How Economists Think About Health Care

Peter Van Doren joins us this week to talk about health care economics. How much should we spend on health care, and how would we know the answer to that question?

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Peter Van Doren joins us this week to talk about health care economics. We talk about risk aversion, risk neutrality, expected value statements, guaranteed renewable care, the ACA as a health care redistribution program, and health-status insurance. How much should we spend on health care, and how would we know the answer to that question?

Show Notes and Further Reading

Van Doren mentions “The Market for Lemons,” (1970) a fascinating concept and paper by George Akerlof.

Mark Pauly’s 2003 paper “Incentive-Compatible Guaranteed Renewable Health Insurance” is mentioned several times in the episode.

Van Doren also talks about John Cochrane’s writings on health-status insurance. Here is a Cato Policy Analysis from 2009 on the topic.


Aaron Powell: Welcome to Free Thoughts from in the Cato Institute. I’m Aaron Powell. 

Trevor Burrus: I’m Trevor Burrus.

Aaron Powell: Joining us yet again is Peter Van Doren. He is senior fellow at the Cato Institute and editor of Regulation Magazine. Welcome back to Free Thoughts.

Peter Van Doren: Thanks for having me.

Trevor Burrus: We should just call these, “Trevor and Aaron go to school With Peter Van Doren as our guest,” what we’re going to be learning today from Peter.

Aaron Powell: Today, we’re going to be learning [00:00:30] about health insurance.

Trevor Burrus: Health care economics, generally speaking. 

Aaron Powell: What is insurance? At least how do economists tend to think about insurance?

Peter Van Doren: Let me give you a definition and some terms in it. Then I’ll unpack those terms. Well, all markets involve gains to trade. Remember that, we’ve talked about that. 170 podcasts have talked about that. People don’t tend to think of insurance in terms of the basics, [00:01:00] that it’s gains from trade. All right. It’s gains from trade between whom?

The answer is insurance contracts or contracts between risk-averse people and risk-neutral companies. I need to define risk aversion, risk neutrality. I’ll throw in risk-seeking as a third bonus definition. Before that, to do that, I need to introduce the [00:01:30] term, “Expected value statements,” which is in economics statistics, expected value is the probability of an event times the value of the event if it occurs.

Trevor Burrus: Getting hit by a bus, so how much that would cost times the 0.13% or what are some probability we come up with that would produce a expected current value …

Peter Van Doren: Correct.

Trevor Burrus: Of [00:02:00] getting hit by a bus.

Peter Van Doren: I want to compare two expected value statements. The first is you have a choice of a 10% chance of a $10,000 accident happening to you in a given year or you have with certainty, with a 100% probability of paying $1,000 every year. To repeat, [00:02:30] these are two equivalent expected value statements which is the probability times the cost. The products in these two statements are equal which is 0.1 times $10,000 is 1,000 or $1,000 times 1.0 is $1,000. 

You can pay $10,000 every 10th year when you have an accident or you can pay $1,000 ever year. What I want to do now is ask each of you, [00:03:00] Trevor and Aaron, to tell me are you indifferent between those two things? Do you prefer one to the other?

Trevor Burrus: I probably prefer paying $1,000, but there is no accident in that situation, right?

Peter Van Doren: I haven’t revealed all that yet. Basically, what I’m doing, well, go ahead, Aaron.

Trevor Burrus: Aaron.

Aaron Powell: I guess I would need to know how much money I already have. Do I have enough money sitting in my account to cover $10,000 [00:03:30] if it already happens.

Trevor Burrus: Oh come on.

Peter Van Doren: A smart student always adds complications. 

Trevor Burrus: Hey, I’m smart too.

Peter Van Doren: I’m asking you to compare two states of affairs with a given budget, the budget constraint is constant. To go, to reveal what I’m trying to get at with my little inquiry here is if you prefer to pay $1,000 every year rather than paying $10,000 [00:04:00] every 10th year, then you are defined as risk-averse. It’s just a definition. You prefer one expected value statement over the other. If you prefer to pay $10,000 every 10th year, if you prefer that, you are defined as risk-seeking. If you are indifferent between these two statements, then you are risk-neutral. 

An insurance contract is a trade between a risk-averse person [00:04:30] and a risk-neutral company. The insurance company has data on population level damages, how often people run into things, how often people get sick. Given that data, they can calculate the average for the whole population, for any subset of the population. They can then charge those averages called premiums to the whole population or any subset of it. Then sign contracts [00:05:00] with all those folks.

Trevor Burrus: Now, there are some specific concerns or difficulties that arise with insurance because of the incentive structures that it produces that concerns economists, what are some of those?

Peter Van Doren: There are two terms often called their market failures. They occur, and I’ll describe them, one is called moral hazard. The second is called adverse selection. Moral hazard is a [00:05:30] shift in the … Make believe all these folks that I describe sign up insurance contracts and because they are insured, they then change the frequency with which damages occur because they are insured i.e. they get more careless because they now are insured. That increase that shift to the right if you’re visually inclined, that shift to the right of the entire population level of damages [00:06:00] is called moral hazard.

