Tuesday, August 24, 2004
Here comes another "crisis"
[Arnold Kling, "Middle Man Mess," Tech Central Station, 24 August 2004.]
One of the basic tools of the insurance industry is risk pooling. Essentially, if enough people from enough backgrounds are included in a group of insured, then the company can spread the risk of high cost individuals among lower cost individuals and keep costs for them - and their customers - low. Tech Central Station's Arnold Kling explains how the ongoing process of people leaving the employer-based insurance model may lead to calls for greater regulation of the insurance market for all:
"A relentless rise in the cost of employee health insurance has become a significant factor in the employment slump, as the labor market adds only a trickle of new jobs each month despite nearly three years of uninterrupted economic growth.
"Government data, industry surveys and interviews with employers big and small indicate that many businesses remain reluctant to hire full-time employees because health insurance, which now costs the nation's employers an average of about $3,000 a year for each worker, has become one of the fastest-growing costs for companies."
-- New York Times
If employers bear the cost of health insurance, then I'm the Easter Bunny. It is fairy-tale economics to believe that "nice" employers give away health insurance, while "mean" employers withhold it. In reality, employers compensate their employees using a combination of cash and non-cash benefits. Workers bear the cost of health insurance.
The right way to think about health insurance is not as something that employers provide but as something that employers sell to their employees. Your employer is an intermediary between you and the insurance company. Step one, your employer company decides how much to pay for your labor. Step two, the company takes some of that pay and makes you buy health insurance with it.
The reality is that workers always pay for health insurance. The more money that a company pays for employee health insurance, the less it can afford to give the employee in wages. From the employer's perspective, health insurance is part of the cost of labor, and the laws of economics dictate that those costs will be borne by workers, regardless of whether the employer acts as an intermediary.
Health insurance disintermediation is widespread in today's economy. The New York Times article quoted above describes one type of disintermediation, which is the use of temporary workers who do not have health benefits. However, there are many other forms of health insurance disintermediation. When someone quits or is laid off and becomes a self-employed contractor, that is disintermediation. When a firm downsizes its work force and sub-contracts to a small firm that does not pay health insurance benefits, that is disintermediation.
In recent years, there has been a striking divergence between household and payroll measures of employment. According to households, there are millions of more jobs than there were when President Bush first took office, while there are fewer jobs listed on employer payrolls. I suspect that disintermediation accounts for some of this discrepancy, as workers effectively opt out of employer health insurance by becoming self-employed.
In theory, we could force everyone who works for a company, even as an independent contractor, to obtain health insurance through that company. However, you cannot force employers to pay more for labor than the value of what workers produce. If you forced every employer to offer generous health insurance benefits even to contractors and temporary employees, then the recipients' take-home pay would have to be reduced and/or hiring would have to be curtailed.
Disintermediation is a free-market response that is good for workers who otherwise would be unemployed or receive low take-home pay. Those workers who would rather not buy so much health insurance at the company store are able to obtain the employment and wages they prefer because of disintermediation.
As health care becomes a larger and larger share of consumption, health insurance disintermediation will become a larger and larger factor in employment decisions. Low-risk workers will tend to opt out of the corporate labor market. Corporations will tend to hire from a pool of workers with relatively high health risks. This in turn will raise corporate health costs more, which will lead to even more disintermediation.
The phenomenon of low-risk employees opting out of the corporate health insurance market, leaving employers with a high-risk pool, is what economists call adverse selection. The employees who are willing to give up a lot of cash wages in exchange for health insurance represent an adverse risk population.
Joseph Stiglitz's work on adverse selection and insurance markets earned him a share of the Nobel Prize in 2001. One of his theories is that an insurance market may disappear entirely because of adverse selection. As more low-risk people opt out, the average cost of insuring high-risk people increases, to the point where high-risk people cannot afford insurance. Although we are a long way from that point in health insurance today, it is sobering to consider that disintermediation could be leading in that direction.
The problem posed by Stiglitz is that free choice and insurance pooling may be incompatible. If multiple types of insurance coverage are available, then low-risk consumers will gravitate toward a different type of coverage than high-risk consumers. The high-risk consumers lose the benefit of being pooled with low-risk consumers.
The consequences of health insurance disintermediation are generally favorable. It gives workers opportunities for jobs and take-home pay that otherwise would not be available. I would like to see complete disintermediation, so that health insurance is always bought directly by individuals, rather than through employers.
However, disintermediation raises two possible concerns for public policy. One concern is that some workers who opt out of the company store as their source of health insurance are doing away with health insurance altogether. A hard-core libertarian might not care, but others, myself included, would favor some form of mandatory catastrophic coverage.
A second concern is that disintermediation is reducing risk pooling, which may leave some high-risk consumers unable to pool risks with low-risk consumers. High-risk consumers might be protected by catastrophic re-insurance paid for by taxpayers.
If the government response to health insurance disintermediation were limited to a requirement for everyone to obtain high-deductible health insurance coverage and a provision for catastrophic re-insurance, that would be a relatively positive outcome. However, what is likely to happen instead is that health insurance disintermediation is going to lead to demagogic claims that we face a "crisis," and that this "crisis" justifies a much heavier hand of taxpayer funding and regulation as the "solution."
