Don't like Obamacare? Here's an alternative
Fortune editor Shawn Tully suggests a solution to fixing the health-care system. Keep it simple and let the free-market decide the rest.
NEW YORK (Fortune) -- This is the second installment in a series of health-care columns by Fortune's Shawn Tully.
Unlike the House bill that fills 1,100 pages, my proposed health-care plan can be expressed in four simple bullet points. The marketplace, with more than 100 million consumers writing their own checks, will take care of the rest.
About two in three Americans get health coverage through their employer. On the surface, the system appears to work well: Most people like their plans. The deductibles and co-pays are usually low, and they don't have to worry about shopping for insurance. But the employer plans also carry a heavy cost that's hidden from the employee. Workers don't realize it, but they're sacrificing a big part of their pay because their company is providing coverage. The employer is often offering extremely rich, expensive plans.
That sounds good, until you realize that you're losing thousands of dollars in take-home pay, or tens of thousands, in exchange for coverage that you'd never buy if you had that money in your paycheck.
The goal of a free-market plan is to channel the cash companies now spend to cover their employees back to the workers who really pay for it. That puts consumers in charge. Once in command, those consumers would typically receive bigger paychecks, and have plenty left over after buying perfectly serviceable insurance, chiefly for the unexpected illnesses that are extremely costly to treat. They would also pay for a lot more medical expenses out of their own pocket with the extra cash. That's a good thing, since it would encourage Americans to shop for best prices and highest quality. In other words, they would behave like normal consumers, a practice the current system discourages, and the Obama plan would discourage even more.
So why do we have a system where employers, not employees, usually purchase health care? During World War II, strict wage controls prevented companies from attracting scarce workers by offering higher pay. So in 1943, Congress granted employers the right to offer tax-free health benefits in lieu of extra cash in their paychecks. Until then, Americans were buying policies with their own after-tax dollars. But the law transformed the system, and distorted the marketplace: Suddenly, companies could buy insurance for employees at a far lower cost than they could buy it for themselves, via a big tax subsidy. The goal now is to hand both the cash companies spend on health care, and the subsidy as well, back to consumers.
Here's how the current system works, and a blueprint for fixing it. If an employee earns $110,000 a year, and the employer pays $9,000 towards the employee's $12,000 insurance plan, the worker only gets taxed on the $110,000 salary. The extra $9,000 is, in effect, tax-free income. Say the company dropped its plan and gave the employee $9,000 in extra pay. He or she would pocket just $6,000 after taxes. So companies can buy 50% more health care for employee than the employees could buy if they got the money directly. Of course, the government is making up the difference with a $3,000 subsidy. That money isn't free either. The health-care exclusion is the biggest tax break in the U.S. budget, even bigger than mortgage interest. It lowers revenues, and hence raises taxes, by $300 billion a year.
So here's the best solution. Let's repeal the employer exclusion. In our example, the employer would give its workers the money it now spends on health care in extra pay -- in this case, the $9,000. Why? Because in a competitive labor market, companies need to provide the same total compensation or risk losing employees to rivals. That's just basic economics, and it would still happen even with today's high unemployment rate.
Now, the employee has an extra $6,000 to pay for health care. That's the first part of the solution. Part two is to restore the subsidy, but this time give it directly to consumers. The government would collect an extra $300 billion in taxes. It could grant $2,500 a year to individuals, and $5,000 to families from that pot without raising taxes or increasing the deficit. So a family would have an extra $11,000 to spend on health care.
So which plans would families purchase?
That's impossible to predict with certainty. Many may choose expensive plans that cost as much as the ones their companies provide -- in our example a $12,000 policy. But given the choice, millions more Americans could go for far less expensive, high-deductible policies that cover the big-ticket essentials such as a stroke or heart attack.
That's the way insurance is supposed to work -- not as an open-ended benefit, but as protection against unforeseen, catastrophic events. If your house burns down, the insurance company pays. If you wash the windows or fix the screens, you pay.
Let's return to our example. A high-deductible family policy in Pennsylvania or Kentucky costs around $5,500. The employee would then have $5,500 left over to cover routine tests and physician visits. That would unleash the power of the American consumer in an epic way. Then, we'd see if the laws of supply and demand really work in health care.
The Obama plan would take three regulations that vastly inflate costs on the state level, and enshrine them into federal law. It's young Americans who suffer most today from these laws and would suffer more under Obamacare. As we'll see, in many states they're already forced to pay far more than their actual cost, a major reason so many of the healthy twenty- and thirtysomethings have dropped their insurance. Under Obamacare, they'd be forced under threat of heavy fines to pay what amounts to a big tax to pay for other people's care, chiefly that of older Americans.
The first of these regulations is the "standard benefits package." Twenty states -- including Maryland, Colorado, California, Florida, and New York -- require that dozens of specific benefits be covered in any insurance plan. A typical list encompasses hearing aids, chiropractic services, obesity treatments, autism care, and drug-abuse therapy. The Obama plan, for example, would require coverage for dependents until the age of 26. Many of these benefits are in the state plans not because they're essential to basic care, but because they're promoted by powerful lobbying groups.
Obama wants to mandate these plans for all Americans. He then plans to heavily subsidize them. These mandated, rich packages are a major cause of health-care inflation in many states. Eliminating them would allow consumers to pick among a vast variety of plans.
