Should Smokers Pay Higher Health Premiums, Part II

This is a follow up to James’ post on whether or not state and federal employees should pay the same premiums for health care. In a simple insurance market people would purchase insurance and their premiums would be based on how likely they are to get sick. There would be no pooling outcomes. To see this suppose there is a pool of individuals, some high risk and some low risk for needing health care. In this pool everybody pays the same premium for their insurance. However, a competing insurance company could lure away the low risk individuals with lower premiums (and higher deductibles) leaving only the high risk people in the initial pool. With the depature of the low risk people from the pool, the premiums would increase in the pool. This is why you’ll hear economists sometimes say that a pooling equilibrium is always broken by a seperating equilibrium. It is the “cream skimming” strategy above.

Now to compound the problem a bit. If we initially have a pooling equilibrium those who are high risk are to some extent benefitting at the expense of those who are low risk. Thus, changing from a pooling to a seperating equilibrium is going to create winners and losers. On top of this there is also the problems of moral hazard and adverse selection. With moral hazard the presence of insurance will alter people’s behavior. For example, if I have car insurance I might drive a little less carefully than if I didn’t have insurance. Sure it would not be good to have a car accident, but I might figure the benefits of speeding up a bit to get somewhere a bit faster might outweigh the possible downside of having an accident. Toss in the fact that people tend to underestimate the probabilities of bad events and overestimate the probabilities of good outcomes (i.e. I think speeding up is really going to help me get someplace faster, and there isn’t (much of) an increase in the probability of an accident if I speed up), and this result should be fairly obvious. Or think of it this way:

  • Have you ever over slept and then hopped in the car driving much more frantically to get to work on time for something important?
  • Have you ever done this and thought you could have an accident then said to yourself, “Well, I’m insured”?

Basically, when you change the outcomes, you change the behavior as well. This doesn’t always sink in with many people. They think things like, well car accidents are bad…so therefore people are going to drive carefully. But insurance reduces the loss in the bad state (a car accident, getting sick or hurt, etc.). That is a car accident, while still bad is now less bad. The same effect works with health insurance as well. Sure breaking a leg while skiing sucks. It sucks even more if you don’t have insurance. Who do you think is least likely to go skiing? The guy with insurance or the guy without? So the problem with moral hazard is that the mere presence of insurance will change people’s behavior. With health insurance they will engage in riskier activities than they probably would without health care.

Adverse selection is where one type of individual masquerades as another type. With insurance a high risk person might want to try and pass themselves off as a low risk person. Returning to the seperating equilibrium, since the insurance company often cannot observe what type of risk a person is, then the high risk individual will be better off if he can pass himself off as low risk. One response to this is to offer incomplete insurance for low risk individuals that high risk individuals find undesirable.

All of these things complicate the situation noted in James’ post. Currently high risk individuals benefit from the current insitutional arrangement and low risk individuals. However, switching to a new institutional arrangement that requires individuals to pay higher premiums if they smoker or engage in other risky activities could induce some people to opt out of insurance completely. This is especially true when one considers that irrespective of ability to pay, one’s medical costs will be covered (by the rest of us). The same is true for those who are simply high risk (i.e. people who were unlucky to be born with higher risks of say heart disease due to genetics). These people also might opt out of employer provided insurance if their premiums go up. So now with all this we can look at this part of Radley “Randy” Balko’s article,

The question becomes, who should pay the health care costs of a state worker who chooses to smoke, then gets sick as the result of that decision: the person who chooses to smoke, or Georgia taxpayers? I have a hunch what most Georgia taxpayers would prefer.

Some may worry that we’re on a “slippery slope,” here that health insurance companies may soon factor in traits and habits such as obesity, regularity of exercise, or alcohol consumption, too.

But why shouldn’t they? Certainly we should be free to make our own decisions about what habits and vices we choose to indulge. But we should also be prepared to accept the consequences of those decisions. Eat, smoke and drink what you want, but don’t expect people who made better choices or taxpayers to bail you out.

In the ideal world of theory Radley is right. If you decided to eat unhealthy food, drink alcohol (to excess) and smoked, then you’d be a higher risk individual and you’d bear the costs of these decisions either via higher premiums or by bearing the full loss yourself if you opted not to purchase insurance. The problem is we don’t live in that world. When the guy who pigs out on pork rinds, drinks a case of beer and smokes a pack of cigarettes a day keels over of some health ailement and doesn’t have insurance he will still get medical attention. He will be wisked away to a hospital (most likely in an ambulance) and he will get doctors and nurses trying to resolve the medical problem, plus all the drugs and medical procedures. Who will pick up the tab if he cannot or decides not to pay? The rest of us. We’ll either pay via higher taxes, higher health care costs, or both. Further, even without this problem the market for insurance is likely going to result in less than full coverge for at least some people, or what is more generally known as a Second Best outcome (First Best is where nobody can be made better off without making somebody else worse off). This is really a fancy way of saying, that we could, at least in theory, do better.

FILED UNDER: Economics and Business, Health
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Michael says:

    Steve,

    Just a semi-related question. Do you think that, because employers have picked up such a HUGE amount of the healt insurance tab, we’re overpaying?

    In other words, if employers just gave employees the money and people were forced to buy their own health insurance, do you think it would go down significantly?

