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Who’s to Blame for Inflated Health Insurance Costs?

Opinion

Xconomy Boston — 

How often would you go to the doctor if you had to pay for a big chunk out of pocket—or how about if it was completely free? The amount of health care we consume depends on how good our health insurance is. Now, two economists, David Powell and Dana Goldman, have looked at what factors drive up costs and have some data that should affect decisions from policy makers and business leaders.

First, let me define what I mean by a “good” or “bad” health plan. A plan with low deductible, co-pay, and co-insurance is good, while the opposite is bad. In the health insurance marketplace set up as part of the Affordable Care Act, health plans are ranked as gold, silver, or bronze to help make the quality of the plan clearer.

As you would expect, the annual premium of a good health plan will generally be higher than a bad health plan because it offers more coverage. The insurer has to spend more money to cover the expenses of a patient with a good health plan.

What’s interesting is that the added cost of a good health plan is not explained merely by the money the insurer spends to cover the gap left by the lower deductible, co-pay, and co-insurance. There is an excess increased cost associated with a good health plan. This excess cost is the result of two phenomena known to economists and the insurance industry: adverse selection and moral hazard.

Adverse selection may refer to a good plan attracting high-cost consumers. For example, if a person has multiple medical problems or is not consistent with her medical treatment, she might consciously or subconsciously select a better health plan, anticipating high health expenses. The good health plan thus attracts consumers who are expected to have higher than average costs, thereby driving up the cost of the plan for everyone else.

Moral hazard, on the other hand, does not come from inadvertently selecting for higher cost consumers. Instead, when a person has purchased a good health plan, he or she is more likely to use the services offered as part of the plan. For example, if I buy a good health plan that includes a low co-pay for expensive specialist services, I might be more likely to see specialists for issues that could probably be handled by a less expensive primary care doctor. If I had selected a bad health plan instead, I would have probably stuck with the cheaper primary care doctor.

Adverse selection and moral hazard are a big deal. Powell and Goldman, in a paper in National Bureau of Economic Research this January, found that these factors added over two thousand dollars to the cost of the better health plan at the company they studied.

Powell and Goldman used innovative statistical methods to tease apart these two factors and found that at that company, adverse selection accounted for 47 percent of the extra expense, while moral hazard contributed the remaining 53 percent of the expense. In other words, adverse selection and moral hazard shared a roughly equal blame for the excess cost of a good insurance plan at that company.

As the authors point out, adverse selection and moral hazard sometimes move in opposite directions with policy changes, making costs more difficult to control. The Affordable Care Act, for example, attempted to combat adverse selection by requiring all Americans—even the young and healthy—to obtain health insurance. By bringing healthier people into the market, the ACA hoped to reduce adverse selection. At the same time, though, the ACA gave these healthy people more access to the health system, increasing moral hazard. And, by creating minimum coverage requirements such as free annual check-ups, the ACA encouraged greater healthcare utilization by increasing moral hazard. While expansion of coverage was itself a goal of the ACA, it is important to recognize that because moral hazard is such a powerful force, some costs may have increased unexpectedly.

For insurers, the relevance is obvious. Several large insurers, including most recently Aetna and Oscar, have dropped out of exchanges because they found they were not profitable. By their own account, patients in the exchanges were sicker than they expected, an indication that the ACA’s goal of mitigating adverse selection did not work out as planned. While Powell and Goldman have not studied the exchanges, their paper suggests that moral hazard likely also played a role.

Companies insuring their employees should also heed the findings of this paper. A company may wish to mitigate adverse selection by eliminating a bad insurance option so that its healthier employees help dilute the risk in the good insurance plan. But if moral hazard is a strong factor, the company will find that excess costs go up with this approach. “A firm trying to deal with high premiums would definitely benefit from knowledge about the split between moral hazard and adverse selection,” Powell told me.

If all this seems a bit wonkish, well, it is. But when thousands of dollars are at stake for each individual’s insurance plan, these issues can significantly affect budgets. Health insurance expenses cost U.S. companies $620 billion annually, according to Castlight, and the federal government spends $840 billion on healthcare. Insurers, HR execs, and policymakers could help themselves out by reading Powell and Goldman’s paper.