Hidden Costs of Health Insurance

The average American understands the principle behind a car warranty. We never expect the warranty to cover our regular oil changes, smog checks, or brakes. The warranty is, in effect, an insurance policy. If the entire engine were to fail, the warranty would cover a replacement, limiting our losses in the event of a catastrophe. This is the principle behind almost every insurance policy: fire insurance, flood insurance, home insurance, and life insurance. The unfortunate exception is health insurance, and this difference has led to an expensive, inefficient, and unsustainable medical system.

Health insurance, when purchased through an employer, is currently tax deductible. This health insurance generally has low deductibles and high initial costs, because the government subsidizes (through tax deduction) consumers’ initial costs and almost none of the subsequent costs. Unfortunately, this low marginal cost structure renders the entire system inefficient, because it reduces the cost that people pay from their pocket for routine services. For example, a person with a low deductible may pay $30 for a doctor’s appointment, but the doctor may charge $60 for his time. If I am sick enough that I am willing to pay $31 to see a doctor, I will make an appointment and pay the $30 co-pay. However, society’s cost, the $60 the doctor will charge, is $29 higher than my willingness to pay. As a result, the medical system is overused by people who fall into the price gap between their personal cost and society’s total cost.

Furthermore, since in our current health insurance system, coverage is provided through employers, it cannot be moved as people change jobs. This creates labor market rigidity and personal unhappiness, as people feel locked into their job in order to keep their insurance.

And outside of organized company plans, obtaining insurance for the long-term is difficult and expensive because of self-selection of the insured population. Healthy young students generally avoid paying for insurance they will rarely use while people with chronic conditions will often never be able to find an individual plan that will be willing to take them on for a reasonable price. Even people without any serious condition often find it difficult to remain on a plan if they file too many claims in too short period of time. Consequently, tens of millions of Americans are uninsured and unprotected in the case of a medical emergency, leaving the taxpayers to pick up the burden.

President Bush suggested part of the solution to this problem in a radio address in January when he proposed a new “more available, more affordable, and more portable” version of the Health Savings Account (HSA), which allows people who buy high deductible health insurance policies to save their money, tax-free, in an HSA to use for routine medical expenses. This tax relief reduces the disproportionate tax subsidy given to organized health care policies and allows Americans an alternative to the current standard. Yet, although the money contributed to an HSA is tax-free, it is not yet tax deductible like traditional health premiums.

The assumption with HSA is that health insurance should be used to protect against catastrophic medical costs, not day-to-day predictable costs—much like any other kind of insurance available. Using high deductible health insurance will allow Americans to distribute the risk of huge unexpected medical costs while taking on personal responsibility for smaller predictable costs. In addition, it will save families thousands of dollars every year in medical premiums that can be funneled directly into their HSA. As Baker Professor of Economics Martin S. Feldstein ’61 noted in The Wall Street Journal in 2004, the savings in the premium may even exceed the increase in deductible, reducing overall costs!

In addition, this proposal reduces medical inefficiency because patients will be paying for a larger fraction of their regular care through their personal HSA. Therefore, patients will be less likely to overuse the system and will go to the doctor only when their need approaches the cost of the service. Moreover, HSAs are tied to individuals, not corporations. Consequently, shifting jobs won’t affect an individual’s health insurance, which will allow for more consistency over job transitions and the employment status.

Yet, as with most plans, the HSA is not perfect. As Democrats have rightly pointed out, this plan fails to address a major flaw in the current system: the millions of uninsured Americans. Most current uninsured Americans do not have the money needed to add to their own HSA, just as they do not have the money to buy a health insurance policy. Although an HSA program cannot directly address the problem of the uninsured, it can be combined with a Democratic suggestion to help the unfortunate. By rolling back the Bush tax cuts, the U.S. could afford to subsidize high-deductible insurance and an HSA fund for qualifying Americans by providing HSA credit.

Thus, the HSA plan coupled with a support plan for uninsured Americans could reduce or eliminate the three biggest problems with the current health insurance crisis: a wasteful system that results in ballooning costs, a constraining connection between health care and employment, and the millions of uninsured Americans. Unfortunately, the major flaw seems to be political rather than economic. The Bush administration refuses to compromise on their tax cuts and the Democrats refuse to compromise on HSAs. If only they could reconcile and talk about alternatives, we could change the health care system and end this debate.



Ashish Agrawal ’08, a Crimson editorial editor, is a biochemical sciences concentrator in Eliot House.