The effect of community rating in health insurance markets

Maybe there's been enough discussion of Paul Krugman on health care but still this caught my eye.  In a recent blog post Krugman wrote:

The reason we have restrictions on interstate sales of health insurance is that a number of states regulate insurers. In particular, some states have a form of community rating, which basically says that insurers can’t deny you coverage or charge extremely high premiums if you have a preexisting condition. And community rating will be unsustainable if individuals can buy insurance from out of state; insurance companies in states that don’t have community rating will cherry-pick the healthy, good risk people, leaving the community rating states with only the highest-cost people.

Krugman's post seems to be very approving of such community rating.  When it comes to California, which has no community rating, "insurers compete by doing their best to deny coverage to anyone who might actually need medical care."

Based on a close look at the data, Herring and Pauly write (I can't find an ungated version can you?):

Some states have implemented community rating regulations to limit the extent to which premiums in the individual health insurance market can vary with a person's health status. Community rating and guaranteed issues laws were passed with hopes of increasing access to affordable insurance for people with high-risk health conditions, but there are concerns that these laws led to adverse selection. In some sense, the extent to which these regulations ultimately affected the individual market depends in large part on the degree of risk segmentation in unregulated states. In this paper, we examine the relationship between expected medical expenses, individual insurance premiums, and the likelihood of obtaining individual insurance using data from both the National Health Interview Survey and the Community Tracking Study Household Survey. We test for differences in these relationships between states with both community rating and guaranteed issue and states with no such regulations. While we find that people living in unregulated states with higher expected expense due to chronic health conditions pay modestly higher premiums and are somewhat less likely to obtain coverage, the variation between premiums and risk in unregulated individual insurance markets is far from proportional; there is considerable pooling. In regulated states, we find that there is no effect of having higher expected expense due to chronic health conditions on neither premiums nor coverage. Overall, our results suggest that the effect of regulation is to produce a slight increase in the proportion uninsured, as increases in low risk uninsureds more than offset decreases in high risk uninsureds [emphasis added by TC]. Community rating and guaranteed issue regulations produce only small changes in risk pooling because the extent of pooling in the absence of regulation is substantial.

You'll find some unadjusted raw data for states here

Herring and Pauly, who wrote this paper in 2006, stress that what I am describing as the Krugman view is the "conventional wisdom" yet not supported by the facts.  More generally, you can think of their excellent paper is a contribution to the ongoing debate over health insurance and adverse selection.  As the authors say "there is considerable pooling."

I am not, by the way, suggesting that we should move everything to the individual insurance market or that Jim DeMint is an objective analyst of U.S. health care.


Earlier draft of the Herring_Pauly paper:

I'll add one comment to the post above. The second possibility above wouldn't need to be inconsistent with the Herring/Pauly findings. Since there weren't many healthy people in the pool in the first place, even if not many drop out, their increased premiums don't provide much subsidy to the unhealthy, so the community rated rate isn't much lower than what the unhealthy were paying previously -- so not many more of them sign up.

Many analysts, Krugman in this case but certainly not only him, assume that individuals in a market economy actively seek out the skills and information needed to navigate complex transactions such as health care insurance decisions. However, the experts fail to account for the role of emotion and social facilitation in human decision making. The vast majority of Americans do not possess the skill or information to effectively utilize a health care marketplace, nor will they in the near future. Instead, most people feel completely overwhelmed by the system (as do many educated and skilled people by the way... just look at what happened with the medicare drug benefit when that was first open to enrollment). Under such conditions, and frankly even in less complex situations, humans seem to operate under a "behavioral willingness" model wherein rational information is only one of several components in a decision... social facilitation (friends, family, perceived social norms... e.g. advertising) and emotional preference are others. Thus, in the health care marketplace people are not going to make rational choices as much as they will make more "attractive" choices, a concept that incorporates other variables. Most people are not going to spend the vast amount of time it would take to build their skills as they have many other competing priorities. Thus, their decisions will be more governed by "willingness" considerations and not by pure economic logic. I would think that analysts would start to take these emotional and social factors into account after the repeated failure of their models to predict market behavior.

As I understand it, in the auto-insurance market, where there is mandatory coverage, there is an assignment of very risky individuals to companies providing insurance. Could there be a similar program implemented in the health insurance market(s)?

Here is an article that is illustrative:

From PK's column:

"By regulation I mean the nationwide imposition of rules that would prevent insurance companies from denying coverage based on your medical history, or dropping your coverage when you get sick. This would stop insurers from gaming the system by covering only healthy people.

On the other side, individuals would also be prevented from gaming the system: Americans would be required to buy insurance even if they’re currently healthy, rather than signing up only when they need care."

So there wouldn't be a increases in low risk uninsureds.

It can be simultaneously true that community rating causes a small increase in the uninsured (the Herring/Pauly contention which is supported by other research) and also that allowing the purchase across state lines of individual insurance would cause many unhealthy individuals in community rated states to lose their insurance (because less costly individuals jump ship to cheaper, less regulated, states). This posting sets up these two ideas as antithetical, which they are not, even if the ideologies of their authors are.

Some would claim that community rating provides a definitive societal good -- those who need insurance the most can obtain it at a price that does not vary with their individual health status. Of course, this comes at the cost of increasing premiums for the healthier of those among us. I would imagine that if many of us step back and consider from a veil of ignorance whether we might be sick one day, and how difficult it would be to obtain care in that situation in an unregulated state, perhaps a small increase in the number uninsured (this is what studies show) is worth the assurance that one can obtain access to health care when it is needed most.

