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Our Rube Goldberg health insurance system

March 8, 2017 - 12:00am
David Surdam
Rube Goldberg newspaper cartoon. Originally published in Collier's, September 26, 1931

Originally posted on UNIBusinessEthics.com

Suppose you woke up one Sunday morning without health insurance. In the Sunday New York Times and Wall Street Journal, you find coupons for 40% off of “low, low insurance rates” offered to subscribers. Your less-educated friend wakes to the local newspapers to find coupons for 15% off of insurance rates. Your classmates who dropped out of high school buy their National Enquirer and Weekly Star papers and find no coupons for health insurance.

From an ethical point of view, you might find it odd that higher-income (and higher-educated) readers got coupons for hefty discounts on their health insurance premiums, but lower-income (and less-educated) readers receive no coupons.

The coupon aspect arises from the fact that company-provided health insurance policies are not subject to federal (or state) income tax. They are, in essence, paid with pre-tax instead of after-tax dollars. This favorable tax treatment means that, in effect, workers receive a discount on their insurance premiums. People who make higher incomes are in higher tax brackets and receive a larger subsidy in percentage terms than people making lower incomes. If you don’t work or if you are self-employed, too bad for you; you don’t get the favorable tax treatment.

You don’t have to be a staunch egalitarian to think the above scenario is goofy. But in a key way, the scenario corresponds to the contemporary American health insurance situation. Because the federal government agreed to labor unions’ demand for additional compensation during World War II, the government allowed employers to offer health insurance instead of direct wage increases to workers. No one foresaw the ramifications of such a situation; it was a wartime measure.

Seventy years later, we remained tied to an employer-provided health insurance system for the bulk of workers and government-provided health insurance for retirees, disabled, and indigent people. Those with good insurance coverage are loath to support policies that may jeopardize their coverage.

Getting insurance through your employer is not an entirely bad idea. Large employers are attractive to insurance companies because such companies provide a reasonably representative sample of risks. Group policies generally cost way, way less than individual policies. Health insurance premium for individuals are notoriously, but justifiably, expensive. First of all, a large company issuing a policy covering 10,000 workers does not incur 10,000 times the administrative expenses as a policy covering one person. Second of all, as mentioned, the representative-sample aspect of a policy covering 10,000 workers means the insurance company can rely upon actuarially-sound rates that are fairly predictable. Insuring an individual creates a relatively large risk for the insurer. In addition, the insurance company worries that any person voluntarily seeking to buy an individual policy likely considers him- or herself a higher risk relative to the quoted premium (what economists call “adverse selection,” whereby at any given rate, only the riskier insureds are likely to sign up). One big advantage of a single-payer policy covering everyone is the fact that such a complete group would be, by definition, a representative sample.

Between the tax treatment and group policy aspects, an executive for a large corporation gets a double benefit. She gets a hefty discount due to the favorable tax treatment and her per-dollar coverage under the company’s group policy is higher than for an unemployed (or self-employed) person.

To eliminate the perverse effect of the graduated income tax system, some economists advocate eliminating the favorable tax treatment of company-provided health insurance. Such a prescription is unpalatable to many citizens and, therefore, to their legislators.

The Affordable Care Act (dubbed Obamacare) relies upon a complex set of cross-subsidies between groups; young people subsidize older people. Although one could make the argument that young people should subsidize older people under a social contract (when today’s young reach older ages, they can then call upon future young people to subsidize them), the political reality is that few people want to subsidize someone else.

From an ethical standpoint, people fear losing what they have; they may prove unwilling to relinquish their hold on what they have in order to extend a hand to help those who do not have good coverage. President Obama recognized this fear and promised that people could keep their coverage and their doctor. This promise has proven difficult to maintain, as insurance companies exit the market.

If we were starting from scratch, we probably would not erect such a perverse health insurance structure, but turning back the clock will prove difficult.

The views and opinions expressed are those of the author and do not imply endorsement by the University of Northern Iowa.
 

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Headshot of David Surdam

David Surdam

Professor of Economics

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