    I think it would. I also think a great many people would stop engaging in high risk (and therefore, high premium) behaviours, like I just did when I recently quit smoking.

    In fact, I think getting rid of group insurancve could have an amazingly good impact on both the economy and our health in this country.

  2. Fersboo says:

    Steve, I hope you don’t mind, but I am going to field this one. I slept at a Holiday Inn Select last night. Nah, just joshing, I recently attended a seminar on this very question of Michael’s.

    Michael, the answers to your questions are yes, yes, and maybe (see point below).

    Because the end-user does not bear most of the burden of healthcare costs in employer provided systems, there is little end-user incentive to manage the costs. The solution, brought about by legislation late in 2004, is called Consumer-driven Care and there is a good discussion at http://www.lifetimebenefitsllc.com .

    Many insurance companies offer incentives for members to practice healthy lifestyles and preventive medicine. The short-term benefit to the end-user is a rewards program, while decreasing costs constitute long-term benefit.

  3. Michael says:

    I know Clark Howard, who is a well known consumer advocate, STRONGLY recommends getting rid of employer funded health care and letting pweople buy it themselves.

    I honestly believe that if I had to pay a couple hundred extra a month because I smoked that I would have quit smoking a long time ago.

  4. Steve says:

    In other words, if employers just gave employees the money and people were forced to buy their own health insurance, do you think it would go down significantly?

    Probably. For one thing, that money would be taxed. For example, say your company paid $2,000 for health insurance. Instead it put the $2,000 in your pay checks. Now after taxes you might only get say $1,750. You’d clearly have to go with a policy that provided less coverage.

    The other effects noted by Fersboo and yourself would also likely play a role. You certainly notice the cost of something more when you have to write the check vs. your employer.

  5. Some may worry that we’re on a “slippery slope,” here that health insurance companies may soon factor in traits and habits such as obesity, regularity of exercise, or alcohol consumption, too.

    But why shouldn’t they?

    This idiot is seriously proposing that we turn over power to insurance companies that any rational person denies to the government? How do lunatics like this get published? What’s next? Insurance company audits of genetic compatibility as a prerequisite for marriage licenses?

  6. Health Nut says:

    Of course they should.

  7. Michael says:

    You’d clearly have to go with a policy that provided less coverage.

    Although I suppose your premiums would be tax deductible.

  8. Steve says:

    This idiot is seriously proposing that we turn over power to insurance companies that any rational person denies to the government? How do lunatics like this get published? What’s next? Insurance company audits of genetic compatibility as a prerequisite for marriage licenses?

    Again, this is the adverse selection problem. You can get a genetic test, find out you have the genes for a disease, then go out and purchase insurance to cover those costs. Since the insurance company can’t see your genes you’d have an adavantage. Soon such markets would disappear and people would be left covering the entire cost themselves or the tax payer would.

    There. Is. No. Free. Lunch.

    Have you got that?

    Although I suppose your premiums would be tax deductible.

    That would be one way of dealing with the problem of using after tax income to purchase health insurance. Of course, there are a couple of issues here. If there is a tax exemption for health insurance, could there be one of car insurance? After all, people who don’t have car insurance could be imposing (external) costs on the rest of us.

    Still, I think even with a tax break for health insurance we’d see a decline in health care expenditures, at least the “frivolous” ones (plastic boobs, nose jobs, tummy tucks, viagra, etc.).

  9. Steve, you ignorant slut. Once the insurance companies have the power that sheep such as yourself are all too anxious to grant them, you won’t have to go out and pay for that genetic test yourself – the insurance company will have your pedigree available in its records.

    If smokers can be singled out for higher premiums, so can drinkers, and fast food eaters, and people who engage in unprotected promiscuous sex, and people who might be prone to…oh, I don’t know…sickle cell anemia.

    Steve, you should run to your nearest bookstore and purchase a copy of “The Merchant of Venus” by Frederick Pohl. Then get “The Mystery of Capital” by Hernando de Soto. Together, they will help you understand the proper function of government in promoting and regulating capitalism.

  10. John Thacker says:

    Mr. Bluto–

    You clearly don’t understand insurance. Insurance companies make about the same profit regardless. The only difference it makes it whether non-smokers have to pay more to subsidize smokers, or whether smokers bear the full extra cost.

    Yes, there are problems with genetic predispositions. But there are equally problems when people know their own predispositions, but the companies don’t, and they go out and buy extra insurance. Moral hazard, don’t you know.

  11. Mr. Thacker-

    You clearly don’t understand the point, nor do you have any grasp of the concept of a “slippery slope”. Insurance is a method of pooling risk. Once you allow insurance companies to single out target groups for higher expense, based on legal behavior, you set the stage for all manner of intrusion into private matters and abuse.

    And Mr. Thacker, while your innocent faith in the benignity of insurance companies is touching, you clearly don’t realize that by overcharging EVERY member of a target group, regardless of whether or not they actually consume excess services, the insurance companies will garner further profit. You really don’t think they are in business for the purpose of lowering your premiums, do you?

    And btw, Mr. Thacker, do you drink? Are you fat? Any history of insanity in your family? Ever drive around in a small car? What’s your cholesterol level? History of diabetes in your family? Do you ever exceed the speed limit while driving? Do you walk in high traffic urban areas? What’s the radon level in your basement? Ever engage in anal sex? How about oral sex with an IV drug user?