Trevor Burrus: Is that something that we tend to see in … I don’t know if the data is that granular. We ask people what they’re expected, we did this basic question. Then we insure them and we see actually it’s shift a little bit, being a little bit more risky than before they were insured.

Peter Van Doren: Some of it comes from health insurance data actually. It comes from universities. Harvard University had a health insurance plan that had a [00:06:30] low option, high deductible coverage. Then for a not very higher price, you got zero deductible. They did an experiment. What they found is once people were insured against everything, the level of illness and damages in that population, in the health insurance pool at Harvard went up dramatically. When I taught at Princeton, Princeton had the same setup. I had a shoulder [00:07:00] injury from college hockey. I was uninsured as a graduate student. Once I got my first job, I immediately signed up for the low deductible plan, got my shoulder repaired and then left the low deductible plan for the … 

Trevor Burrus: This is part of the problem is what you’re saying?

Peter Van Doren: Yeah, right.

Trevor Burrus: Is that the adverse selection problem?

Peter Van Doren: Yes.

Trevor Burrus: Now, we’re on the second part. Adverse selection is what Peter Van Doren did when he was in graduate school. 

Peter Van Doren: [00:07:30] People who sign up or don’t sign up based on personal knowledge of their own condition, relative to what the insurer has, that’s adverse selection. Nobel Prize winning set of articles, Joe Stiglitz, and Mike Spencer, and Akerlof from Berkeley, the Lemons Problem is a popularized version of adverse selection.

Aaron Powell: [00:08:00] Why would we buy insurance then if … Let’s say I think that I’m going to spend, there is a $10,000 accident possibility, but one in ten chance. If so, if I already have the $10,000 and I could just scroll it away somewhere, is there any reason for me to buy insurance or is insurance always about I don’t already [00:08:30] have enough to cover the cost, this is an easier way or a cheaper way to get into coverage?

Peter Van Doren: To go back to the basics, the choosing to become insured stems from your preferences about two kinds of states of the world which have equivalent expected value. If you are risk-neutral, if all people were risk-neutral, there would be [00:09:00] no insurance. There would be no gains from trade. Risk-neutral people wouldn’t make trades with risk-neutral companies. It’s a nonsensical statement. If you are risk-seeking as a person or risk-neutral, then you both normatively should not buy insurance. Then positively, we predict you will not buy insurance because you are indifferent between paying [00:09:30] large sums of money every now and then for bad things that happen versus paying every year a smaller amount which more or less adds up to the same thing over any long period of time.

Trevor Burrus: We’re not going to be talking about automobile insurance. I mean, that’s not specifically the topic although some of these concerns might be equal, and shared between the two. In the American healthcare market, and specifically, the insurance side of this market which [00:10:00] has come up again because the republicans are looking back at the Affordable Care Act and thinking about what they’re going to do it. Let’s get the lay of the land first about the American health insurance market. How much do we spend on it? What does that spending look like?

Peter Van Doren: Just let me lay out some of the stylized facts.

Trevor Burrus: Stylized facts.

Peter Van Doren: Yes.

Trevor Burrus: This is our band name, by the way. The three of us would be the Stylized Facts. 

Peter Van Doren: [00:10:30] I’ve …

Trevor Burrus: You’re on pickle, Aaron.

Aaron Powell: I’m not going to participate in this. 

Peter Van Doren: I used that adjective again, didn’t I? In 2015, take all the healthcare expenditures in the United States and divide it up 325 million people, the per capita expenditures on healthcare in the United States in 2015, 9,990. $9,990, that’s a lot, per capita. Right? Think, a family of [00:11:00] three …

Trevor Burrus: $30,000.

Peter Van Doren: $30,000, right? In effect, I know I’m a reductionist, but all healthcare fussing is about whether each of us pays more than 9,990 or less than 9,990 i.e. which set of people do we pool with for insurance purposes? Can I find a bunch of people who all spend less than [00:11:30] that and then I claim I’m a part of that pool? Remember, the insurance is the average, the premium will be the average of the people I share expenses with through contract. Well, if we could know ex-ante which people spend a whole lot more than 9,990, consensually, I’m not going to sign a contract with them at the same price.

Trevor Burrus: Basically, you’re saying that if someone is particularly accident prone in your group [00:12:00] and then they actually end up costing $100,000 in a year, that means that you have to pay more to cover them in this basic ecosystem we’re talking about. 

Peter Van Doren: Correct. If we knew that ex-ante, if everyone knew ex-ante whether you’d be above or below 9,990, you wouldn’t sign contracts with them at that price. When I taught my class, I used to bug my students. I wanted to push them into a corner and say, [00:12:30] “You love your grandparents. You care for them dearly.” I said, “Would you voluntarily sign a health insurance contract with them which said take your expenses,” the student’s healthcare expenses each year, “And one of your grandparents’ expenses each year.”

Trevor Burrus: And share them.

