Health Insurance: Clear Diagnosis, Uncertain Remedy: Governments are increasingly turning to private insurance in order to widen access to health care and make it more efficient. Are they expecting too much?

"Governments want to spur private insurance in the hope of solving three big problems bedevilling their national systems of health care: inadequate access to care; soaring costs; and a paucity of innovation. They hope thus to improve their citizens’ health without tearing more holes in tattered public finances."

OTTO VON BISMARCK believed that the ordinary worker “is unsure if he will always be healthy and he can predict that he will reach old age and be unable to work. If he falls into poverty, and be that only through prolonged illness, he will find himself totally helpless.” So in 1883 Germany’s Iron Chancellor introduced a health-insurance law that required both companies and workers to contribute to the costs of care.

Until then health insurance had been essentially a voluntary affair. In many parts of Europe private non-commercial organisations (such as mutuals) had sold health insurance for centuries. Bismarck’s “social” insurance scheme found many imitators. Most of the world’s health care is financed directly by governments, but private insurance, which now makes up nearly a fifth of the total, looks set for a state-sponsored boom.

Private health insurance comes in different flavours (see chart 1). In America, the Netherlands and Germany, it provides primary coverage for those not on government schemes. In Australia, Britain, Ireland and New Zealand, private insurers duplicate the coverage of state-run health systems, usually offering perks like better service or shorter queues. In many countries, notably France, complementary private cover is used to top up official schemes, for example by covering out-of-pocket payments.

Governments want to spur private insurance in the hope of solving three big problems bedevilling their national systems of health care: inadequate access to care; soaring costs; and a paucity of innovation. They hope thus to improve their citizens’ health without tearing more holes in tattered public finances. The evidence so far suggests that relying on private insurance may help in some respects. But it will not solve all these problems, and may even be making some of them worse.

Picking cherries, dropping lemons

Start with access. In countries where state-financed health care is not available to all, some governments are worried that too few of their citizens have sufficient cover. They want private insurance to be expanded to cover everyone. The most prominent effort is under way in America, where about 47m people lack health insurance of any kind. Under Barack Obama’s plan, which is bogged down in Congress, the private-insurance market would expand dramatically—but so would regulation. The proposal would require all Americans to buy cover. To make it affordable, the government would regulate products and prices and offer subsidies for the poor.

This effort is similar to reforms undertaken over the past decade in the Netherlands and Switzerland. The Swiss were keen to expand access to all, and to contain costs; the Dutch saw private insurance as a boon both to consumer choice and to innovation in the delivery of health care. To ensure equitable access, both countries forbid private insurers from discriminating against applicants because they are in poor health or at high risk of falling ill. This practice, known as “lemon dropping”, continues in the American market for individual health coverage.

Inevitably, however, some insurers (say, those offering cheap, bare-bones packages) will attract younger, fitter and cheaper customers while others (with a reputation for quality or gold-plated coverage for chronic diseases) will attract the old, the sick and the costly. In the Netherlands, Switzerland and Germany, which copied some earlier Swiss reforms, regulations force companies that make “excess” profits in this way to hand over that money to those who end up with costly patients. Uwe Reinhardt, a health economist at Princeton University, jokes that Germany has the illusion of 200 private health insurers but because of risk adjustment it in fact has just one. The Dutch are now shifting from risk-smoothing after the fact to doing it even before the fiscal year begins.

Such a tightly regulated expansion of private insurance—in effect, turning health insurance into a utility—can expand coverage. European countries that followed this path now enjoy near-universal access. So does the American state of Massachusetts, which has implemented similar reforms. If Congress eventually accepts Mr Obama’s proposals, the rest of America will also see coverage increase markedly.

This is also likely to be true in developing countries, whose public health-care systems are often hopelessly overstretched and underfunded, although because poor countries cannot afford the subsidies and regulatory apparatus of the rich world, coverage is likely to be confined to the better off. Healthy middle-class people in India are enjoying private hospitalisation insurance in today’s lightly regulated market. But private insurers had better pick cherries while they can: Swiss Re, a big reinsurer which is helping private health insurers get off the ground in developing countries, points out that as countries get richer and people become politically more assertive, governments squeeze insurers to cross-subsidise the sick and poor.

