those with chronic conditions.