Different River

”You can never step in the same river twice.” –Heraclitus

February 24, 2005

Event-based Health Insurance

Filed under: — Different River @ 9:17 pm

One of the problems with health insurance is that it isn’t really insurance. Normally, the idea behind insurance is you trade a small probability of a large loss (say, a 0.0001% chance that your house burns down) for a certain (100% probability) small loss (the premium you pay). Homeowner’s, renter’s, car insurance, and even term life insurance work this way. Health insurance doesn’t — with health insurance you (and/or your employer) pay a premium designed to cover not only small-probability events (heart attacks in 30-year-olds) but near-certain events (childhood vaccinations and check-ups, antibiotics for occasional bronchitis), and events known in advance to be certain for particular individuals (insulin for diabetics, medicine for asthmatics). Arnold Kling discusses this issue in more detail here.

Another problem is that once a health problem is diagnosed, there are often several treatment options, and once your deductible is met there is no reason not to go for the most expensive treatment available. For example, if treatment A has a 95% chance of working and costs $500, but treatment B has a 97% chance or working but costs $5,000, any normal person would try A first and use B only if A didn’t work — but a person with insurance (with, say, a $100 deductible) would rationally choose B first, since the person pays the same for either one and B has a better chance of working.

Both in the article linked above and here on the EconLog blog, Arnold Kling proposes to solve this problem using something he calls “event-based insurance.” The idea is:

Event-based insurance means receiving a lump-sum payment at the time of diagnosis. Thus, even if the treatment goes on for years, the consumer has money to pay for it. The consumer does not have to worry about losing coverage with a pre-existing condition, because the consumer already has received benefits for that condition.

It would be reasonable to include a disability component to event-based insurance. If an ailment is going to cause a lapse in work, then the insurance payment can include a lump sum based on the typical amount of work time lost with that ailment.

For Discussion. What problems would event-based insurance solve, and what problems would it create?

In principle, this is a great idea. It would make health insurance more like regular insurance, and — more important — it would also rationalize the market for health care by giving patients incentives to consider the monetary costs, as well as the benefits (and side-effect costs) of various treatment options and various health care providers. (The reason for this is that if they get cured for less than the lump-sum payment, they could keep the change — and if they couldn’t get cured for that amount, they’d have to pay the difference or do without.)

However, one problem with event-based (better, “diagnosis-based”) insurance is that it doesn’t interact well with the technology of how medicine is actually practiced. In particular, event-based health insurance would make payments after a diagnosis is determined — but a huge percentage of medical costs these days is in diagnostic tests and images. (MRIs and CAT scans are expensive!). For example, in 2002, 17.7% of Medicare spending was for diagnostic images and tests (see page 78 of the document in this PDF file), and that’s not including the substantial share of physician visits devoted to diagnosis — not to mention things like biopsies and exploratory surgeries (which, since they involve surgery, count as “procedures” not “tests”). I would not be surprised if it turned out that more than a third, maybe more than half, of total health care spending is for diagnosis rather than treatment.

Furthermore, medicine is often practiced in a “sequential” manner, in which treatments lead to diagnoses, as well as the other way around. For example, suppose a patient comes in with chronic breathing trouble. The doctor could immediately order a CAT scan of the lungs and an MRI, looking for everything from lymphoma to pulmonary fibrosis to lung cancer. All of these diagnoses are possible, but the highest probability event is that it’s asthma. So, instead of ordering all these tests, the doctor writes a prescription for a couple of asthma drugs, and tells the patient to try them. If it works, the problem is solved and the diagnosis is simultaneously confirmed. The doctor may not even order the definitive test for asthma. If the asthma drugs don’t work, then the doctor goes on to try other asthma drugs and/or test for asthma, then test for other diseases, most likely in order of their probability (unless some tests are very cheap, in which case they’ll be done anyway).

Because some tests are very expensive, and some treatments are relatively cheap, this could actually be the optimal approach to treatment given both the costs of treatments and tests, and the probabilities of various diseases. If the probability (given known symptoms) of a disease is high, and the treatment for that disease is low in cost (both in terms of money and side-effects), and the tests for alternative, low-probability diseases are expensive, then it can be optimal to “treat and see if it works” rather than “test for everything before treating for anything.”

However, event-based health insurance is dependent on the latter approach, since no payment is given without a definitive diagnosis. As a result, event-based health insurance could actually increase the cost of health care for some classes of symptoms, and could delay treatment for a majority of patients — since tests take time and by definition most patients have the common diseases.

In other words, part of the reason health insurance is not “real” insurance is due to historical and regulatory issues, but part of the reason is due to the inherent nature of health care.

