Kerry’s Health Care Reinsurance Proposal

Kerry’s plan to have the government provide reinsurance for health insurance represents a major attempt at addressing the health care problem that the US is currently facing. The heart of the proposal boils down to this: the US government would agree to cover 75% of any employee’s medical bills that are in excess of $50,000 in one year. In exchange, firms that want to take advantage of this government insurance program must agree to provide health insurance to all employees. Would this do anything to reduce the cost of health care in the US?

The Washington Post wrote this a couple of months ago about the proposal:

Kerry’s catastrophic-illness relief plan is the only new health care proposal — and the most expensive — of this campaign season. It marks the first time in 12 years that a political leader has attempted to reorient the insurance market away from dodging the costliest patients and in the direction of implementing higher quality of care.

The concept of a national reinsurance pool has garnered support from a wide spectrum of players from labor unions and former Vermont governor Howard Dean on the left to former House speaker Newt Gingrich and former Bush economic adviser R. Glenn Hubbard on the right.

How would this national reinsurance pool help our nation’s health care problem? In a couple of ways. First and most obviously, it would simply reduce the cost to health insurers of providing health insurance, resulting in lower premiums. Part of this cost would be shifted to taxpayers, but as we shall see, the cost to taxpayers will be less than the savings reaped by people buying health insurance.

Second, the Kerry proposal would dramatically reduce the riskiness of providing health insurance for a small firm, and thus disproportionately reduce the cost of health insurance for small companies. Why? Because 20% of all health care costs in the US are generated by just 0.5% of people in the US.

Think of it this way. Since the claims for one seriously ill person can easily reach $100,000 or more in a year (while most people’s claims are probably just in the hundreds of dollars), it’s much harder for an insurance company to predict what the aggregage health care costs will be of a group of 10 people compared to a group of 1,000 people. The law of large numbers means that you can pretty much rely on population averages when trying to guess how much health care the large group will need over the year; but for the small group, you either have to spend a lot of time and energy evaluating each of the 10 individuals to estimate each one’s likely health care needs for the coming year, or else you have to just take a chance. And insurance companies hate just taking chances.

The best estimates that I have seen by an economist of the effects of this reinsurance proposal are those by Kenneth Thorpe, professor at Emory’s school of public health. He estimates that the Kerry plan would reduce the variance of firms’ insurance claims by about 50 percent. This in turn will have two effects. It means that it will become dramatically cheaper for small firms to provide health insurance to their employees. Combined with the plan’s requirement that all participating firms offer health insurance to all employees, Thorpe estimates that about 3 million currently uninsured people will start receiving health insurance. This in turn will help to reduce the country’s overall health care costs by allowing more preventative care and early detection of health problems.

In addition, the reinsurance pool will dramatically reduce the incentives that insurance companies’ currently have to spend large amounts of resources identifying potential very high-claim individuals and separating the potential high-claim companies from the low-claim companies.

According to Thorpe, the average small firm would see their health insurance bill fall by about 4% — even after they extend health insurance coverage to all employees. Analytically this net savings to the country seems obvious. Insurance companies are institutions that take on risk from individuals, spend valuable resources to understand exactly how much risk they are facing, and then are paid a premium to absorb that risk. If the risk they face falls, then the premiums that they can demand will also fall.

That’s why Kerry’s reinsurance plan will result in a net savings to the country as a whole, as less health care resources are spent on late care for the uninsured and on the screening and administration that insurance companies do because of the fear of unknowingly insuring a very high-claim person. To an economist, this should seem an ideal outcome, because it implies a gain in both equity and efficiency. Hopefully non-economists would see it that way as well.