However, aiming for universal access by expanding private insurance has costs as well as benefits. To some extent, as private insurance grows it will call forth extra resources, helping to relieve the strain on state health-care systems. But because private cover is often supplemental and incomplete, many still turn up at public hospitals for the most expensive procedures (at the taxpayer’s cost). And government doctors and nurses may be encouraged to divert time to lucrative private patients.

The provider rules

Worse yet, there is evidence that private insurance can lead to even higher public spending on health—compromising governments’ second objective of bearing down on the costs of health care. Supplementary insurance that reduces or eliminates “out of pocket” spending or “co-payments” blunts patients’ incentive to watch costs: an extra specialist’s visit or fancy scan is attractive if it seems to be free. Also, America, Australia and Canada offer tax breaks and subsidies for private coverage, such as that offered through employers. This also encourages over-insurance and over-consumption of health care.

To this has to be added the cost of treating health insurance like a utility: regulating prices and stopping insurers cherry-picking and lemon-dropping. This cuts across government’s other objective, encouraging innovation: Mark Pauly of Wharton Business School argues that “the goal of limiting risk selection clashes with the goal of innovation.” Even Clark Havighurst, an academic affiliated with the American Enterprise Institute, a conservative think-tank, says: “As long as health insurers’ only significant function is the simple one of financing health care, government itself is probably capable of performing that role nearly as well as they do—without incurring competition’s added costs”, such as marketing, duplicative regional offices and so forth.

The second reason why governments have turned to private insurance is cost control. The hope was that by ruthlessly tackling costs and promoting efficiency, market-minded insurers would help rein in runaway health inflation where flabby government bureaucrats could not.

However, private insurance seems to have pushed expenditure up not down. Francesca Colombo of the OECD sums up the evidence: “Whatever the role played in a health system, private health insurance has added to total health expenses.” It is no coincidence, she says, that the countries with the biggest private health-insurance sectors—America, France, Germany and Switzerland—also have some of the highest health-care costs per person.

There are several explanations for this. Researchers at Swiss Re point to problems with incentives. Because a third party pays the bill, patients have every incentive to consume too much health care. The true cost of health services is rarely made clear to them. Nor is the true price of insurance, especially if coverage is provided through an employer.

Another incentive problem also arises from lack of transparent pricing. Studies have shown that the fees for similar procedures vary widely among hospitals in the same area. Because hospitals and doctors both decide on the services patients must have and dictate the price of those services, they often enjoy a powerful informational advantage over insurers. Swiss Re argues that competition on price and quality is rare because of a lack of data on the outcome of treatment. It adds that because doctors and hospitals have an informational advantage, they have an incentive to over-supply their services.

A further force driving up costs in private insurance markets is a long-term shift in the nature of medical risk. Paul Mango of McKinsey, a firm of consultants, argues that health insurance was simpler half a century ago. Lives were shorter, risks were clearer and more easily pooled. People live longer now, in part because of medical and economic advance. That is not bad news for insurers in itself, but bad behaviour is making customers fatter and sicker as they age. Chronic diseases and unhealthy lifestyles are pushing costs up. Once untreatable diseases can be managed, but at a cost.

The biggest factor behind the cost conundrum, however, is that insurers lack market power. Health-care providers hold all the cards. On this argument, the problem with private health insurance is not that market forces do not work: it is that reforms have not gone far enough to allow proper competition to emerge. For example, in Germany and the Netherlands some insurers have started to negotiate special deals with providers that make the management of chronic diseases easier for patients. However, there are strict limits on what they can bargain for. And insurers cannot easily favour only the best hospitals, because politicians will not let inefficient hospitals go bust.

Reforms initiated in 1996 never managed to contain costs in Switzerland, which has one of the most expensive health systems after America’s. Robert Leu of the University of Bern argues that “competition was not really set free.” Insurers do not negotiate on tariffs with individual hospitals but with a cartel of local hospitals and the cantonal government.

The problem is worse in America. George Halvorson, the chief executive of Kaiser Permanente, an innovative hospital chain that offers health insurance integrated into its own health care, points to a chart showing how difficult it is for private insurers to tackle costs in the country’s “fee for service” health system, which rewards transactions rather than health outcomes. As insurers have squeezed hospitals, the average duration of hospital stays has indeed fallen—but that has been more than offset by a rise in prices (see chart 2). You might ask why competition among hospitals has not held prices down. The explanation is that there is not much of it. Hospitals have local oligopolies or even monopolies, especially after a recent wave of consolidation, so price competition is rare. The opacity of pricing makes it hard for insurers (and harder still for patients) to shop around.

