Guaranteed Renewability and Health-Status Insurance are the Same Thing

by Reihan Salam

Michael Cannon of the Cato Institute, a leading opponent of the Affordable Care Act, offers a critique of Josh Barro’s characterization of private insurance as essentially a government program. Cannon embraces the idea that the tax subsidy for employer-sponsored insurance is best described as a government program, yet he argues that Josh misunderstands key aspects of the pre-Obamacare individual insurance market. For example, Josh describes “guaranteed renewability” (GR) as “rent control for health insurance”; just as rent control limits rent increases landlords can charge their tennants, his implication is that guaranteed renewability prevents private insurers from revising premiums as a consumer’s health status changes. In Cannon’s view, guaranteed renewability is best understood as a form of what Chicago Booth economist John Cochrane has called “health-status insurance” (or time-consistent health insurance). That is, private insurers are charging you a premium for health insurance bundled with a premium for insurance against the possibility that your health status will change in such a way that you will become a more expensive insurance beneficiary.

To use Josh’s rent control analogy, guaranteed renewability is more akin to a program in which renters enter into a contract that bundles a rent charge with a premium for insurance against the possibility that market value of the rental unit will increase over time. The cost of this latter kind of insurance would vary considerably across metropolitan areas and neighborhoods. Similarly, GR policies will vary in price in part according to the value of health-status insurance — health-status insurance premiums for older people will be higher than they would be for younger people, etc. (This is part of why advocates of market-oriented health-system reform emphasize the importance of getting people to enroll in health insurance early in life.)

Cannon explains how GR policies work from the perspective of insurers:

Insurers don’t write GR policies at a loss any more than they price any other type of insurance at a loss. Mark Pauly and Bradley Herring have shown insurers cover the cost of GR the same way they cover the cost of all insurance: by charging people a risk-adjusted premium before the insured-against loss occurs. Carriers add a GR surcharge on top of the medical-insurance premium you pay to cover your medical bills in Year One. Those funds then cover, in Year Two and beyond, the cost of offering standard-rate coverage to everyone who develops a long-term illness in Year One. (In Year Two, the surcharge covers the cost of providing standard-rate coverage to everyone who develops a long-term illness in Year Two, and so on.) Pauly and Herring have shown that there is no reason for healthy consumers to defect from this arrangement. That’s because they’re not being taxed to subsidize someone else. They are voluntarily buying something for themselves that has the glorious effect of subsidizing others.

And he adds that even before HIPAA mandated that individual-market policies contain a GR component, the vast majority of private insurance plans (75 percent) were already GR plans. He maintains that the success of GR is an indication of how the health insurance might evolve if the public sector reduced its role in insurance markets, e.g., by eliminating the tax subsidy for employer-sponsored insurance:

All of which is to say that despite all the things that federal and state governments have done to hamper it and hinder it and crowd it out, the individual market has worked quite well. Guaranteed renewability is a market success. It has enabled the individual market to provide more secure access to health care for sick people than the type of insurance the federal government coerces 90 percent of Americans into purchasing. It does so without the distortionary effects that ObamaCare supporters admit the law’s community-rating price controls will create. Cochrane predicts that without such price controls or the tax preference for ESI, markets would spur further innovations that make access to care more secure. (Imagine insurance companies aggressively competing to cover the sick.) Even as Congress was drafting ObamaCare, the individual market was innovating right underneath Congress’ nose with new products that would make coverage more secure. But such innovation cannot happen with ObamaCare in place.

My sense is that though the existing tax subsidy works very poorly, there is a role for some degree of government paternalism in the insurance market, as large numbers of people will likely underestimate the risk that they will face catastrophic medical expenses. But his point that Obamacare is stymieing innovation in the insurance market that might benefit all consumers, including low-income consumers, is well taken.