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What is Insurance? by Jonathan Gruber

The debate over health care reform implementation in Massachusetts has become focused on the critical issue of defining the level of “minimum creditable coverage”, the minimum level of insurance generosity that will satisfy the individual mandate. This is not a decision that can be avoided; without such a definition, the mandate has no teeth.

But this decision has become needlessly controversial because the debate has moved away from the fundamental goal of insurance: to insure individuals against unexpected medical risk.

This definition of insurance has nothing to do with the typical American conception of health insurance. Most Americans think of health insurance as medical prepayment: you pay an up-front premium and in return all of your medical expenses are covered (what experts refer to as “first dollar coverage”). But such a system has an inherent flaw: any time something is free, it will be overused. This should not be a controversial statement to anyone who has ever gone to an all-you-can-eat buffet. Having paid at the door, you always end up eating more than if you were paying for each item your ordered.

But isn’t medical care different from food? Don’t individuals only use medical care when they really need it? The answer to this question is clearly no. There is substantial evidence of overuse of medical care by the insured. The classic piece of evidence for this proposition is the famous RAND Health Insurance Experiment (HIE) in the 1970s. In this experiment, individuals were randomly assigned to insurance plans that were more or less generous, ranging from first dollar coverage to policies where indivduials paid 95% of the cost of their medical utilization. Once individuals had spent $1000 (about $4000 in today’s dollars), however, they were fully insured – so no one was going uninsured in these plans.

The lessons of the HIE are clear, yet have been conveniently misinterpreted by parties on both sides of the debate. I review these lessons in a paper prepared for the Kaiser Family Foundation, available at http://www.kff.org/insurance/7566.cfm. First, medical care is price sensitive: those who paid nothing for their care used about one-third more than those who paid almost the full cost at the point of service. Second, on average, the extra medical care consumed by those who received care for free had no beneficial impact on health: individuals in the first dollar coverage plan were no more healthy, on average, than those in the full cost plan. Third, there is some evidence (although it is not very precise) that there were some health benefits for low-income, chronically ill populations; most of this benefit was found in screening for chronic illness and maintaining treatments for that illness. The 25 years of research since the results of the HIE were reported have done nothing to overturn these central conclusions, although no study has so carefully studied the health impacts of insurance generosity.

At the same time, there is a large literature in health services research which shows that having insurance, relative to having none, is important for health outcomes. The resolution between these seemingly conflicting results is that it matters whether individuals have some insurance, but, given insurance coverage, for the typical person it does not really matter how generous that insurance is. Once again, coming back to the buffet analogy, it is clearly harmful to not allow individuals to eat – but less critical that you allow them to eat as much as they want.

These results have two clear implications for health policy. First, it is vital that we provide health insurance coverage to the uninsured as a means of improving their health. Second, that insurance need not be as generous as first dollar coverage. There is no clear benefit to covering all medical costs, and a clear cost in terms of encouraging excessive use of medical care. Insured individuals should therefore bear some of the costs of their medical care utilization, but with a limit when costs rise to a sizeable share of income. In addition, insurance should provide reduced cost sharing for prevention and maintenance of chronic illness.

This suggests that the structure of the minimum creditable coverage plans that are being discussed makes a lot of sense. All of the plans being considered provide some up front medical care that individuals can use to get preventative care and be evaluated for more serious medical disease. If individual are found to be chronically ill, they can then buy up to more generous plans that are more appropriate to their health status.

Ideally, insurance plans would be more flexibly designed to accommodate the lessons of the HIE, for example offering different levels of out-of-pocket costs by income level or by illness level. There is some exciting work being done now on designing such “value-based insurance plans”, whereby co-payments are targeted to the needs of the particular individual being insured. But such plans are still in their infancy, so that today the choice remains between offering first-dollar coverage or a plan where individuals pay more of their costs up front. The evidence is clear that the latter design provides real insurance, in the true sense of the word.

Jonathan Gruber, Professor of Economics at MIT and member of the Connector Board

This program aired on March 9, 2007. The audio for this program is not available.

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