I should add, however, that the case for event-based (or diagnosis-based) insurance is not completely lost. It is possible that an optimal health insruance system could involve a diagnosis-based component for certain well-defined diseases and conditions. For example, I have actually received in the mail offers for something called “cancer insurance” that pays a set amount for any diagnosis of cancer. They sell it as a way to pay for deductibles, co-payments, and items not covered by ordinary health insurance, but in principle there’s no reason why an insurance scheme couldn’t have a complex system of different payments for different types of cancers, perhaps will additional payments if cancers proceed beyond specificed stages. However, not all diseases are as well-defined as all that, and you still need a way to cover the diagnostic tests.

Another problem I’d like to see dealt with is insurance for chronic conditions. For example, a diagnosis of Type I (“juvenile”) diabetes is basically a guarantee of a lifetime of large health expenses. It would be nice to have insurance against this. There are two problems, however.

First, diabetes (and many other chronic conditions) is usually diagnosed in children and adolescents, but most of the payments are made when those same people are adults. So by the time you get to buy insurance, you already have the event that should trigger payment. Insurance would have to be purchased by parents for their children, but that’s not likely to happen as long as parents have the reasonable expectation that their children will be able to obtain, as adults, health “insurance” that will pay these expenses.

Second, people diagnosed with chronic conditions by definition live a long time after they are diagnosed. And, medical technology is developing quickly and all indications are it will continue to do so. It’s not all that difficult to calculate the cost of treating diabetes for a lifetime — if you get to assume that technology will remain at today’s level for that entire lifetime. But it won’t. Improvements in medical technology can either increase or decrease costs (I have written on this in my “real life” and should post about it some time). A patient insuring against diabetes would want to have enough to pay for (say) an artificial pancreas in case one is invented in his/her lifetime, even if it’s more expensive than a (remaining) lifetime of test strips and insulin shots. An insurance company has no good way to estimate that cost — and furthermore, the insurance company would want to be “protected” against the chance that test strips and insulin injections become much cheaper over the patient’s lifetime.

By the way, diabetes is just an example — the same sort of concerns would hold true for numerous other chronic conditions, including genetic conditions.

4 Responses to “Event-based Health Insurance”

  1. mWhat thenrsfish Says:

    The probability vs. cost that you start with is also where HMO’s started. The problem is, when you are ill, scared,
    in pain, and fairly limited in your physician choices, this take the antibiotic for two weeks and see what happens
    even though it has never worked before, it might this time gets a bit frustrating. When my daughter was 5 months old
    she had pnuemonia and some fairly severe breathing problems. We ended up in the emergency room. I had a decent ER
    doc who really listened. Finally, he said. I don’t see the symptoms at this moment, but what you are describing to
    me is pretty scary stuff. So, since the fever is down now, I could send you home with a different antibiotic and see
    if the breathing obstruction happens again, or I can admit her and and do the antibiotics by IV with a breathing tent

    Well, this mother was not about to spend another night watching her infant’s chest and stomach concave while the baby
    struggled to breathe. If I had an HMO, I would not have been given that choice. The HMO would have dictated it.
    If I knew I would end up having to pay several thousand dollars later on out of pocket I still would have made that
    same choice. But what if the hospital required cash up front (as they do for uninsured) I didn’t have it in my
    account. About a year later I interviewed a woman for my work who had two small boys – 2 and 4. Both had extreme
    Asthma and breathing difficulties. With her older child she had spent many hours in doctors offices and emergency
    rooms. Now her husband was working two jobs, neither which had health insurance. She was home with these fragile
    children. The reason I was interviewing her is that the medical evidence did not exist for her younger child because
    she had no car. She had all the medicines at home, no car, no one to leave her 4 year old with at midnight – 4 in
    the morning when her younger child had the most breathing problems, her husband was at work with the one car and
    she didn’t have money for a taxi to the hospital. She laid next to her child and prayed and gave him his brother’s
    breathing treatments – the only thing that ever resulted fromt he brother’s long hours in ER’s years before. She
    didn’t sleep much. She was afraid for her child’s life most of the time.

    Rational or not, during those moments, I was very thankful for my very expensive PPO health insurance. Perhaps, if
    I was a more financially responsible person, I could better manage the premiums in a savings account and use them
    for expenses as they came up. I like the safety net of knowing it is “prepaid”. But this woman, with a family who
    worked hard and struggled, she would have to decide between medicine and milk.

    The answers are not easy. And I am glad that minds as fine as yours are grappling with them. I know on a practical
    level, I chose doctors who look to how I am going to have the FASTEST, most complete treatment. If a doctor says
    to me, try this and see if it works, if not come back in two weeks and we will try the other. I talk to them about
    why, why not the other first. If they don’t see things the way I do. I change doctors. But I can do that because
    I choose to pay more for my health insurance.

    At the same time, I am contemplating undergoing some treatments for a physical problem (we are not talking cosmetic
    stuff here) My insurance covers only testing, diagnosis, and actual treatment – not medical intervention
    to achieve the desired result. I don’t have a problem. It make sense to me. If a body part needs repairing – the
    policy pays. If I want a doctor to force my body to do something it won’t do on its own. That’s my choice and
    not really a medical problem.

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