I wrote in Part 1 that medical care is an economic good. More specifically, it is a consumer good delivered directly to patients, primarily in the form of services. Experience has taught us that the most effective, efficient, and fair way to create and distribute consumer goods and services is through open consumer markets that allow each customer to determine a product’s value before deciding whether to purchase it with her limited available funds. Such value assessments require consumers to consider the answers to two fundamental questions:

  1. Which sellers’ are offering me products and services that will provide the best quality for my needs?
  2. Of those best sellers, which offers the lowest price?

In (slightly) technical terms, value equals quality divided by price, meaning that the higher the quality and/or the lower the price, the higher the resulting value. The challenge in getting higher quality, lower priced health care, therefore, lies in creating a consumer market for it. Actually, it means creating two markets, one for health insurance and one for medical services. But if we do the insurance market right, the second will naturally follow.

How do we do this?  We start by redefining health insurance so that it must cover only health care that is both medically necessary and normally unaffordable. We don’t expect car insurance to pay for oil changes, so we shouldn’t require health insurance to cover $4 prescriptions, $65 doctor visits, or $90 massage therapy sessions. Such coverage would still be allowed, but most people wouldn’t find it worth the higher premiums. That’s because we have  just created a consumer market for normally-affordable medical services in which providers compete for consumers’ dollars the old-fashioned way: by delivering better, more appropriate care for ever lower prices.

Now we have to create an insurance market that overcomes the fundamental market failure (see Part 1) that prevents so many people from having open access to affordable health insurance. To do that, we need national regulatory reform to create a set of rules under which such a market would emerge and operate. Here are the rules:

  1. Universal Access to Individual, Private Insurance. All American residents will be able to buy individual health insurance from participating private insurers. After a phase-in period, employers will no longer provide employee insurance or health benefits, but will give the money directly to their employees to make their own purchases. Federal and state governments will no longer regulate medical prices and will likewise stop directly providing health insurance and medical benefits (also after a phase-in period), but will instead give the money directly to their constituents in the form of restricted payments with which they can purchase their own health insurance and services. The primary government role in this regard will become one of providing financial assistance to people who are unable to afford care on their own.
  2. Voluntary Participation, But Without Free Riders. No one will be required to buy health insurance. However, enrollment controls (e.g., limited open-enrollment periods, intra-year lockouts, late-enrollment penalties, provider payment requirements, imposition of individual financial responsibility) will ensure that virtually no one will be able to game the system to its detriment by remaining uninsured until they get sick. Many health reform proponents want to mandate coverage for all consumers in the belief that the two policy goals of voluntary participation and prevention of free riders are mutually exclusive. They are most definitely not.
  3. Benefit Requirements. Private insurers will be free to offer whatever kinds of coverage at whatever premium levels in whatever markets they wish. Covered benefits, however, will have to meet minimum requirements that, in essence, provide comprehensive, medically necessary care that is normally not affordable by individuals.
  4. Premiums. Insurers will not be allowed to adjust premiums based on individual health status or history. Instead, insurers will set premiums according to highly-modified community rating rules that allow premium variations based on each consumer’s behavior (i.e., control of personally controllable health risk factors, such as smoking and obesity), age, gender, residence location, and employment risks.
  5. Tax equity. Everyone will receive equal tax treatment, regardless of employment status or eligibility for government medical assistance. My preferred method is via individual, tax-advantaged Health Funding Accounts (HFAs) that are conceptually similar to Health Savings Accounts (HSAs), but more comprehensive in scope. HFAs would become the central funding mechanism for all individual health insurance and medical care purchases.

Under this health reform package, the consumer will reign supreme. The government’s roles would be appropriately limited to those of rule maker, fair referee, enforcer, and safety net of last resort—not insurer or regulator of actual prices or benefits (beyond the above requirements).

If there is a fundamental problem with this approach, it is not technical, actuarial, or financial—it is political. Although we know markets work in practice, too many influential politicians and policy wonks don’t believe they work in theory—at least not for health care. The difficult task will be to transcend that way of thinking.

In Part 3, I’ll talk about how and why these changes will actually fix our broken health care system.