Naked Economics: Undressing the Dismal Science pdfdrive com

really is different.
The fundamental challenge of health care reform is paying for the “right”
treatment—the “product” that makes the most sense relative to what it costs.
This is an exercise that consumers perform on their own everywhere else in the
economy. Bean counters should not automatically say no to super-expensive
treatments; some may be wonderfully effective and worth every penny. They
should say no to expensive treatments that are not demonstrably better than less
expensive options. They should also say no to doing some tests “just to be sure,”
both because these diagnostics are expensive, but also because when
administered to healthy people they tend to generate “false positives,” which can
breed expensive, unnecessary, and potentially dangerous follow-up care.
There is an old aphorism in advertising: “I know I’m wasting half my money;
I just wish I knew which half.” Health care is similar, and if the goal of health
care reform is to restrain rapidly rising costs, then any policy change will have to
focus on quality and outcomes rather than just paying for inputs. New York
Times financial columnist David Leonhardt describes the treatment for prostate
cancer (where fabulously expensive technology does not appear to be delivering

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better health) as his own “personal litmus test” for health care reform. He writes,
“The prostate cancer test will determine whether President Obama and Congress
put together a bill that begins to fix the fundamental problem with our medical
system: the combination of soaring costs and mediocre results. If they don’t, the
medical system will remain deeply troubled, no matter what other improvements
they make.”
But we’re not done with health care yet. The doctor may know more about your
health than you do, but you know more about your long-term health than your
insurance company does. You may not be able to diagnose rare diseases, but you
know whether or not you lead a healthy lifestyle, if certain diseases run in your
family, if you are engaging in risky sexual behavior, if you are likely to become
pregnant, etc. This information advantage has the potential to wreak havoc on
the insurance market.
Insurance is about getting the numbers right. Some individuals require
virtually no health care. Others may have chronic diseases that require hundreds
of thousands of dollars of treatment. The insurance company makes a profit by
determining the average cost of treatment for all of its policyholders and then
charging slightly more. When Aetna writes a group policy for 20,000 fifty-year-
old men, and the average cost of health care for a fifty-year-old man is $1,250 a
year, then presumably the company can set the annual premium at $1,300 and
make $50—on average—for each policy underwritten. Aetna will make money
on some policies and lose money on others, but overall the company will come
out ahead—if the numbers are right.
Is this example starting to look like the Hope Scholarships or the used-car
market? It should. The $1,300 policy is a bad deal for the healthiest fifty-year-
old men and a very good deal for the overweight smokers with a family history
of heart disease. So, the healthiest men are most likely to opt out of the program;
the sickest guys are most likely to opt in. As that happens, the population of men
on which the original premium was based begins to change; on average, the
remaining men are less healthy. The insurance company studies its new pool of
middle-aged men and reckons that the annual premium must be raised to $1,800
in order to make a profit. Do you see where this is going? At the new price, more
men—the most healthy of the unhealthy—decide that the policy is a bad deal, so
they opt out. The sickest guys cling to their policies as tightly as their disease-
addled bodies will allow. Once again the pool changes and now even $1,800
does not cover the cost of insuring the men who sign up for the program. In
theory, this adverse selection could go on until the market for health insurance

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fails entirely.
That does not actually happen. Insurance companies usually insure large
groups whose individuals are not allowed to select in or out. If Aetna writes
policies for all General Motors employees, for example, then there will be no
adverse selection. The policy comes with the job, and all workers, healthy and
unhealthy, are covered. They have no choice. Aetna can calculate the average
cost of care for this large pool of men and women and then charge a premium
sufficient to make a profit.
Writing policies for individuals, however, is a much scarier undertaking.
Companies rightfully fear that the people who have the most demand for health
coverage (or life insurance) are those who need it most. This will be true no