Peter Van Doren: And share them by dividing by two. They go, “Oh no.” Right? I’m putting them in a moral dilemma which is they care but would [00:13:00] they voluntarily sign such a contract. The answer they regretfully had to tell me was, “No. I would not. I want to a lower premium for me and a higher premium for my grandparent.” That’s the rub, and healthcare is we’re playing a long complicated, sometimes bitter debate about who will [00:13:30] share cost with whom under a totally free market style health insurance system. Is coercion or force necessary to deal with the sickest individuals? Today, we’ll talk about my claim is that guaranteed renewable individual health insurance did exist and can exist. 
That coercion i.e. what’s called community [00:14:00] rating and a central part of the Affordable Care Act is one method of dealing with this dilemma. It is not the only dilemma. It is the claim that individual guaranteed renewable health insurance cannot exist. Therefore, we need to have community rating, and that, I want to argue in today’s discussion is not true.

Aaron Powell: What type of groups are we talking about that you can select between? You gave the example of your grandparents. [00:14:30] Are you going to be stuck in a group with people who are much older than you and therefore likely to spend more versus someone who is younger, so that’s an age one. Do the groups vary also say geographically?

Realistically, when we’re picking, because you said we might choose, but what kind of choice is there in those groups right now?

Peter Van Doren: Well, age. Age is certainly an indicator. I’ll give you some numbers. The per capita expenditures vary predictably by age. These are 2012 numbers. [00:15:00] Less than 19 years of age, the average is 3,550 a year. Between 19 and 44, it’s 4,458 a year. Between 45 and 64, it’s 9,500 more or less. From 65 to 84, it’s almost $17,000 per capita. Above age 84, it’s $32,400 a year. Healthcare expenditures rise predictably with age. They also [00:15:30] increase with what I call high cost conditions, cancer, diabetes etc. etc. the usual horribles. 

Part of the key guaranteed renewable individual health insurance contracts is that from the data, we know the incidents of those conditions by age. We can precisely design premiums for everybody that’s normal by age. [00:16:00] Because we know the probability of these high cost conditions and how long they persist, we can price out what high cost insurance would add onto the normal premium for people at every age.

Aaron Powell: These guaranteed renewables, would these be something where I buy a plan when I’m at, I guess, 26, my parents have kicked me off their plan and I’m healthy. I [00:16:30] buy it at sum amount. Then I keep paying that sum amount for the less of my life?

Peter Van Doren: The schedule of premiums would rise with age but it would not rise as fast as if you bought a series of term insurance contracts for each year for that same number of years. In other words, by you saying, “I am going to keep paying this [00:17:00] company over a long period of time.” The company in turn can then predictably smooth the rate at which the premiums rise. The increase would be smoother than if you bought a series of …

Trevor Burrus: Single year.

Peter Van Doren: Non-renewable single year health insurance contracts.

Trevor Burrus: Given this concentration of cost, we have this difficult issue, as you said [00:17:30] about most of it seems to be concentrated in … Most of health care cost, it would be concentrated in a certain segment of the population, toward the end-of-life care. Therefore, one level of the problem is it would make some sense for young people to just not go insured if they just don’t have that risk. 

If they have their own risks assessment is [00:18:00] they’re riskier people and they’re okay with the possibility of getting some problem, looking at the numbers here that you have, you say that the top 1% of healthcare users in 2014, 22.8% of healthcare costs and the top 5% of healthcare users account for 50.4% of everything that we spend on healthcare in this country. Just 5% people account. You think you might get there. I mean most people are like, “If I get old, then I’ll become one of those [00:18:30] high healthcare users. Before then, why should I be insured?”

Aaron Powell: Well, let me just piggyback on that question so they can understand these numbers a bit more. We say 5% spend 50%, is that just because we are dealing with rare but expensive events? You’re either spending nothing, basically.

You were healthy that year and you spent close to nothing or you spend an extraordinary [00:19:00] amount because you got very sick or you were injured. It’s not like there is 5% of these people are this group of really sick people. I don’t know if I’m making a lot of sense, but a random selection of all us.

Trevor Burrus: They become sick possibly.

Aaron Powell: They become sick or they get hit by a truck. We can’t point to a population and say, “Yeah, it’s those guys,” the way that we can say people who are really old might be the problem.

Peter Van Doren: All right. If I hear you right, I think you’re asking can I know ex-ante, which people [00:19:30] fall in the high cost category. We know ex-post and I think you’re asking ex-ante. In general, we know that if you’re over age 85, you’re more likely to fall in that category. Although ironically, if you make it to 85, actually healthcare cost go down slightly because the set of people, they’re not random, that end up being that old are in fact extraordinarily healthy on average.

The [00:20:00] short answer to your question is no. We cannot predict ex-ante. Yes, the incidence of high cost things in any given year makes you in this very sick category. Again, 330 million people in the United States. 1% is three million. The sickest three million people in the United States, we spend over $100,000 a year on their healthcare. [00:20:30] Now, the papers that underlie this discussion, one by Mark Polly shows that the persistence of these high cost conditions, the median persistence is about four years. You either get better or you die. That’s what makes guaranteed renewable health insurance possible because the median sick person doesn’t go on forever.

Aaron Powell: [00:21:00] That’s how the insurance company can come out not broke in this is because they can say, “Yes, we’re locking ourselves into potentially getting far less in premiums than this person is going to cost us but we know they’re probably not going cost us a ton for very long.

