Might High-Risk Pools Bear Unintended Consequences?

Cross-posted from The Agenda on National Review Online.

The Summer 2010 issue of Yuval Levin’s National Affairs is out, and it contains three intriguing articles on health care reform.

The first, by Paul Howard and Stephen Parente (subscription required), effectively summarizes the debate of the last 15 months. Howard and Parente propound free-market ideas for reform, such as: interstate insurance competition; voucherizing Medicare, Medicaid and Obamacare’s insurance subsidies; and turning Obamacare’s “Cadillac Tax” into a “Buick Tax” so as to further the conversion of the employer-based insurance market into an individual one. Importantly, from their perspective, these reforms could be implemented whether or not the Affordable Care Act is repealed.

In a separate piece, John Hood presses the case for reform of Medicaid, which is an underappreciated driver of our fiscal crisis because its responsibilities are shared between the states and the federal government. Fundamentally, Hood shares the view of Howard and Parente that vouchers will help rationalize Medicaid spending and budgeting.

Hood points out a worrisome trend: that many well-off people game the Medicaid system by transferring assets to other family members, so that they can fall under the wealth threshold for Medicaid subsidies.

Hood favors eliminating these loopholes, along with the direct federal role for managing Medicaid, instead advocating block grants to the states. Block grants incentivize states to experiment with productive Medicaid reforms, because they retain the savings from any successful innovations. In addition, block grants allow for predictable budgeting.

Another idea raised by Howard and Parente is assembling a system of high-risk pools as a way of improving access to health insurance for those with pre-existing conditions. James Capretta and Tom Miller take up the subject of high-risk pools in depth, in an original and provocative article. Capretta and Miller argue that a fully-funded system of high-risk pools would spend around $17 billion a year to cover the 4 million people who need them, and by isolating those people from the rest of the insurance pool, make insurance coverage far more affordable for everyone else. Their piece contains a number of thoughtful proposals for ensuring that the pools would function as intended.

Controversially, they argue that the federal government should directly fund these high-risk pools, since fiscally-constrained states have not been able to adequately do so thus far. My preference would be that high-risk pools remain the province of the states, so that states can experiment with their structure—something that can only happen if states are not constrained by the myriad distortions of federal policy.

There are two other large challenges with high-risk pools that merit further debate (though Capretta and Miller do address them). The first is: what sort of mechanism could be erected to ensure that high-risk pools don’t metastasize into moderate-and-high-risk pools, and eventually all-risk pools? That is to say, is it possible to define “high-risk” in such a way as to sufficiently constrain the political temptation to expand such risk pools to cover larger constituencies? Just as with pension packages for government employees, it would be easy for a politician to expand the size of a high-risk pool, knowing that the full costs of doing so would show up decades later, when the patients are older, and when that politician is off sipping piña coladas on some tropical island. Insurance lobbyists will fight hard for such risk pool expansions, knowing that their own businesses will prosper by dumping risky individuals onto the state.

Capretta and Miller suggest that capping federal expenditures at some dollar figure, such as $15 to $20 billion, might do the job. But there will always remain the risk that a more spendthrift Congress will blow through the cap. This is another reason why it might be better for the states to run these pools—states’ inability to sustain deficits will prevent the programs from getting out of hand.

There is a second, related problem, one that John Goodman has raised: that the government is fundamentally incompetent at pricing risk. “Price setting errors that government makes in the market for risk,” writes Goodman, “will invariably be worse than in just about any other market.” (Think of what the government has done to the housing market.) The potential is strong for such government intervention to significantly distort the conventional insurance market, as it has done with Medicare and Medicaid.

All in all, the creation of high-risk pools is a promising idea that, I believe, is not yet ready for prime-time. We will need to refine the concept further at the state level before we can jump in with both federal feet. Capretta and Miller deserve our thanks for helping to frame the discussion.

Weekend Links: Risk Pool Problems, How Obamacare Increases Costs

Must-read articles from the past week.

John Goodman had a strong week over at his National Center for Policy Analysis blog. On May 3, in a piece entitled "Why are Health Care Costs So Hard to Control?", he blows apart some of the myths around the Obamacare approach to regulating medicine, such as "more widespread insurance equals lower costs":

All insurance involves a pooling of risk. Since people are naturally risk averse, this pooling is potentially valuable. Once resources are pooled, however, people have incentives to change their behavior and do things they would not otherwise have done. People with life insurance may kill themselves, or allow themselves to be killed, in order to leave a substantial sum to a surviving wife or children. (Fans of “Damages” will know what I mean.) People with fire insurance may be less careful about avoiding fires — particularly if they would like to redo their home anyway.

In health care, people with insurance obtain tests and procedures and even undergo hospital surgeries they would not have opted for had they been spending their own money. Economists call this type of behavior “moral hazard,” although there should be some sort of penalty imposed on the person who came up with that term.

Read the whole thing.

On May 5, Goodman came out with another piece entitled "Rational Risk Pools". In it, he persuasively argues that it is not possible for politicians to run risk pools efficiently:

Here’s something you can take to the bank. Politicians are incapable of setting the right price for anything — whether it’s the price of wheat or corn or any other good or service. As Phil Porter and I have shown, there is no known political process (not democratic voting or any other mechanism) that even in theory can produce the right result.

Here’s something else you can take to the bank. Price setting errors that government makes in the market for risk will invariably be worse than in just about any other market.

Another article worth reading in full. If Goodman is right, he has shot down Republicans' most promising idea for addressing those with serious pre-existing conditions. Are risk pools worth pursuing, despite their imperfections, or should free-market advocates try to come up with another approach?

Finally, on May 4, Robert Bluey of the Washington Examiner published an outstanding report detailing how Obamacare's prohibition of physician-owned hospitals is consolidating the power of incumbent hospital monopolies, and how these hospital monopolies are the principal driver of health inflation:

Physicians at McBride Orthopedic Hospital had ambitious plans for their Oklahoma City hospital before Obamacare. Two new operating rooms and a four-bed intensive-care unit were part of a multimillion-dollar expansion project that promised to bring competition and more health care choices to the community.

But once President Obama's signature was dry on the 2,409-page Patient Protection and Affordable Care Act, so, too, was the McBride project. The recently enacted law imposed a series of new federal regulations on physician-owned hospitals, including an immediate ban on expansion...

Imagine if the government owned General Motors and the Congress passed a bill that barred Ford from producing "any new cars and couldn't expand on its existing cars," Galliart said. "What other industry would put up with this? If we were spending money recklessly and harming people, that's one thing. But physician-owned hospitals are doing it better and more efficiently."

Remember those words the next time you hear the White House try to blame insurance companies for higher premiums.