The second cost-raising regulation is "community rating." Under strict community rating, providers are forced to charge the same premiums for all patients, no matter what their actual costs. The restrictions are extremely strong in nine states, including New York, New Jersey, Massachusetts, Vermont, Colorado, and Oregon.
But young people cost far less to insure than older Americans for a simple reason: They require far less care. Yet in community-rating states, workers in their 20s are forced to pay close to, if not the same, premiums as people in their 50s and 60s whose medical expenses are three to four times larger. For the young, the problem is magnified by standard benefits packages, since they drive up the average cost of all policies in the state. And if any group wants basic policies (rather than extremely comprehensive, rich ones), it's young Americans. As a result, community rating has pushed millions of young people out of the insurance market.
The third damaging regulation is called "guaranteed issue." It requires that insurers accept anyone who applies, including patients with pre-existing conditions such as diabetes and cancer. Once again, the laws undermine the whole concept of insurance. "The carriers want to insure you for insurable events -- stroke, heart attack, or an unexpected illness," John Sheils of the Lewin Group, a health-care consulting and research firm. "What they worry about is patients who go to see their doctor, learn they have diabetes, and enroll to have the provider pay for their care."
A major problem with guaranteed issue is that, once again, it punishes the young and healthy. If a lot of patients suffering from diabetes and heart conditions enroll in the plan, the average cost rises steeply. Once again, in states like New York, New Jersey, and Vermont, everyone has to pay the same, or nearly the same premiums. That's not such a problem for older people because they'll still pay less than what they really cost. But it's a burden on the healthy population, and especially the young.
To be sure, America must help diabetes patients pay for their expensive care, and we'll tell you how in a minute. But the costs shouldn't be inordinately born by young Americans just starting their careers at relatively low salaries.
The Obama plan would make all three of these big inflators the law of the land. The free-market solution is to let freedom ring by eliminating all three restrictions. Here's an elegant solution: Allow consumers to buy insurance across state lines -- a freedom that's now banned and would stay banned under Obamacare. Today, a 25-year-old in New York pays six times as much for coverage as someone the same age in Kentucky. If the restriction on nationwide shopping were abolished, New Yorkers could buy their policies at a fraction of the current cost in Illinois or Pennsylvania. Business would flow to the least-regulated, lowest-cost markets. That would be a big victory for deregulation.
Creating a true national market is essential to my proposal. But the free-market solution will work only if it overcomes a huge obstacle: protecting people with pre-existing conditions. The numbers are hard to get, but a good estimate is that several million Americans suffer from cancer, diabetes, or another chronic illness. Many of them are now insured by their employers. Those companies don't charge them any more for insurance than they do their younger colleagues.
Remember, under my proposal, employers will drop their plans and put the money they now spend on health care into their workers' paychecks. So let's take a middle-income worker with diabetes. Today, in New York State, he or she would be covered, because the patient could enroll in a plan required to take all comers and could not be charged any more than a healthy 30-year-old.
But once consumers can shop across state borders, the young people who subsidized those with pre-existing conditions will flee to low-cost plans offered in other states. Community rating would disappear. In theory, the diabetes sufferer would face a huge increase in premiums. America can't allow that to happen.
It's clear that to make a mostly free-market plan work, those with chronic illnesses need to be protected. Fortunately, the template is already in place. About 30 states, usually those without requirements for community rating or guaranteed issue, have high-risk pools that automatically enroll people with pre-existing conditions. Their premiums generally can't exceed 150% of the average plan within the state, even though the patients may actually cost far more. The full costs of the high-risk pools are covered from state income- and sales-tax revenues.
Under a free-market plan, states that don't now have high-risk pools would create them, modeled after the models that work best. The problem posed by pre-existing conditions would be temporary. As consumers start spending their own money on coverage, the market would explode with creative insurance plans. It's likely that carriers will offer plans like the ones in Europe that offer coverage for as much as 40 or 50 years. Under those policies, in exchange for making essentially a lifetime commitment to the insurer, the consumer pays a specified schedule of rates that cannot be changed.
Many elements of this free-market model are included in two excellent plans. One is Sen. John McCain's proposal as a candidate. But McCain didn't take on the problem of pre-existing conditions that's a linchpin of any reform package.
Today, the best solution is the one proposed by a group of Congressmen, including Paul Ryan, a Wisconsin Republican. It would include most of the elements I've recommended. But what the Ryan plan misses -- as did the McCain platform -- is the importance of reforming laws that limit the supply of medical services.
Indeed, giving health-care consumers control over their own money -- the money employers now spend for them -- would create a true market where bargain prices and high quality should reign. That's "should."
But deregulating the demand side isn't enough. Health care is rife with more monopolistic restrictions than any other industry: certificate-of-need laws that restrict the number of hospitals in states from California to New York, medical-licensing restrictions that prevent nurses and other practitioners from providing basic care, and limitations on the number of physician specialists. Believe it or not, it has practically become gospel in medical circles that shrinking the doctor supply is a way to save money. At best, it's extremely dubious economics to think that shrinking the supply of anything can reduce costs!
Deregulating the supply side isn't even part of the health-care debate at the moment, yet it's crucial to our free-market model. The Obama plan does nothing to ease these restrictions and, in fact, is offering the providers more monopolistic protections to support the plan.
Read Shawn Tully's other installments in this series:
Designing the ideal health care system