Peter Van Doren: Four years is the median in the data underlying the …

Trevor Burrus: If they paid us premiums for a very long time before that, we still think we’ll come out ahead basically, on some level.

Peter Van Doren: Correct.

Trevor Burrus: If we lock them in at a slightly rising premium [00:21:30] at 18 or something. Then looking at our actuarial tables, when they’re 74 and they have a very expensive disease for four years, we will be able to afford that and make a profit.

Peter Van Doren: Now, to be precise, the data in the paper, in fact, most healthcare papers, only study the 19 through 64-year-old population. They just sadly, from Cato’s purposes, [00:22:00] the argument about individual guaranteed renewable health insurance assumes that medicare exists and that medicare takes over after age 64. I don’t want to over claim that by starting at age 18, we can take care of things at age 90. That has not been studied so I don’t want to over claim that.

Conceptually, there is nothing strikes me that’s not impossible about that. It would be more [00:22:30] expensive at every age because you’re having to in effect, start paying for those things that inevitably … To answer Aaron’s, okay, in the data that are in this paper, approximately …

Trevor Burrus: This is the Polly paper? 

Peter Van Doren: The Polly paper.

Trevor Burrus: Which we’ll put a link up in the show notes.

Peter Van Doren: Approximately a quarter of males and females who are initially low risk at age 18 will develop a high risk condition by age 55 and almost 40% [00:23:00] are high risk by age 64. If we go to age 75, a much higher number would be in one of the high cost conditions. Aaron asked, “Why if I’m young, again, would and should,” and I want to keep those statements separate, “Why would it be rationale,” let me use that term. Why would a rationale person [00:23:30] who is young, who knows that the incidents of high cost conditions for his or her age group is very low, why would such a person buy the kind of policy that I’m describing?

I go back to the definition. It’s because they’re risk-averse. Because when you’re young, you don’t make that great money. You don’t have that much savings. If you have a car accident or a bus accident or you get leukemia or whatever, [00:24:00] you would be wiped out. You would be denied care because you would not have enough resources to pay for it. In fact, what’s odd about the uninsured young is that people who should be most interested from an economist’s point of view, in being insured are young people without much wealth or access to wealth because they have no buffer to pay for things that go wrong. Yet oddly, kids don’t seem to [00:24:30] care as much about that as economics would predict, and often, are subsidized by their own parents to be forward-looking. 

Trevor Burrus: Well, let’s take a step back then because you don’t like to think about these questions about justice. These are words that don’t usually enter in the way you’re thinking. Healthcare really charges people up. It makes people very upset. They have a view of [00:25:00] what everyone deserves, how people deserve healthcare as a matter of right, all these things which I know is not your field. As more of a broader, when someone says these things, when you hear someone say, “Everyone deserves a certain level of healthcare. Shouldn’t vary based on your age or your sex or your race or these things,” how do you hear that? Do you decode that in your head as a claim about distribution? [00:25:30] The free market, I mean, all these things that you hear, I feel you probably hear those claims in different ways.

Peter Van Doren: Well, let’s talk about it in the Affordable Care Act way which is to talk about community rating as a normative solution to the underlying data that we’ve been talking about.

Trevor Burrus: That’s just part of the law that says that the price can’t vary between people except for five characteristics, age, smoking, geography, maybe a couple [00:26:00] others. 

Peter Van Doren: Even those, there are ceilings that is the premiums can vary so much by age, not whether or not that is the real difference by age. In effect, political limits have been put on the variation. The central insight of economics in my view is that it says let prices do whatever they need to do and deal with distributional issues separately and transparently. [00:26:30] If you, because of your conditions, in effect require very high cost care. You don’t have the resources to fund that care. We have two choices, well, three choices.

One is we can appeal to charity to pay for those things or two, we can explicitly [00:27:00] subsidize the care of that person. Economists tend to favor, if we’re going to transfer resources, do not transfer to institutions. Transfer to people.

Then that let people decide what to do with things. Then if they don’t choose to use the resources we give them for healthcare or education, the things we hope that they would invest in if we give them transfers, if they do not do that, then [00:27:30] from a libertarian standpoint, then our job is done. 

Trevor Burrus: Because they’ve made a choice.

Peter Van Doren: If their lives continue to not go well, despite either the charity, again, libertarians would differentiate between a charitable contribution and a tax and transfer scheme, but economist’s least favorite thing would be setting a publicly subsidized thing that’s separate for those who need care i.e. in the old days, [00:28:00] we used to subsidize city hospitals. There would be hospitals where middle class people would go, and then a so-called city hospital that was publicly funded and had a predominantly poor population, well, that puts poor people who need care in a very terrible position because they don’t have any choices. 

In effect, they’re not only poor but we also say, “If you’re going to get anything, you have to go here.” We don’t [00:28:30] give them choice. Whereas food stamps is a redistribution of economic resources. We don’t say, “In order to get food, you have to go to this provider that’s government sanctioned.” Having an explicitly publicly provided insurance program for poor people would strike most economists as odd because it restricts their choices. We should [00:29:00] separate, are we going to transfer resources to people or not?

