Healthcare Premiums under Alternative Scenarios

Players' Actions

The Obama Healthcare Plan

Healthcare Premiums under Alternative Scenarios

I was thinking about the various situations and implications associated with the current healthcare system and some of the changes that have been proposed. I wanted to get a better handle on what, exactly, each of the issues means in terms of dollars spent by people paying into the healthcare system. To this end, I created a little numerical model that lets me play with the different scenarios to see what they each mean in dollar terms.

The assumptions I’m making that form the general layout of the model are:

• There are 100 people in the population.
• The population is distributed into three classes, high, medium, and low, based on the level of lifetime healthcare spending per person.
• Each person in the population that pays into the healthcare system makes a payment every month for healthcare from the time they are 18 years old until the time they die.
• The monthly payments made by the portion of the population that pays into the system exactly cover the total lifetime healthcare costs of the population.

Different Scenarios 

Base Case

The numbers I’m using for my Base Case Scenario are:

• The distribution of people across classes is: 10% high lifetime healthcare expense (H), 30% medium expense (M), and 60% low expense (L) (see row [1]).
• Lifetime expenditures per person for H are $1 million, for M are $500,000, and for L are $100,000 (see row [2]).
• Life expectancy is 70 years (see row [4]).

Let’s first assume that each person in the population pays his own costs of healthcare. In this case, monthly payments per person by healthcare class are (see row [6]):

H: $1,603
M: $801
L: $160 

Alternative 1: Some People Don’t Pay into the System

In my first alternative scenario, I assume that a portion, say 10% of the population - the same portion for each class type, H, M, and L (see row [8]) - does not pay into the healthcare system. In this case, those people who do pay will have to pay not only for the healthcare costs they incur over their lifetime, but they also pay the healthcare costs for those people in their healthcare class who do not pay. Under this scenario monthly payments per person by healthcare class are (see row [10]):

H: $1,781
M: $890
L: $178

If 10% of people do not pay into, but do use, the healthcare system, then people who do pay into the system effectively pay an 11% tax to account for the nonpayees (see row [13]). If a larger portion of the population does not pay, say 20%, then the effective tax on payees becomes 25%.

Alternative 2: Some People Don’t Pay into the System & Payees All Make the Same Payments

In my second scenario, I assume that on top of the existence of nonpayees described in Alternative 1, there is also a redistribution of payments, so that everyone pays the same price for healthcare, even though they use different amounts. Under this scenario, monthly payments per person by healthcare class are (see row [18]):

H: $552
M: $552
L: $552

Under this scenario of equal payments for all, high expenditure healthcare people (H), end up paying 66% less than they would under the Base Case, and M people pay 31% less, but L people pay 244% more (see row [20]).

Under the second alternative case, if I instead assume that lifetime healthcare costs for the high expenditure people double to $2 million, then under the redistribution, accounting for nonpayees, the monthly payments for each payee increase to $730, yielding a higher healthcare subsidy for H (77% instead of 66%), a lower subsidy for M (9% instead of 31%), and a larger tax for L (356% instead of 244%).

Players' Actions

With this stripped-down description of the basic scenarios at play in the Healthcare Game, we can now get a better idea of what the various players' (healthcare users and private insurers) incentives are under the various scenarios.

Healthcare Users’ Incentives

Base Case

Under the Base Case scenario, if users pay all their own costs of healthcare, then they have every incentive (1) to take preventative measures to decrease their healthcare costs, and (2) to optimize (minimize) their use of healthcare.

A more realistic description of the Base Case that takes into account how the insurance system works would be to have each of the users in the population use different amounts of healthcare, but to have the insurance companies group users into rough categories based on average usage. In this case users in the Low Healthcare Expense category might use anywhere from $0 to $250,000 during their lifetime, but the average user in the group uses $100,000, and each user in this group will pay this average price. In other words, the more realistic case works more like a hybrid pay-your-own-way plus redistribution model. In this more realistic scenario, users have less incentive to minimize their healthcare expenditures, since they only pay the average costs of users in their group, and not their own individual costs. However, users will have an incentive not to use too much healthcare so as to be bumped up into the next higher expense group and have to pay the higher associated costs.

Alternative 1: Some People Don’t Pay into the System

When there are users in the population who don’t pay for their own healthcare (uninsured who don’t pay or insured who default), then the excess costs relative to payments are borne by the people who do pay, in the form of higher prices (monthly payments). The users who pay have similar incentives as those under the Base Case scenario. By not having to bear the costs associated with their actions, however, the people who do not pay have no incentive to minimize their healthcare expenditures.

A more realistic description of the way the current healthcare system works is that in addition to having people in the system who use healthcare but do not pay for it, there are other people in the system who only pay for a portion of the care they use. In particular, I think it’s pretty safe to say that anyone who spends time in the hospital will end up using more care than they pay for. I can go further by stating that anyone who receives an “expensive” service (most services that involve technology (machines or pharmaceuticals) would be considered expensive here) will end up paying substantially less than the cost of providing that service.

