this may help explain it a little:The unraveling of employer-based insurance
In 2003 only 16 percent of health care spending consisted of out-of-pocket expenditures by consumers. The rest was paid for by insurance, public or private. As we'll see, this heavy reliance on insurance disturbs some economists, who believe that doctors and patients fail to make rational decisions about spending because third parties bear the costs of medical treatment. But it's no use wishing that health care were sold like ordinary consumer goods, with individuals paying out of pocket for what they need. By its very nature, most health spending must be covered by insurance.
The reason is simple: in any given year, most people have small medical bills, while a few people have very large bills. In 2003, health spending roughly followed the "80–20 rule": 20 percent of the population accounted for 80 percent of expenses. Half the population had virtually no medical expenses; a mere 1 percent of the population accounted for 22 percent of expenses.
Here's how Henry Aaron and his coauthors summarize the implication of these numbers in their book Can We Say No?: "Most health costs are incurred by a small proportion of the population whose expenses greatly exceed plausible limits on out-of-pocket spending." In other words, if people had to pay for medical care the way they pay for groceries, they would have to forego most of what modern medicine has to offer, because they would quickly run out of funds in the face of medical emergencies.
So the only way modern medical care can be made available to anyone other than the very rich is through health insurance. Yet it's very difficult for the private sector to provide such insurance, because health insurance suffers from a particularly acute case of a well-known economic problem known as adverse selection. Here's how it works: imagine an insurer who offered policies to anyone, with the annual premium set to cover the average person's health care expenses, plus the administrative costs of running the insurance company. Who would sign up? The answer, unfortunately, is that the insurer's customers wouldn't be a representative sample of the population. Healthy people, with little reason to expect high medical bills, would probably shun policies priced to reflect the average person's health costs. On the other hand, unhealthy people would find the policies very attractive.
ou can see where this is going. The insurance company would quickly find that because its clientele was tilted toward those with high medical costs, its actual costs per customer were much higher than those of the average member of the population. So it would have to raise premiums to cover those higher costs. However, this would disproportionately drive off its healthier customers, leaving it with an even less healthy customer base, requiring a further rise in premiums, and so on.
Insurance companies deal with these problems, to some extent, by carefully screening applicants to identify those with a high risk of needing expensive treatment, and either rejecting such applicants or charging them higher premiums. But such screening is itself expensive. Furthermore, it tends to screen out exactly those who most need insurance.
Most advanced countries have dealt with the defects of private health insurance in a straightforward way, by making health insurance a government service. Through Medicare, the United States has in effect done the same thing for its seniors. We also have Medicaid, a means-tested program that provides health insurance to many of the poor and near poor. But nonelderly, nonpoor Americans are on their own. In practice, only a tiny fraction of nonelderly Americans (5.3 percent in 2003) buy private insurance for themselves. The rest of those not covered by Medicare or Medicaid get insurance, if at all, through their employers.
Employer-based insurance is a peculiarly American institution. As Julius Richmond and Rashi Fein tell us in The Health Care Mess, the dominant role of such insurance is the result of historical accident rather than deliberate policy. World War II caused a labor shortage, but employers were subject to controls that prevented them from attracting workers by offering higher wages. Health benefits, however, weren't controlled, and so became a way for employers to compete for workers. Once employers began offering medical benefits, they also realized that it was a form of compensation workers valued highly because it protected them from risk. Moreover, the tax law favored employer-based insurance, because employers' contributions weren't considered part of workers' taxable income. Today, the value of the tax subsidy for employer-based insurance is estimated at around $150 billion a year.
Employer-based insurance has historically offered a partial solution to the problem of adverse selection. In principle, adverse selection can still occur even if health insurance comes with a job rather than as a stand-alone policy. This would occur if workers with health problems flocked to companies that offered health insurance, while healthy workers took jobs at companies that didn't offer insurance and offered higher wages instead. But until recently health insurance was a sufficiently small consideration in job choice that large corporations offering good health benefits, like General Motors, could safely assume that the health status of their employees was representative of the population at large and that adverse selection wasn't inflating the cost of health insurance.
In 2004, according to census estimates, 63.1 percent of Americans under sixty-five received health insurance through their employers or family members' employers. Given the inherent difficulties of providing health insurance through the private sector, that's an impressive number. But it left more than a third of nonelderly Americans out of the system. Moreover, the number of outsiders is growing: the share of nonelderly Americans with employment-based health insurance was 67.7 percent as recently as 2000. And this trend seems certain to continue, even accelerate, because the whole system of employer-based health care is under severe strain.
We can identify several reasons for that strain, but mainly it comes down to the issue of costs. Providing health insurance looked like a good way for employers to reward their employees when it was a small part of the pay package. Today, however, the annual cost of coverage for a family of four is estimated by the Kaiser Family Foundation at more than $10,000. One way to look at it is to say that that's roughly what a worker earning minimum wage and working full time earns in a year. It's more than half the annual earnings of the average Wal-Mart employee.
Health care costs at current levels override the incentives that have historically supported employer-based health insurance. Now that health costs loom so large, companies that provide generous benefits are in effect paying some of their workers much more than the going wage—or, more to the point, more than competitors pay similar workers. Inevitably, this creates pressure to reduce or eliminate health benefits. And companies that can't cut benefits enough to stay competitive—such as GM—find their very existence at risk.
Rising health costs have also ended the ability of employer-based insurance plans to avoid the problem of adverse selection. Anecdotal evidence suggests that workers who know they have health problems actively seek out jobs with companies that still offer generous benefits. On the other side, employers are starting to make hiring decisions based on likely health costs. For example, an internal Wal-Mart memo, reported by The New York Times in October, suggested adding tasks requiring physical exertion to jobs that don't really require it as a way to screen out individuals with potential health risks.
So rising health care costs are undermining the institution of employer-based coverage. We'd suggest that the drop in the number of insured so far only hints at the scale of the problem: we may well be seeing the whole institution unraveling.
Notice that this unraveling is the byproduct of what should be a good thing: advances in medical technology, which lead doctors to spend more on their patients. This leads to higher insurance costs, which causes employers to stop providing health coverage. The result is that many people are thrown into the world of the uninsured, where even basic care is often hard to get. As we said, we rob Peter of basic care in order to provide Paul with state-of-the-art treatment.
Fortunately, some of the adverse consequences of the decline in employer-based coverage have been muted by a crucial government program, Medicaid. But Medicaid is facing its own pressures.