If we do, we shouldn’t second guess all their choices. We shouldn’t engage in the stereotype. “It seems to me that are poor people are whatever, don’t make proper choices.” We all have all this hand-ringing over are food stamps overused or underused for junk food or whatever. I, personally, am not interested in those discussions. I don’t like engaging in them because [00:29:30] to me, it demeans the individual. We’re giving them money. That’s the end of discussion. Then let’s stop second guessing everything they do because I don’t want people second guessing everything I do.

Aaron Powell: I’m going to push us in that discussion just a little bit. I often put on my friends on the left hat, but this time my friends on the right, the more conservative hat. If the goal, [00:30:00] what we want to stay off and the reason why we would be worried about not having any subsidy is that we want to prevent people from having their lives destroyed by bad things happening to them. We don’t want to watch people die on the street. We don’t want to watch people die of illnesses that could be cured and so on. There is a compassion angle to it. 

We [00:30:30] can say yes, it’s maybe internalizing or not respecting them to say all these people practice poor judgment. It does seem like poor judgment does play a role to some extent in some level of poverty, goes back to the marshmallow test and what not. It seems like, yes, it’s more respecting of them to say, “We’re going to give you this chunk of money. You can spend it however you want.” [00:31:00] Then if we’re naïve about the degree of poor judgment that exists, and poor judgment seems like another thing that may decline maybe related to age too. 

The very young people who are saying they’re the ones who have to make this decision about whether they need insurance or not because they’re the ones who are least likely to get sick. It’s this harder call than the older person who is like, “Yeah. I better have this thing,” are also the ones who are most likely to practice poor judgment because judgment typically [00:31:30] improves with age. Our libertarian desire to let people have the resources and then leave them alone to make the choices seems like it could lead us back to the very situation we were trying to avoid in the first place with the subsidies which is people leading, having awful things happen to them and then suffering the consequences.

Peter Van Doren: True. In the end, [00:32:00] this an empirical question which is, “What in Peter’s world of transfers and no centrally-provided programs, what percent of bad behavior would exist? We could find out. We could do experiments. Two, then there is just type one and type two errors which is of the set of people we’re helping, if we centrally provide things [00:32:30] through explicit programs and say, “If you want healthcare, you have to go Boston City Hospital or Washington General. That’s the only way you get help otherwise you don’t get any.”

Or think of education, the only way you get subsidizes is if you attend public schools. If you want to do something different, you’re on your own. I’m making a voucher-like argument for healthcare that’s equivalent to what people on the right [00:33:00] often describe in education. Then there is an empirical question of if the ratio of people that Aaron describes is a large portion of the population we’re trying to help, then his concerns clearly strike me as important. My arguments would diminish in importance because my giving the 5% of people who need to be subsidized, the freedom to make better choices, [00:33:30] given that they would do it, whereas 95% of the people we’re helping would make poor choices, let’s say.

If that’s true, then my stance seems to be while very principled, might be described as a waste of taxpayers’ money.

Whereas if the percentages were reversed, and again, we can think of food stamps. People on the right, there is a study released recently [00:34:00] on the barcode data has finally been released by the Department of Agriculture. We now know what percent of food stamp moneys are used for snacks and soda and things like that. It’s higher by a bit than the normal retail non-food stamp subsidized purchasing population. 

Is that bad enough so that I want to go back to [00:34:30] stored cheese in the cheese storage thing which then was sent to food banks, which then was handed out to poor people who had to show up at the right time and the right place to get cheese. Do I want to go back to that system?

Aaron Powell: I have tasted government cheese. Nobody wants to.

Trevor Burrus: When have you tasted government cheese?

Aaron Powell: I knew someone whose grandfather received, and I don’t quite know why or how.

Trevor Burrus: Like a government?

Aaron Powell: Government cheese and it was no.

Trevor Burrus: There is our first album name. [00:35:00] We’re, by the way, Stylized Facts’ first album could be called Government Cheese.

Peter Van Doren: I think we could agree maybe that we need … An empirical answer would inform our value choice about which kind of error is the worse, the they screw up error or we want to give them freedom perspective.

Aaron Powell: Well, let me ask a question about the guaranteed renewables that touches on this but also might be something someone listening to would be concerned about which is [00:35:30] so the idea would be that I make the decision when I’m young and healthy to buy insurance.

Peter Van Doren: Well, the Polly paper actually said you can buy guaranteed renewable insurance at age 55. 

Aaron Powell: Sure.

Peter Van Doren: It would just be more expensive.

Aaron Powell: Right. The idea is that I buy it not knowing what the future holds. Then if I get really sick, my premiums don’t go through the roof so I’ve done okay. That’s my incentive, to keep with that policy going forward. [00:36:00] That seems to work for people who are in the position to make a decision about whether to buy insurance or not and what kind. How does it handle say sick kids? We have a neighbor whose son, 18-month-old son has cancer. They’re spending a ton of money. There is a lot of healthcare costs involved, which is presumably on their insurance. 

