Justifying Government as the Backstop in Health Insurance Markets

Abstract

Disasters-earthquakes, floods, hurricanes, forest fires, or terrorist attacks-usually bring out selfless behavior as people band together to help those in need. Disasters and our responses to them are reminders that we are in a society together. Unfortunately, for at least the last fifty years, this image of one society has faded when we have tried to work out details for implementing universal health insurance in the United States. A large part of the disagreement about how to achieve universal coverage is over the extent to which we are willing to allow government to intervene in private markets. Yet disasters provide a blueprint for what the role of government might be to help private health insurance markets work more efficiently for everyone and to enable more people to obtain coverage. Throughout our history, philosophical arguments about the role of government in a market-oriented society have shaped many of our laws and the division of responsibilities among the federal and state governments and the private sector. In the last three decades, economists and, increasingly, politicians have argued that the free market advances economic growth and opportunity more effectively than government policies intended to achieve such goals. This view rests on the widespread belief among American economists that competitive forces yield efficiency in both the production and the allocation of goods and services. Moving from a static to a dynamic context, economists also see free market competition as a strong spur to innovation. As the view has taken hold that competition yields efficiency in markets, policy-makers have paid increasing attention to the way in which government regulation might inhibit competition and incentives for companies in a market to be efficient. There is now a widespread belief among economists, policy analysts, and policy-makers that government should intervene in a market only when conditions for competition are not in place, and the market fails to be efficient. In the case of health insurance, the absence of a competitive market can arise for a variety of reasons. Within a geographic area, there are traditional concerns about monopolies. There are also more subtle concerns involving the role of information. Perfect competition requires that all market participants have perfect information on what is being bought and sold. By contrast, health insurance markets can be plagued by adverse selection-the phenomenon in which people who anticipate high medical care costs will be most likely to purchase health insurance. One consequence of the possibility of adverse selection is the extensive use of screening mechanisms by insurers to avoid high-risk (potentially high-cost) enrollees. This results in people who are perceived to be high-risk being unable to obtain coverage at affordable premiums, or denied coverage altogether. It also results in inefficiency in the health insurance markets as insurers invest in the non-productive efforts of screening to avoid high-risk people. Such efforts increase the costs of insurance for all who obtain coverage.