Stop Hating on High-Deductible Health Plans

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Recently, I read a Los Angeles Times article that referred to high-deductible health plans as “much hated by employees.” That struck me as incongruous, since high-deductible — or catastrophic — plans are what insurance principles support. If that is true, why would employees hate them?

How do insurance principles support high-deductible, or catastrophic, plans?

Insurance’s rationale is reducing risk from uncertain events. Insuring what would certainly occur, say, annual checkups, offers no risk reduction — no benefits to weigh against the added costs of insurance administration — yet such coverage is frequently included. Similarly, small health care risks are cheaper to cover with modest levels of savings than by bearing the administrative costs of utilizing insurance. If those are insured, it is not because of the principles of insurance.

The benefits from risk reduction must also outweigh the costs of over-consumption of health care induced by the artificially low prices for care insurance faces health care consumers with. But when health care costs are primarily borne by insurers, there are many margins at which individuals will want both more and better care (e.g., better and more specialized doctors and hospitals, more costly newer drugs, tests and treatment, etc.). Much of that care will be worth far less than its cost. For example, someone with 80% coverage who valued a $5,000 medical procedure at $1250 would face a bill of $1000, and would find it personally worthwhile, even though it wastes $3750 in value.

People’s differences also point away from coverage mandates which increase costs, when many see little or no benefit from them. For example, teetotalers would not willingly insure for alcoholism treatment and those certain they would never use drugs would not insist on addiction treatment.

Coverage for pre-existing conditions also fails as insurance. It doesn’t reduce people’s exposure by pooling uncertain risks, but instead forces one subgroup to cover a different subgroup’s costs after they are already known to be higher.

All of the above support high-deductible plans as sensible applications of insurance principles. Certain, highly predictable and small medical expenses escape the administrative costs of insurance. People need not pay for coverages they expect to gain too little from. And the most important things risk-averse people wish to insure against—catastrophes—are covered, but since many medical services are not, the insurance-induced overconsumption of medical care that results is far smaller than for more expansive coverage.

So why would employees hate such exemplars of health insurance principles? The tax deductibility of employer-provided health insurance (even when it is really pre-paid, predictable health care rather than true insurance against uncertainty) can provide the answer.

If the administrative costs of utilizing insurance, even in the case of expenses that will be certain, is less than the subsidy via the tax code — equal to one’s combined marginal tax rate (from federal payroll taxes and federal and state income taxes) — individuals would still want coverage, even though it cannot be justified in terms of insurance principles. And that is true for everyone who pays income taxes, though the subsidy is strongly tilted toward higher income individuals facing higher marginal tax rates.

Consequently, the tax code subsidy has induced employers and employees to find health care coverage that exceeds what is defensible by insurance principles as still in their interests. Of course, it advances those interests only because tax deductibility “exports” much of the costs to others.

Therefore, employees may indeed “hate” high-deductible policies, not because they are in accord with insurance principles, but because they involve scaling back the magnitude of the tax-code subsidies they had been getting before. But that hatred, triggered by reductions in subsidies that were always questionable (remember that employer-paid health plans were not created in response to some assertion of “market failure” in health care, but to find a way to give employees higher compensation in the face of government-imposed wage and price controls in World War II), is not a reliable indicator of justifiable health care policy “reform.” After all, to the extent Americans realize the burdens of others’ coverage forcibly imposed on them through the tax code, many would hate them with far more justification than workers disgruntled by getting reduced amounts of unjustified subsidies.

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