When there are people who don’t pay the full costs of their care, then from the standpoint of the model I created, this is equivalent to having a larger portion of nonpayees in the population. That is, when people don’t pay the full costs of the services they use, it is equivalent to putting another tax on people who do pay (i.e., everyone’s monthly payments go up). Furthermore, if people pay substantially less than the costs associated with “expensive” services, then they have an incentive to use “too many” expensive services.

Now consider users who have preexisting medical conditions. If users have to pay for the services they use, then people with preexisting conditions will presumably pay more than many other users. Since they’re paying for their own care, they have every incentive to take preventative measures and optimize their use of medical services. If, however, insurance companies are not allowed to charge people with preexisting conditions more than people without those conditions, then this is the same as having people who don’t pay the full cost of their care. So people who do pay are taxed even more, and the people with the preexisting conditions have no incentive either to take preventative measures or to minimize the use of services, particulalry expensive services.

Alternative 2: Some People Don’t Pay into the System & Payees All Make the Same Payments

When healthcare costs are redistributed so that everyone pays the same price, then no one has an incentive to minimize their own expenditures. In particular, high expense people pay much less than the costs associated with the services they actually use, so they certainly have no incentive to rein in any of their costs. Also, in this scenario, low expense people end up paying much more than the costs associated with their own use, which means they have no incentive to minimize their own costs. In fact, low expense users may actually feel that “since they’re paying for it anyway” they may as well use as much care as they can. 

Private Heathcare Payers’ (Insurance Companies) Incentives

In the model I presented above, it is the insurance companies who take in the monthly premiums from the payees and pay the costs of healthcare for users when they occur. That is, insurance companies enable payees to smooth the costs of healthcare expenses over their lifetimes. In exchange for providing this smoothing (and redistribution) service, insurance companies mark up payees’ monthly payments somewhat so that the amount of payments payees end up paying into the system is somewhat higher than the actual costs of the healthcare services they receive. Timing differences between users’ monthly payments to insurance companies and users’ actual use of healthcare service muddles things up a bit. In particular, insurance companies must collect monthly payments from users before users actually incur the costs of healthcare services. As such, insurance companies must essentially guess how much the lifetime healthcare costs for users will end up being and set monthly payments based on these guesses.

In addition to payment smoothing services, the insurance companies also provide redistribution services from payees to nonpayees. That is, they collect they payments in excess of use from people who pay into the system to cover the costs incurred by people who do not pay or who pay less than the costs of the services they use. 

Base Case

Under the Base Case scenario, since users pay their own costs, they have the incentive to optimize their use of healthcare services. This means that in the end the payments made by users pretty much end up covering their healthcare costs. Insurance companies generate profits from the markups they apply to users’ monthly payments. If the actual usage by users ends up being higher than the amount they expected and used in their monthly payment calculations, then they will have to increase the monthly payments required from payees. 

Alternative 1: Some People Don’t Pay into the System

Under the first alternative scenario, there are people who don’t pay (any, some, or none of) the costs of the healthcare services they use.

If insurance companies correctly anticipate the excess in costs over payments for people who don’t pay or only partially pay for their care, then they can set the “tax” levels on payees accordingly. That is, they can charge users who pay onto the system adequately more than they use in services so as to make up for the shortfall by nonpayees.

The problem comes either (1) when nonpayees use more healthcare services than the insurance companies anticipated they would use, either because of adverse incentives and/or because healthcare costs rise more than expected, or (2) the “tax” levels on payees become excessive and they become nonpayees. In either case, monthly payments by payees are not enough to cover the total costs of services for payees and nonpayees. If insurance companies are able to increase the tax on payees to cover the shortfalls, then insurance companies can remain solvent. If, however, either healthcare usage by nonpayees becomes excessive and/or the number of payees who default on payment or drop out of the system becomes excessive, then the insurance companies will not be able to remain solvent.

Alternative 2: Some People Don’t Pay into the System & Payees All Make the Same Payments

Under the second alternative scenario, there are people who don’t pay (any, some, or none of) the costs of the healthcare services they use, plus there’s a redistribution of costs so that everyone makes the same monthly payments. Under this scenario the problems in Alternative 1 are exacerbated. The low healthcare usage group ends up paying such high monthly payments either to cover everybody else’s costs, and/or to cover their own costs, that they end up defaulting or dropping out of the system faster than is the case under Alternative 1. As in Alternative 1, if insurance companies are able to increase the tax on payees to cover the shortfalls, then insurance companies can remain solvent. If, however, either healthcare usage by nonpayees becomes excessive and/or the number of payees who default on payment or drop out of the system becomes excessive, then the insurance companies will not be able to remain solvent.

The Obama Healthcare Plan

Here is an except of section titles from the current Obama Administration's healthcare proposal, HR3200:

TITLE I—PROTECTIONS AND STANDARDS FOR QUALIFIED HEALTH BENEFITS PLANS

Subtitle A—General Standards

Sec. 101. Requirements reforming health insurance marketplace.

