Consider two mechanisms we depend upon heavily which require routine maintenance and diagnostic check-ups and occasionally (and unfortunately) have catastrophic problems which necessitate expensive treatments: our cars and our bodies. Because the ownership and operation of both creates this schedule of expected maintenance, markets have sprung up to provide both services and insurance for health and automobiles. However, as far as I am aware, despite these similarities we face no car insurance crisis in the Untited States. Why have these outwardly similar situations produced such divergent outcomes?
Before analyzing the particulars of health and automobile insurance, let's lay a framework for our analysis. There are a few important shared characteristics of these interactions that will become important. First, there are predictable or routine small problems which make up the majority of maintenance. Second, larger problems, either results of accidents or improbable malfunction are both less common and significantly more costly. Third, a portion of routine maintenance is preventative or diagnostic and tends to reduce the incidence of larger catastrophic costs. Finally, an economic principle: when people bear the full cost of any maintenance, they will tend to purchase only as much as is worth it to them: They economize.
As a benchmark, let's first analyze the healthy system: car maintenance and insurance. Cars routinely need to be serviced in a variety of ways: checkups, oil and fluid changes, new tires, new brake pads, etc. These routine, and therefore expected, costs are planned for and either purchased in bulk (as in a warrantee) or from savings. These problems often vary in severity so individuals, based on economic and other circumstances, choose the services they value. Because these maintenance costs fall on the individual, they economize and "auto care" costs are kept down. However, cars can often encounter catastrophic problems, namely accidents. Because the costs are large and can not be planned for, people can not effectively save for them on their own, so they buy insurance. Car insurance firms take a number of factors into account when setting premiums, including previous record and car maintenance. As a result, they can avoid moral hazard: when people act recklessly because they are insured.
On the other hand, the health care system is somewhat less healthy. For the same routine costs: medication, checkups, dentist visits, etc., individuals often rely on health insurance. This system assesses individuals only a portion of the actual costs of services. To illustrate how important this distinction is, consider two situations. First, a man considering reupholstering his car: He hopes the change will make the car a little more attractive, which he would be willing to pay $300 for. He will only purchase the upholstery if it costs less than $300. Now, a woman thinking about going to the dermatologist for some blemishes: She also wants an aesthetic improvement. She might value the sum visit and treatment at $300. It may cost upwards of $500, but as long as her co-pay is less than $300 she will purchase the appointment and medication. Because people do not economize, health care costs are not kept under control. At the same time, when individuals do experience unexpected catastrophic cost, their coverage can fail.
To stem the flood of objection e-mails, let me say at the outset that this is a tremendously simplified model. There are incredible holes in the model: You can't junk your body and buy a new one, and if people can't afford the maintenance costs they can choose not to own a car, etc. These illuminate unique facets of health care and might direct government action. However, I think the model is still informative. By removing part of the cost of routine checkups and medication, we have incentivized people to overspend on and undersave for these foreseeable costs. This insight alone goes some way in diagnosing America's burgeoning health care costs.
McClellan can be reached
at chmcclellan@amherst.edu