That 18-month-old probably was never in a position [00:36:30] to buy insurance for himself. If he had parents who chose not to buy it for themselves or for him when he was born, is he now stuck either not being able to buy it or only ever being able to buy it at this extraordinary cost because he is now in this much higher bracket?

Peter Van Doren: The only fool-proof logical way to deal with the questions you raise is to drive the discussion we’re having all the way [00:37:00] back to age 0. You’re correct. One cannot insure against something that is known. Poor children or children through no fault of their own end up with very costly childhood diseases, that’s already known. We know that. What could insurance do for them? The answer is it can simply share [00:37:30] the variants in the cost among that population of very sick people.

Trevor Burrus: I want to just clarify as well …

Peter Van Doren: Some leukemia people would be slightly higher cost than others. One can insure against that variance.One could not insure against the fact, which is that they have leukemia. 

Trevor Burrus: Just making sure that we’re using the right words here because some people might be listening to what you’re saying, “They can absolutely insurance if you made it the law [00:38:00] that …”

Peter Van Doren: But what you’re saying in the hypothetical …

Trevor Burrus: But also on some definitional level, that’s not insurance anymore. The law is just saying that a third party has to pay for this thing. It’s not actually insuring against that uncertain future risk.

Peter Van Doren: Well, one can insure against only the unknown variance of sum distribution. Well, it’s known at the population level but you don’t know where you’re going to fall in it. If you know where you’re going to be [00:38:30] …

Trevor Burrus: Then you’re demanding someone else pay it, it’s not insurance.

Peter Van Doren: That’s a subsidy. 

Trevor Burrus: We just call it subsidy. 

Peter Van Doren: Yeah.

Trevor Burrus: Which is how some of the stuff worked. The Affordable Care Act for example, it was about cross subsidizing between groups of people and not calling it a welfare payment. 

Peter Van Doren: Correct. Remember, 10 minutes ago I said the economist tendency is to let prices [00:39:00] be transparent and to let all facts be known and then deal with the need to subsidize or not subsidize completely separately. In the real world, there is a perception, particularly among democrats that the public, because America is even though not a Cato kind of into free markets, they’re into it, because of culture and tradition, more than maybe we give them [00:39:30] credit for here in Cato. 

The resistance to explicit redistribution is rather large in the United States. Political forces that lead to redistribution have to be hidden particularly in the views of democrats who generate these programs think that the public support for them would be much much less if the transparency that I prefer did in fact exist. [00:40:00] The only way to redistribute is to have something called community rating where everyone gets a policy at the population average. Then to avoid adverse selection, we have to have an individual mandate. We have to use force to get everyone to sign up because people who are 23 know that their cost probably are not going to be $9,990, the per capita average, that year.

To charge them that premium, they won’t [00:40:30] buy it unless they’re forced to. In the real world, there is lots of cross subsidies in American policy programs. It’s all very hidden. If you go out and ask voters are they being subsidized, most of them will probably say no because they don’t realize that they’re being subsidized.

Trevor Burrus: I want to talk about, and maybe actually we’ve already covered it to some extent. One of the papers that you cite in the outline you gave us for today is by John [00:41:00] Cochrane who I think is Chicago.

Peter Van Doren: He was. He has now gone to Stanford, to Hoover.

Trevor Burrus: Hoover, yeah. His idea of health status insurance, which you heard, is a product that mimics the guaranteed renewability portion of an insurance from a community rating thing. 

Peter Van Doren: Well, Cochrane basically read the Polly paper and said, “Oh, I wrote a paper like that only in a completely different journal way before Polly did.”

Trevor Burrus: Actually to summarize, we [00:41:30] touched on it but the Polly paper says in sum. What is the general? Because we’ve mentioned a few times but we actually haven’t.

Peter Van Doren: Polly did. This is a paper that’s 2003. It’s 14 years ago, way before the Affordable Care Act. It said it examined the medical expenditure panel data. It examined the healthcare expenditures in the United States at the individual level, a big, big sample of those. It then [00:42:00] said, “What would guaranteed renewability …” Well, prior to this paper, Polly actually invested corporately provided, employer-provided health insurance and realized that the premiums don’t rise as much with age as one would think they would. 

Well, health care costs rise by age. We know what that is. The premiums that companies charge their employees and in turn, that companies charge, [00:42:30] insurance companies charge employers don’t rise as much with age as actual health expenditures rise with age. 

Trevor Burrus: Which honestly, it’s confusing.

Peter Van Doren: Polly scratched his head and said, “What’s up with that?” He then went on to say, “Well, what would a guaranteed renewable world look like?” He said it would at every age have a very low cost component for the majority of people that don’t get any health care at all in a year. Then there are 12 high cost conditions and he figured out what those were. He said, [00:43:00] “These occur with the following incidents at every group. Let’s add to the very low cost premium.”

Trevor Burrus: You mean 12, like cancer, that kind of thing?

Peter Van Doren: Actual conditions.

Trevor Burrus: Yeah, conditions, okay.

Peter Van Doren: He added that actuarily fair amount to the low cost premium at every age group. Then went out and said, “How do health insurers, what prices do they charge for guaranteed renewable individual health insurance?” He found that the calculations he made more or less mimicked what companies actually charged.