Sec. 102. Protecting the choice to keep current coverage: Grandfathered Health Insurance Coverage Defined- Subject to the succeeding provisions of this section, for purposes of establishing acceptable coverage under this division, the term ‘grandfathered health insurance coverage’ means individual health insurance coverage that is offered and in force and effect before the first day of Y1 if the following conditions are met: (1) Limitation on new enrollment, (2) Limitation on changes in terms or conditions, (3) Restrictions on premium increases.CommentsClose CommentsPermalink

Subtitle B—Standards Guaranteeing Access to Affordable Coverage

Sec. 111. Prohibiting pre-existing condition exclusions: A qualified health benefits plan may not impose any pre-existing condition exclusion ... or otherwise impose any limit or condition on the coverage under the plan with respect to an individual or dependent based on any health status-related factors ... in relation to the individual or dependent.

Sec. 112. Guaranteed issue and renewal for insured plans: The requirements ... relating to guaranteed availability and renewability of health insurance coverage, shall apply to individuals and employers in all individual and group health insurance coverage ... except that such section ... shall apply only if, before nonrenewal or discontinuation of coverage, the issuer has provided the enrollee with notice of non-payment of premiums and there is a grace period during which the enrollees has an opportunity to correct such nonpayment.

Sec. 113. Insurance rating rules: The premium rate charged for an insured qualified health benefits plan may not vary except as follows: (1) Limited age variation permitted, (2) By area, (3) By family enrollment.

Sec. 114. Nondiscrimination in benefits; parity in mental health and substance abuse disorder benefits.

Sec. 115. Ensuring adequacy of provider networks.

Sec. 116. Ensuring value and lower premiums: A qualified health benefits plan shall meet a medical loss ratio as defined by the Commissioner. For any plan year in which the qualified health benefits plan does not meet such medical loss ratio, QHBP offering entity shall provide in a manner specified by the Commissioner for rebates to enrollees of payment sufficient to meet such loss ratio.

I have not read the text of the bill. However, I can make some comments based on (my interpretation of) the general ideas behind some of the sections:

Sec. 102. Protecting the choice to keep current coverage.

Obama has made it clear that he does not intend to banish private healthcare insurers from the system. He has said that if you're happy with your current provider, then you may keep your current coverage:

First of all nobody is talking about some government takeover of health care. I’m tired of hearing that. I have been as clear as I can be. Under the reform I’ve proposed, if you like your doctor, you keep your doctor; if you like your health care plan, you keep your health care plan. These folks need to stop scaring everybody, you know?

However, what he does not say is that the provisions in the new healthcare bill might end up forcing the private insurance companies to accept payments from users that are less than the costs of providing them healthcare services. In this case, private insurance companies may not profit from continuing to provide healthcare services, leading them to exit the market, and thus forcing users into the government-run program.

Sec. 111. Prohibiting pre-existing condition exclusions.

As I indicated above, if insurance companies are not allowed to exclude users from their plans because they have preexisting conditions, then this is the same forcing insurance companies to provide coverage for users who don’t pay the full cost of their care. Under "normal" business conditions, insurance companies would charge those users who pay into the system a "tax" to cover people with preexisting conditions who are not made to pay their full costs of healthcare use. However, under Obama's plan, specifically under Section 116, it sounds like the insurance companies will not be able to pass the (full) excess costs associated with preexisting conditions onto other payees. In this case, insurance companies might have to absorb these excess costs themselves, which would decrease profitability and potentially lead them to stop providing healthcare insurance.

Sec. 112. Guaranteed issue and renewal for insured plans.

Guaranteeing initial and ongoing coverage to healthcare users would only be a problem for those users who have preexisting conditions. or higher than expected usage of healthcare services. In this case, guaranteeing such users initial and ongoing services would end up being the same as forcing insurance companies to provide coverage for users who don’t pay the full cost of their care, which leads to the conclusion discussed in Sec. 111 above.

Sec. 113. Insurance rating rules.

This says that if a user is diagnosed with a medical condition that has high costs of treatment, the insurance company cannot increase the monthly payments of that user to cover the higher costs of healthcare use. This leaves the insurance company with users who do not end up paying the full costs of their healthcare services, , which, again, leads to the conclusion discussed in Sec. 111 above.

Sec. 116. Ensuring value and lower premiums.

A "medical loss ratio" is defined as the cost of health care services provided as a percentage of premium revenues. By bounding an insurance company's medical loss ratio, the Obama plan is ensuring that insurance companies cannot generate "excessive" profits when healthcare costs end up being lower than expectations. This prevents insurance companies from generating a reserve of funds during good times to be used during bad times. This provision significantly decreases the expected profits from provide healthcare insurance, which could lead private companies to leave the market, thus stranding users with the public insurance option.

Conclusion

The Obama healthcare plan seriously limits the potential profitability to private healthcare companies of providing healthcare insurance to users. Should the legislation pass, it would not be surprising to see many (most? all?) of the private health insurance companies exit the market, leaving users with no choice but to enroll in the public healthcare plan. To say then, that Obama's healthcare plan allows people to stay with their current providers, is extremely misleading.