Characteristics Of An Ideal Health Care System

Policy Reports | Health

No. 242
Monday, April 30, 2001
by John C. Goodman

Rationale For Government

Figure I - The Growth in the Uninsured

Aside from the burden of providing charity care to the poor, is there any legitimate reason for government to care whether people have health insurance? Although many reasons have been offered, the main - and by far the most persuasive - argument is the "free rider" argument outlined below. Yet if this is the reason why government has a legitimate interest in the health insurance decisions of individuals, then the public policies we adopt must solve the problem. The most commonly proposed solution to the free rider problem is to have government require people to purchase insurance. Yet a government-imposed mandate is neither necessary nor sufficient. There is a better solution - one that limits the role of government and expands the choices open to every citizen.

"People who fail to insure are likely to get health care anyway - even if they can't pay for it."

The Free Rider Argument. The traditional argument for government intervention is that health insurance has social benefits, over and above the personal benefits to the person who chooses to insure. The reason is that people who fail to insure are likely to get health care anyway - even if they can't pay for it. And the reason for that is that the rest of the community is unwilling to allow the uninsured to go without health care, even if their lack of insurance is willful and negligent.

This set of circumstances creates opportunities for some people to be free riders on other people's generosity. In particular, free riders can choose not to pay insurance premiums and to spend the money on other consumption instead - confident that the community as a whole will provide them with care even if they cannot pay for it when they need it. In other words, being a free rider works. It works because there is a tacit community agreement that no one will be allowed to go without health care. And this tacit agreement is so established that it operates as a social contract that many people substitute for a private insurance contract.

Figure II - Income Distribution of the Uninsured

"More people are uninsured now than a decade ago."

Evidence of a Free Rider Problem: The Growing Number of Uninsured. What evidence is there that free riders are a problem? One piece of evidence is the number of uninsured:1

  • According to the Census Bureau, in 1999 there were 42.6 million people who were uninsured at any one time, a larger percentage of the population than a decade ago [see Figure I].
  • The rise in the number of uninsured has occurred during a time in which per capita income and wealth, however measured, have been rising.

Although it is common to think of the uninsured as having low-incomes, many families who lack insurance are solidly middle class [see Figure II]. And the largest increase in the number of uninsured in recent years has occurred among higher-income families:

  • About one in seven uninsured persons lives in a family with an income between $50,000 and $75,000, and almost one in six earns more than $75,000.
  • Further, between 1993 and 1999, the number of uninsured increased by 53 percent in households earning between $50,000 to $75,000 and by 85 percent among households earning $75,000 or more.
  • By contrast, in households earning less than $50,000 the number of uninsured decreased approximately 5 percent.

More information about middle-class families who are voluntarily uninsured emerged from a recent California survey of the uninsured with incomes of more than 200 percent of poverty:2

  • Forty percent owned their own homes and more than half owned a personal computer.
  • Twenty percent worked for an employer that offered health benefits, but half of them (10 percent of the total) declined coverage for which they were eligible.
  • However, this group was not opposed to insurance in general, as 90 percent had purchased auto, home or life insurance in the past.
  • About 43 percent felt that health insurance was not a good value for the money, and rising insurance premiums will only increase this number.
Figure III - Average Rates of Growth in the Uninsured

"Many families who are uninsured are middle-class."

These results are contrary to the normal expectation of economists. Economic theory teaches that as people earn higher incomes, they should be more willing to purchase insurance to protect their income against claims arising from expensive medical bills. Similarly, as people become wealthier the value of insuring against wealth depletion (say, by a catastrophic illness) also rises. So insurance should be positively correlated with income and wealth accumulation. The fact the number of uninsured rose while incomes were rising and that the greatest increase in lack of insurance was among higher-income families suggests that something else is happening to make insurance less attractive.

"The percentage of uninsured has grown faster in states with more regulations."