Trevor Burrus: First of all, [00:43:30] there is an important point which you said a little bit but we can make very clear. Guaranteed renewable health insurance …

Peter Van Doren: Did exist. 

Trevor Burrus: Existed before Obamacare, so at least one of the things that many policy proposals claimed that it was impossible to free market to have this …

Peter Van Doren: The dems seem to, in my view, state something that … The current concern we know, half are facts. They stated something that good [00:44:00] reputable research in my view refuted, which is that this market that you say can’t exist did exist. It did exist. Now, many people didn’t buy it in part because most people have employer coverage. The set of people that need individual health insurance in the United States is 10% of the adult population, something in that range. 

Then Cochrane’s paper said, “Ah. What I’m going to provide is affordable present [00:44:30] value contract that sits with you …” Because all the horror shows that led to Obamacare, “I can’t get insurance. I have a pre-existing condition.” Those large were transitions from employer they have been employed or something. Then they covered and they were laid off.

Then during a recession, after 18 months, they still don’t have a job. Then they’re out of luck. Cochrane said, “Let’s just extend the Polly notion of can we write a financial derivative for the transition from [00:45:00] back and forth between an employer provided and an individual plan?”

Because in the United States, people flop back and forth. Once you have a condition and it’s known, “The individual market doesn’t want you because they know what.” So you’re just going to share risk with other people who have cancer. It turns out that premium is $40,000 a year. Cochrane said, “Can’t you design a probabilistic financial derivative [00:45:30] whose cash goes with you so that as you cycle between employer and individual coverage, no one will discriminate against you?”

Because yes, you’ll face a high premium in the Cato world because that’s what you need to pay on average but you’ll come with this pile of cash because you’ve paid for the derivative that pays for this low probability but high cost health transition that you’ve gone through.

Aaron Powell: Does the paper mention or do we have a sense of how much such [00:46:00] a thing might cost? In order to have health status insurance, am I going to have to be paying an extra $500 a month or is it $20 a month?

Peter Van Doren: Well, remember, go back to the data I gave you about the incidence of high cost conditions is very very low at young age and increases linearly. Well, non linearly actually with age. By age … What did I say before?

Trevor Burrus: 64 [00:46:30] was one … 16,000 but that’s what we currently pay.

Peter Van Doren: Right here, a quarter of both males and females who were initially all low risk at age 18 would be high risk by age 55. Every year, as you age, the probability of being in a high cost condition increases. Depending on the high cost condition, as that probability approaches [00:47:00] 0.5 times $50,000 a year, you could … Yes, the premium could be high if you don’t start out when you’re young but in fact try to get guaranteed renewable insurance at age 55 because half of you by next year, the data I just gave you, if you’re 55 and you join, 40% of those people who join at that age next year could be in [00:47:30] a high cost condition. That gets expensive.

Trevor Burrus: It seems that some people, they have a problem with the fact that we’re talking about the economics of people’s lives right now. 

Peter Van Doren: A sentiment that I understand …

Aaron Powell: Like a scene in Fight Club.

Trevor Burrus: Which scene in Fight Club?

Aaron Powell: Where he is doing the calculation about whether to reissue or recall for the cars based on [00:48:00] how frequent, which is played as a horror show.

Trevor Burrus: Yeah. It’s a sentiment I understand. Nothing is free. How do you react to this why are we talking about nickels and dimes with people’s lives attitude?

Peter Van Doren: Because someone has to pay. By not wanting to talk about this, healthcare has gone from 8% of GDP to 17% [00:48:30] of GDP.

Trevor Burrus: Do you think that’s part of this thing that we don’t like to talk about the nickel and dimes of people’s lives and then we politically do things …

Peter Van Doren: If everyone says it’s immoral to talk about a budget constraint, then …

Trevor Burrus: This is a problem.

Peter Van Doren: There is a budget constraint.

Trevor Burrus: Yeah. That does seem to be a problem. 

Peter Van Doren: We can make believe there isn’t a budget constraint. When we do that, we end up spending a lot of money on this thing. I mean, Robin Hanson at GMU says [00:49:00] in his view, a lot of healthcare expenditures are to assuage guilt over death and things related to it. It doesn’t really stop it. We’re in a fluent country. We spend a lot of money to avoid these … Interesting discussion is [00:49:30] medicare now allows one to spend a lot on one’s death.

Trevor Burrus: Wait, wait. Clarify what you mean by that.

Peter Van Doren: Medicare covers everything until you die. We know, the data show, I’d have to go back and look. I can’t say off the top of my head. A non-trivial percent of medicare expenditures occur in the last six months of life. We know that. Now, we’re not very good at predicting that six months. We can’t go [00:50:00] to a complete game in which I’m about to describe.

What if families were given the following choice? You can spend $200,000 on me in the next two years or I could stop healthcare treatment and the government would split the savings with you and your relatives. Many many people find this discussion absolutely abhorrent. They would think, [00:50:30] “No. We should not.” This is econ gone nuts. We should not go down this path.

