According to President Obama, hordes of helpless American are being “held hostage by health insurance companies that deny them coverage or drop their coverage” when they get sick. That was the central message he took to the road last week in what appears to be an increasingly desperate attempt to save his ponderously unworkable trillion-dollar health reform package. In conjuring up insurers riding roughshod over hordes of Americans, the President also tramples the truth. The fact is that the 91% of all privately insured Americans with employer-based insurance never face denial of coverage for pre-existing conditions (so-called “pre-ex”) or loss of insurance when they get sick (called “rescission”). It’s illegal.
What the President is spending so much political capital castigating is the remaining 9% of the private insurance market—the part that provides essential individual health insurance to people ineligible for employer coverage. Pre-ex and rescission are relevant here because individual insurers must operate differently from employer-based insurers.
To understand why, imagine that some none-too-bright entrepreneur opens a health insurance supermarket to sell coverage to everyone who walks in. He then quickly goes broke, because his only customers are sick people. Healthy people stay away until they become sick. Thus, total premiums fall far short of the revenue needed to pay total medical costs. This phenomenon is called “adverse selection.” As I have written elsewhere, it is the fundamental reason for the free market’s failure to provide affordable health insurance to everyone.
The only way insurers can survive selling individual insurance is to screen all applicants to make sure they are essentially healthy. Thus, people must buy it before they get sick, just as they have to insure houses before they burn or cars before they are wrecked. Then, when some insured members do inevitably become ill, premiums will be sufficient to pay medical costs. Individual insurance companies currently turn down only about 11% of applicants because of pre-existing illness. Contrary to what the President would have you believe, rejecting these folks is not a matter of insurer rapacity, but of economic survival. Yet less than 1% of Americans have been turned down for individual health insurance because of pre-existing medical conditions.
Then there’s rescission, which is illegal for all private health insurers—with one exception. If a person lies about his health status to get individual coverage, the insurer can rescind his policy when it later discovers a material misrepresentation. Insurers must enforce this or else penalize their truthful members who otherwise must pay excessive premiums to cover the costs of the cheaters. Still, the incidence of actual rescissions (0.15% in 2006) is vanishingly small (more people hit deer with their cars in Missouri). And again, it’s the only circumstance under which insurers can take away insurance from people who get sick.
Nonetheless, excluding people from insurance coverage for pre-existing conditions—with necessary rescission enforcement—is a key barrier to getting to a market-based solution for our health care system. But it can be entirely resolved by regulatory reforms that will allow insurers profitably to enroll everyone individually. And such regulations themselves needn’t cost the government an additional dime.
Ironically, the President’s favored solution to the insurance supermarket problem, a mandate for everybody to buy health insurance, won’t work, because the noncompliance penalty (a 2.5% excise tax) is too small to be effective. Many healthy people—assuming they even file tax returns—will rationally view the tax as a low-cost option to wait and buy insurance only after they get sick. This will inevitably drive up premiums so that that even the eighteen million people who now buy individual insurance may not be able to afford it under the Obama reforms.
The President is grossly exaggerating the problems and solutions of pre-ex and rescission. He, like the regrettable Speaker Pelosi, is only further villainizing health insurers for doing what they must to earn profits that, political demagoguery aside, amounted to only 2.8% of revenues in 2006. Worse, he is using misdirection that focuses us away from the far bigger problems of uncontrolled health care costs, mediocre quality, and lack of insurance portability that his chosen reforms won’t touch.