The third attraction of private insurance, innovation, is also proving elusive. “It is striking how uninnovative health insurance is,” says Regina Herzlinger of Harvard Business School. She points to various examples from America, supposedly the world’s most sophisticated market for private health cover. Many people count long-term care among their biggest financial worries, she says, so why do most insurers not cover it? Why is Discovery, a South African firm, paying its customers to get healthy while most Western insurance giants do not?

The bureaucratic brake

She believes she knows why private insurers are not as inventive as they should be. The buying of health insurance is too concentrated in the hands of “risk-averse bureaucrats”, she insists: human-resource managers at big companies or in the public sector. The OECD agrees, concluding in a report that so far “private health insurance has had only a minimal impact on the quality of care” in most countries.

Others argue that private insurance can—if done properly—lead to innovation. Jan Willem Kuenen of the Boston Consulting Group argues that if allowed to do so, private insurers can catalyse hospitals and doctors to perform better. Having compared the quality of health services across Europe, his firm concludes that countries relying primarily on insurance, like France, Germany and the Netherlands, do better than those that rely chiefly on tax, like Britain, Italy and Spain—which also happen to spend less on health relative to GDP (see chart 3). Gelle Klein Ikkink, director of health insurance for the Netherlands, concurs: “We don’t believe government bureaucrats can motivate providers to deliver higher quality health care—but we firmly believe competitive insurers can.” That, he says, is why the Dutch go through all the trouble of risk-smoothing rather than have a single state insurer.

Some developing countries, whose systems are too young to have developed bad institutional habits, are jumping ahead. Hospital chains like India’s Apollo Group, which lures many Western medical tourists with cheap yet modern treatment, offers its own insurance schemes. Some African firms are miles ahead in the use of text messaging, financial incentives and other clever tools, for instance, to encourage patients to take AIDS drugs properly.

The growth of private health insurance in Kenya began to force hospitals to improve; neighbouring countries without private insurers were less lucky. In Rwanda a novel hybrid of non-profit insurance co-operatives and government reinsurance has greatly expanded health cover for the poor. Leapfrog Investments, a for-profit financial group, sees such potential in micro-insurance for the poor that it is creating a $100m fund to invest in private insurers.

The rich world is perking up a bit too. Ronald Williams, chief executive of America’s Aetna, argues that health insurers like his own firm do much more than government schemes like Medicare to encourage the prevention and management of disease. Unlike the government, his firm pays for extra nurses to work with doctors accepting Aetna’s patients. His firm’s efforts at managing diabetes, he says, have reduced hospital admissions by 26% and costs by 10% for those patients.

America has long had isolated examples of excellence. Kaiser Permanente’s Mr Halvorson insists that private insurance can boost the quality of health provision, “but only if competition is based on care delivery and outcomes.” Sadly, this is often not so. He claims that American private insurers and Medicare pay the worst hospitals as much for the same procedures as they do the best ones, even though the chance of death at the worst is 80% higher. According to Alain Enthoven of Stanford University, an economist whose theory of managed competition inspired Dutch reformers: “If they are to deliver innovation, insurers need more market power…or they must integrate like Kaiser Permanente.”

Americans spend more on health care than any other people in the world. The question is, do the results reflect the expense? In some areas, such as advanced-cancer care, America’s health system is the best there is. Yet according to Christopher Murray of the University of Washington and Julio Frenk of the Harvard School of Public Health, America is falling behind many countries in infant mortality and overall life expectancy. In an essay published last month in the New England Journal of Medicine, they note that rich countries such as Australia have similar demography but healthier people. Within America, they write, “the health disparities…are shocking…some counties have life expectancies similar to some of the poorest parts of the world.”

Still, private insurance has its defenders. Aetna’s Mr Williams observes that American consumers are much more demanding than those elsewhere. He points out that they expect hospital visits to include such things as valet parking, good food, short queues and speedy access to specialists. But do all these extras improve health? “I suspect”, he says, “these service features are not related to better clinical outcomes or health quality.”

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