Thanks for the post, it will be useful ammunition. I do find, as usual, the anti-GOP tone odd. You don't need to put it in to impress us, though many comments come from the right-leaning. DeMint shows a vastly superior understanding of economics, and we get a disclaimer on how he's "not objective." Obama, who you supported for President, by most accounts, pushes a program down our throats that flies in the face of even the most basic microeconomics -- and -- what...?

I am not, by the way, suggesting that we should move everything to the individual insurance market or that
Jim DeMint is an objective analyst of U.S. health care.

Nor are the advocates of "herdcare" on the left. If everything Obama & his legions promise were true-
the bill sucks because of its rationing (aimed against the elderly, explicitly by the requirement to
undergo "counseling" on end of life issues. The damn thing is Logan's Run.

There is actually nothing wrong with unhealthy people footing their own bill when they take advantage of the information asymmetry of knowledge of their own health to try to screw the rest of us who planned ahead and chose not to be freeloaders. And there is nothing wrong with the insurance company attempting to weed out such people on our behalf under our voluntary system.

And the argument is not about community rating. It is about the limiting of people being able to buy across state lines because insurance companies will "cherry pick" the healthy. Now both Alex and Tyler have shown (at leas once each) that the cherry picking goes the other way. And, we know it goes the other way as it is the young and healthy that make up the majority of the number of uninsured (40 Million) that keeps getting cited by the reactionary left.

Krugman et. al. are just better at spinning it into a guilt trip by implying they are all poor children than I am at explaining the reality of it. Jim DeMint doesn't claim to be an economist, that I know of. Does Paul Krugman claim not to be a politician?

Let's be clear about what the debate is about.

The debate is what form of health service rationing is going to dominate the US market.

If you are middle class working for a small business and someone in the small business has been sick, then the odds are high that you will be rationed in your health services, with the services you can afford limited to what you can pay out of pocket. Maybe you will be healthy and not need care, as most people are. But if not, then because you didn't chose to work for, or are not allowed to work for, a big employer that is regulated by ERISA and large enough to negotiate real risk pooling with insurers (with the threat of a company run risk pool sort of like a public plan), your access to risk pooling will be severely rationed.

If you are unemployed and and older, then in most cases your access to risk pooling will be rationed, and even then, the access to preventative care will be rationed to the amount you can afford.

Unless you don't have nny assets or income, in which case you get free government run health insurance which rations your care less than for-profit insurers.

If you can survive to age 65, you are now freed from almost all rationing of health services, generally getting so many services your health often ends up worse. When 65, you get the services of several specialists, but the GP coordinating care is rationed, so he ends up merely referring and not managing.

So, the debate about community rating is a debate about only a small part of the health service rationing that takes place in the US.

Ricardo: "The catch is that there is often a built-in exclusion for covering pre-existing conditions that lasts for 6-12 months."

I don't see this as a "catch". As you pointed out, COBRA benefits allow a bridge for those who lose their employer-provided insurance. The rest are simply gamblers who chose to accept the risk of being uninsured when they were healthy.

Ricardo: "No such thing as free. If you don't pay your hospital bill, they will send debt collectors after you."

According to a study by the IRS, U.S.non-profit hospitals provide, on average, 7% of their services as uncompensated care. You may argue this is insufficent to cover those uninsured due to insufficient income. But that uncompensated care was free to those patients.

Glenn: "It isn't market driven because there is no way we as Americans are going to be hard hearted enough to just let people die."

I think you are restricting the term "market driven" to mean "free market". Even with the government interevention currently in the health care industry, it is still driven by market forces.

Glenn: "Or course, we don't and won't simply let people die because they can't afford to pay for their healthcare. We have all sorts of ways of making sure that people who can't afford the healthcare the need get it."

True. But we have chosen inefficient means of providing health care to the poor. One way we could have provided health care for the poor is to give them vouchers with which to purchase health insurance. Then the government could have stepped aside and let free market forces find the most efficient solution. The problem is that Democrats and Republicans would almost certainly use a different definition for the word "poor". Democrats have no problem piling trillions of dollars in entitlements on the backs of the nation's most productive.

John Dewey: "True. But we have chosen inefficient means of providing health care to the poor. One way we could have provided health care for the poor is to give them vouchers with which to purchase health insurance."

True but as Dave Barry would say "that's a great idea except that it is dumb". The idea that vouchers to the poor for healthcare would save money is just silly. It either assumes a) that price is the only consideration taken into account when spending on healthcare and the poor will buy the cheapest policy and that brings down healthcare, or b) that the poor will be able to good judgement calls on healthcare considerations. The problem with a) is that there is no motivation for healthcare providers to give any particular quality of service for a price. So yeah, you get doctors visits for free but a $50,0000/lifetime limit on hospitalization. Sounds good but it is no where near enough for the kind of chronic illness that are our biggest healthcare expense nationally. The problem with b) is that while not everybody who is needy is dumb, even experts have problems figuring out the best healthcare plan.

Besides, giving people vouchers is still an artificial price support. It is paying for healthcare for those who would otherwise be out of the market. For the market to work, people need to be able to walk away from a purchase and force the seller to come down in price. Otherwise cost that the market will bare is artifically high. That's hard to do when you are dying.

All these free market schemes seem pretty much like money that we are taking from tax payers and giving to businesses to me. Vouchers seem to be one of the worst ideas - we would simply be providing a new revenue stream to insurance companies. After all, insurance companies don't provide healthcare, they only transfer money. Vouchers are sort of a price support for middle men.

I think there are a few additional states with community rating laws working their way through the legislature right now.

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