The Health-Status Insurance Solution

How free markets can provide health security

"Health care reform that reduces costs while expanding coverage is no longer just a dream we hope to achieve—it's a necessity we have to achieve," declared President Barack Obama as he announced his nomination of Kansas Gov. Kathleen Sibelius to be the new Secretary of Health and Human Services. On Thursday, President Obama will convene a health care summit of stakeholders representing insurers, pharmaceutical companies, physicians, policymongers, Congress, and patient advocates at the White House to discuss just how to achieve these goals. The president set out eight principles for guiding the process of health care reform, including protecting families from being bankrupted by medical expenses, making insurance affordable, aiming for universality, portability, and choice, focusing on prevention, improving patient safety, and being fiscally sustainable.

Summit attendees will break into various working groups that are supposed to engage in "outside-of-the-box" thinking. As it happens, they now have some fascinating "outside-of-the-box" thinking on health insurance reform to draw on. Earlier this month, University of Chicago economist John Cochrane published an intriguing policy analysis for the libertarian Cato Institute that looked at how "health-status insurance" can provide health security for Americans. Cochrane claims that with health-status insurance, free markets can solve the vexing problem of how to insure people with pre-existing medical conditions and "provide life-long, portable health security, while enhancing consumer choice and competition."

So how does health-status insurance work? As Cochrane explains, "Market-based lifetime health insurance has two components: medical insurance and health-status insurance. Medical insurance covers your medical expenses in the current year, minus deductibles and copayments. Health-status insurance covers the risk that your medical premiums will rise." Cochrane offers the example of a 25-year-old who will likely incur $2,000 in medical expenses in a year. His medical policy component would thus cost about $2,000 per year, plus administrative fees and profit. For purposes of illustration, Cochrane then assumes the 25-year-old has a 1 percent risk of developing a chronic medical condition that would increase his average medical expenses to $10,000 per year. In that case, he would be able to buy medical insurance for $10,000 per year—which is a big financial hit. That's where health-status insurance comes in: It insures that you can be insured in the future.

The 25-year-old could pay for insurance against the 1 percent risk that his premiums would jump by an additional $8,000 per year. To pay for his increased insurance premiums until age 65, Cochrane calculates that at a 5 percent interest rate, he would need a lump-sum of $148,370. To cover a 1 percent risk, the premium for the health-status component of his insurance would be about $1,480 per year, so the 25-year-old's total premium—medical and health-status—would be about $3,500 per year. Again, this is just an illustration. Cochrane shows that actual health-status insurance premiums would more likely be around $700 per year at age 25, rising to $900 per year at age 55.

Under Cochrane's proposal, if an insured person develops an expensive chronic condition, a lump-sum payment would be deposited into a health-status insurance account that would be available only to pay medical insurance premiums. This restriction would limit the temptations to commit fraud (faking an illness to get the money and then run) or to spend it and then show up at an emergency room unable to pay. In addition, if the insured becomes unexpectedly healthier and his premiums decline, the money could then be returned to the insurer.

Creating and selling separate health-status insurance policies would mean that medical insurance companies would no longer have an incentive to offload sick people. Instead, because those with pre-existing conditions would have the funds to pay higher premiums, insurers would compete for their business. "Constant competition for every consumer will have the same dramatic effects on cost, quality, and innovation in health care as it does in every other industry," argues Cochrane.

Health-status insurance also helps delink medical insurance from employment because employees would always have the ability to purchase medical insurance. For example, a worker diagnosed with diabetes would receive a lump-sum payment in his health-status insurance account. That means he can switch jobs without worrying about whether or not he can obtain medical insurance. In addition, health-status insurance would be cheaper than medical insurance, so people between jobs might drop their medical insurance but continue to maintain their future insurability by paying health-status insurance premiums.

But what about people who are already sick? As Cochrance acknowledges, "Private insurance cannot cover events that have already happened." So at the start, the government might deposit money into the health-status insurance accounts of people with pre-existing conditions who would then purchase private medical insurance.

If health-status insurance is such a good idea, why don't insurers already offer it? Cochrane believes that it has been stalled because health insurance is a highly over-regulated market. "Any insurer who rolled this out would quickly have both regulators and lawyers going after them," Cochrane says. In addition, there are strong regulations in place that discourage insurers from extensively using risk-ratings to set premiums. Eliminating the tax and regulatory preferences for employer-provided group health insurance would go a long way toward encouraging the development of a robust health-status insurance market.

Nevertheless, the individual health insurance market is already moving in this direction. The UnitedHealth Group now offers a Continuity policy that guarantees purchasers the right to buy an individual medical insurance policy in the future even if they become sick. For example, in order to guarantee future access to a $3 million lifetime benefit policy with a $5,000 deductible, a 50-year-old male Ohioan would pay 20 percent of the policy's current $172 per month premium, or about $34 per month. While this is a step in the right direction, Cochrane points out that health-status insurance would not tie people to any particular insurer in the future. Their health-status insurance would enable them to shop around for policies from various carriers.

While Cochrane acknowledges that his proposal is not a comprehensive health care reform program, adopting it would go a long way toward satisfying President Obama's eight health care reform principles, especially affordability, aiming toward universality, portability, and choice, and being fiscally sustainable. "Health-status insurance can simultaneously give us complete and portable long-term insurance, great individual choice, and cost-containment beyond the dreams of any health policy planner," concludes Cochrane. Asked if he has been invited to the president's health care reform summit this week, Cochrane said no, but quickly added, "If I got the phone call, I would definitely be there." Mr. President, there's still time for your summiteers to hear about this outside-of-the-box thinking.

Ronald Bailey is Reason magazine's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is now available from Prometheus Books.