Cause of the Problem: Increasing State Regulation that Favors Free Ridership. A possible cause of the problem is the proliferation of state laws making it increasingly easy for people to obtain insurance after they get sick. Guaranteed issue regulations (requiring insurers to take all comers, regardless of health status) and community-rating regulations (requiring insurers to charge the same premium to all enrollees, regardless of health status) are a free rider's heaven. They encourage everyone to remain uninsured while healthy, confident that they will always be able to obtain insurance once they get sick.

Moreover, as healthy people respond to these incentives by electing to be uninsured, the premium that must be charged to cover costs for those who remain in insurance pools rises. These higher premiums, in turn, encourage even more healthy people to drop their coverage. Figure III shows the consequences numerically:3

  • From 1990 through 1996, 16 states passed aggressive regulations to increase access to health insurance for people with health problems.
  • These states experienced growth in their uninsured population eight times that of the states that did not.

Other regulations that raise the cost of insurance for the healthy exacerbate this condition. Among these are laws mandating coverage for such services as acupuncture, in vitro fertilization and even marriage counseling.4 For example:

  • Duke University researchers showed that the probability an individual will become uninsured increases with each new mandate imposed by government.5
  • A study for the Health Insurance Association of America (HIAA) found that 20 percent to 25 percent of uninsured Americans lack insurance due to benefit mandates.6

"Federal legislation has made it increasingly easy to obtain insurance after one gets sick."

Cause of the Problem: Federal Regulation That Favors Free Ridership. Federal legislation has also made it increasingly easy to obtain insurance after one gets sick. The Health Insurance Portability and Accountability Act of 1996 had noble intent: guarantee that people who have been paying premiums into the private insurance system do not lose coverage simply because they change jobs. But a side effect of pursuing this desirable goal is a provision that allows any small business to obtain insurance regardless of the health status of the employees. This means that a small, mom-and-pop operation can save money by remaining uninsured until a family member gets sick. Individuals can also opt out of their employer's plan, then enroll after they get sick. (They are entitled to full coverage for a preexisting condition after an 18-month waiting period.)7

Figure IV - Health Spending on the Uninsured in Texas

Cause of the Problem: National Spending on Indigent Health Care. Another piece of evidence is the amount we currently spend on free care for those who cannot or do not pay their medical bills. No one knows what the exact number is. However, public and private spending on free care is considerable. For example, a study by the State Comptroller's office found that Texas currently spends about $1,000 per year on free care for every uninsured person in the state, on the average [see Figure IV]. This implies that the value of "free" care is about $4,000 a year for a family of four.

Interestingly, $4,000 is a sum adequate to purchase private health insurance for a family in most Texas cities. Therefore, one way to look at the choice many Texas families face is: they can rely on $4,000 in free care (on the average) or they can purchase a $4,000 private insurance policy with after-tax income. Granted, the two alternatives are not exactly comparable. Families surely have more options if they have private insurance. But to many, the free care alternative appears more attractive.

"For many, relying on the safety net is more attractive than buying insurance."

Consequences of Free Ridership: An Increasingly Fragile Safety Net. As we shall see below, when people elect to move from a status of "uninsured" to "insured," say by enrolling in an employer's health plan, they receive a tax subsidy from the federal government. However, when people drop insurance coverage the federal government makes no extra contribution to any local health care safety net. As a consequence, the growth in the uninsured is straining the finances of many urban hospitals.

"For many, relying on the safety net is more attractive than buying insurance."

The problem is exacerbated by less generous federal reimbursement for Medicaid and Medicare and by increasing competitiveness in the hospital sector. Traditionally, hospitals have covered losses that arise from people who can't pay for their care by overcharging those who can. But as the market becomes more competitive, these overcharges are shrinking. There is no such thing as "cost shifting" in a competitive market.

There is ample evidence that this problem is not trivial. For example:

  • Preliminary findings from a RAND study show that safety net spending by the nation's hospitals is not keeping pace with the overall increase in per capita spending.8
  • A National Academy of Sciences Institute of Medicine study found that the safety net of local clinics, hospitals and charities is "overburdened and threadbare," and "could collapse with disastrous consequences."9

Read Article as PDF