Proponents of the status quo in the health care system, i.e. those entities that are capturing the billions of excess dollars that Americans are paying for ever-diminishing availability and declining quality, are portraying the proposed fixes as a typical tax and spend approach by liberals. The claim is that health care delivery will suffer and Americans will be worse off.

This argument is a gigantic red herring. America does not have a health care delivery problem – it has a health care insurance problem. The insurance industry, which is not regulated at the Federal level and is lightly regulated by most states, (especially Arizona, Connecticut, and Nebraska, where many of them are headquartered) is a succubus that has its fangs sunk into every food chain in the American economy. A good portion of the current economic crisis is traceable to the unregulated insurance industry – AIG being the poster child. But that is another discussion.

There are two core principles of insurance:
1. Spread the risk of losses.
2. Prevent adverse selection.

Spreading the risk means that coverage should be as broad as possible. Claims are statistically predictable; if one person will get cancer each year (but we don’t know which one), and it costs $100,000 to treat her, then an annual premium of $1000 from one thousand people will suffice. It is true that if the cost were lower, the premium would be lower, and this leads to a discussion of the efficiency of the health care system and the costs of treatment. But if we could spread the risk of one cancer across one million people, the annual premium would be only ten cents a year. Of course, the number of cancers would also go up, but at least for this disease, the overall incidence of cancer per 100,000 people has been falling since about 1992. (Source: http://progressreport.cancer.gov)

“Spreading the risk” inherently requires cross-subsidy. Those who do not get sick pay premiums that then pay for the treatment of those who do get sick; the premiums of those whose houses do not catch fire pay for the losses of those which do.

Like all cross-subsidy arrangements, an incentive exists for those who think they can beat the odds to drop out of the insurance pool. Men don’t want to pay for pregnancy coverage; the young don’t want to pay for Alzheimer’s treatment, New Yorkers don’t want to pay for earthquake damage in California. It also creates an incentive for profit-maximizing insurance companies to cover those who are less likely than average to place claims. The result is that those who remain in the insurance pool face higher and higher proportions of claims and higher and higher insurance premiums. This cycle creates an incentive for further “opting out” and the vicious cycle proceeds. This is the essence of “adverse selection” where the pool of insured individuals becomes increasingly riskier.

The policy implications are obvious:
1. To spread the risk as widely as possible, get the entire population into a single pool. That means “single payer.”
2. To avoid adverse selection, either make membership in the pool mandatory or require “Pay or Play” so that drop outs cannot avoid their contribution to the pool.

Note that this says nothing at all about the provision of health care services. While the current system of insurance creates distortions in the provision of health services, the insurance problem is separable from them. But the health care providers that live on those distortions have teamed up with the insurance companies to drag those smelly red herrings into the discussion. Watch out when they start waving their hands and turn up the volume.