[Arnold Kling, "Middle Man Mess," Tech Central Station, 24 August 2004.]
One of the basic tools of the insurance industry is risk pooling. Essentially, if enough people from enough backgrounds are included in a group of insured, then the company can spread the risk of high cost individuals among lower cost individuals and keep costs for them - and their customers - low. Tech Central Station's Arnold Kling explains how the ongoing process of people leaving the employer-based insurance model may lead to calls for greater regulation of the insurance market for all:
"A relentless rise in the cost of employee health insurance has become a significant factor in the employment slump, as the labor market adds only a trickle of new jobs each month despite nearly three years of uninterrupted economic growth.
"Government data, industry surveys and interviews with employers big and small indicate that many businesses remain reluctant to hire full-time employees because health insurance, which now costs the nation's employers an average of about $3,000 a year for each worker, has become one of the fastest-growing costs for companies."
-- New York Times
If employers bear the cost of health insurance, then I'm the Easter Bunny. It is fairy-tale economics to believe that "nice" employers give away health insurance, while "mean" employers withhold it. In reality, employers compensate their employees using a combination of cash and non-cash benefits. Workers bear the cost of health insurance.
The right way to think about health insurance is not as something that employers provide but as something that employers sell to their employees. Your employer is an intermediary between you and the insurance company. Step one, your employer company decides how much to pay for your labor. Step two, the company takes some of that pay and makes you buy health insurance with it.
The reality is that workers always pay for health insurance. The more money that a company pays for employee health insurance, the less it can afford to give the employee in wages. From the employer's perspective, health insurance is part of the cost of labor, and the laws of economics dictate that those costs will be borne by workers, regardless of whether the employer acts as an intermediary.
Health insurance disintermediation is widespread in today's economy. The New York Times article quoted above describes one type of disintermediation, which is the use of temporary workers who do not have health benefits. However, there are many other forms of health insurance disintermediation. When someone quits or is laid off and becomes a self-employed contractor, that is disintermediation. When a firm downsizes its work force and sub-contracts to a small firm that does not pay health insurance benefits, that is disintermediation.
In recent years, there has been a striking divergence between household and payroll measures of employment. According to households, there are millions of more jobs than there were when President Bush first took office, while there are fewer jobs listed on employer payrolls. I suspect that disintermediation accounts for some of this discrepancy, as workers effectively opt out of employer health insurance by becoming self-employed.
In theory, we could force everyone who works for a company, even as an independent contractor, to obtain health insurance through that company. However, you cannot force employers to pay more for labor than the value of what workers produce. If you forced every employer to offer generous health insurance benefits even to contractors and temporary employees, then the recipients' take-home pay would have to be reduced and/or hiring would have to be curtailed.
Disintermediation is a free-market response that is good for workers who otherwise would be unemployed or receive low take-home pay. Those workers who would rather not buy so much health insurance at the company store are able to obtain the employment and wages they prefer because of disintermediation.
As health care becomes a larger and larger share of consumption, health insurance disintermediation will become a larger and larger factor in employment decisions. Low-risk workers will tend to opt out of the corporate labor market. Corporations will tend to hire from a pool of workers with relatively high health risks. This in turn will raise corporate health costs more, which will lead to even more disintermediation.
The phenomenon of low-risk employees opting out of the corporate health insurance market, leaving employers with a high-risk pool, is what economists call adverse selection. The employees who are willing to give up a lot of cash wages in exchange for health insurance represent an adverse risk population.
Joseph Stiglitz's work on adverse selection and insurance markets earned him a share of the Nobel Prize in 2001. One of his theories is that an insurance market may disappear entirely because of adverse selection. As more low-risk people opt out, the average cost of insuring high-risk people increases, to the point where high-risk people cannot afford insurance. Although we are a long way from that point in health insurance today, it is sobering to consider that disintermediation could be leading in that direction.
The problem posed by Stiglitz is that free choice and insurance pooling may be incompatible. If multiple types of insurance coverage are available, then low-risk consumers will gravitate toward a different type of coverage than high-risk consumers. The high-risk consumers lose the benefit of being pooled with low-risk consumers.
The consequences of health insurance disintermediation are generally favorable. It gives workers opportunities for jobs and take-home pay that otherwise would not be available. I would like to see complete disintermediation, so that health insurance is always bought directly by individuals, rather than through employers.
However, disintermediation raises two possible concerns for public policy. One concern is that some workers who opt out of the company store as their source of health insurance are doing away with health insurance altogether. A hard-core libertarian might not care, but others, myself included, would favor some form of mandatory catastrophic coverage.
A second concern is that disintermediation is reducing risk pooling, which may leave some high-risk consumers unable to pool risks with low-risk consumers. High-risk consumers might be protected by catastrophic re-insurance paid for by taxpayers.
If the government response to health insurance disintermediation were limited to a requirement for everyone to obtain high-deductible health insurance coverage and a provision for catastrophic re-insurance, that would be a relatively positive outcome. However, what is likely to happen instead is that health insurance disintermediation is going to lead to demagogic claims that we face a "crisis," and that this "crisis" justifies a much heavier hand of taxpayer funding and regulation as the "solution."
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