Trevor Burrus: Did you say econ gun nuts?

Peter Van Doren: Gone nuts.

Trevor Burrus: Oh, gone nuts. Okay.

Aaron Powell: Also, you just described an Agatha Christi novel. 

Trevor Burrus: Will and splitting. 

Aaron Powell: Yeah.

Trevor Burrus: Yeah, exactly.

Peter Van Doren: Grandma wanted us. 

Trevor Burrus: Yeah.

Peter Van Doren: Now, some people, I know a family because they chose the diagnosis with pancreatic cancer, the survival rate is very very low for that, [00:51:00] they chose to do no care. None. Because they know the treatments involved would probably not do much and make life, the quality of life not very good. This family conscientiously decided way before any symptoms were horrible to just forego all treatment. Well, that family saved the nation a ton of money. Now, they did not do it to save money. They did it [00:51:30] because of their own healthcare decisions. If lots of families did that, we’d save lots of money. The question is, is there any reasonable way in which some of those savings … Right now, those savings aren’t shared with the family in question. 

Trevor Burrus: Well, it seems to me that the real moral quality [00:52:00] of the healthcare debate needs to come in about the actual cost of these procedures because if you make things cheaper, questions about distribution change. If you made treating cancer a $20 pill because of some sort of innovation then your discussion of how much spend and how much distribution is changes. 

Peter Van Doren: One libertarian example that should be near and dear to our listener’s hearts is dialysis is [00:52:30] the one treatment, kidney dialysis is the one treatment that’s 100% funded by medicare regardless of age, regardless of age. It’s not just old, anybody on dialysis in the United States, that is free. Kidney transplants are not and a market for kidney, a market to incentivize a donation of kidneys is illegal. To the libertarians, this is crazy. 

We will spend a gazillion dollars on dialysis. [00:53:00] You’re hooked up to a machine for three days a week for the rest of your life or we could give money to somebody to create more supply of kidneys for transplant purposes.

Trevor Burrus: Yeah. That’s one side but also innovation for actually coming up with better ways of doing things that are cheaper. This also seems to be a thing that we can’t ignore the discussion that maybe we can lower that $9,000 by coming up with cheaper ways of [00:53:30] doing things or is it always going to be the case that people are spending … Does it always fill the amount of money allotted to it or could we actually bend that down and spend $8,000 per person and save as many lives and make as many people happy or does it just the money fill what is allowed to it?

Peter Van Doren: Many on the right claim that because of government involvement in healthcare, because [00:54:00] of the extensive government involvement in healthcare that Moore’s Law which governs the IT world rapidly decreasing cost because of technological innovation, that that does not arise in healthcare because of government involvement. If there were more market forces, the miracle of cost reduction that we see with computers and smartphones would also [00:54:30] show up to a much greater extent in healthcare. That’s a fair way of putting the claim. In the end, it’s testable but hard because we don’t have … Government involvement in healthcare is so extensive everywhere in the world. The United States is an outlier for our lack of … We’re on the low end of government involvement that it’s very hard to test, find a place or set of circumstances in which we [00:55:00] can see whether or not this claim is true. 

Aaron Powell: You mentioned a lot of the healthcare expenses, as Trevor mentioned, is paying for guilt around death. 

Trevor Burrus: That was Peter, yeah.

Aaron Powell: Guilt around death is something we can innovate our way out of. It may simply be that yes, if we can cure cancer, it just means that now that last little bit in whatever is going to kill a person or old age, we’re still [00:55:30] willing to spend up to our level of guilt or if it’s on you, up to your level of fear of death or something that’s …

Trevor Burrus: I think it’s another way to put it what I was asking. Let’s say we do come up with a $20 pill for treating cancer. A lot of people in their 60s who get cancer take that pill, cancer is gone. Now, they live to 95. Keeping someone alive at 95 for one day more, to six months more in some situations is very expensive. Now, we just spend it at that point. We’ll always …

Peter Van Doren: [00:56:00] Heart disease has gone down. Smoking rates are down among men. Compare 1970 to now, the expenditures on heart attacks, heart disease etc. etc. that’s gone down over time. Now, we spend it on hip replacements. The price of those is going up. The literature in healthcare economics tends to argue that [00:56:30] because the subsidies exist, the money flows into healthcare. Companies find technological breakthroughs that are very expensive that will do stuff for health even though it’s marginal. This Octivo, you’ve seen an ad on television for Octivo.

Trevor Burrus: Did you say Devo?

Peter Van Doren: Octivo.

Trevor Burrus: Okay. I thought you were going to start singing with it something. 

Peter Van Doren: I’m thinking, got the pronunciation right. Notice, all drugs have three syllables. They just draw …
Trevor Burrus: Octivo. Okay.

Peter Van Doren: It’s a lung cancer [00:57:00] drug, late stage. It says it gives people longer life, blah, blah. It did the trial. It was approved. It’s three months, three months extra life, three months. It’s expensive. Okay. 

Trevor Burrus: There is a brighter for it.

Peter Van Doren: Right now, medicare approves it. Well, insurers approve everything not because the marginal benefits are greater than the marginal cost, as long as the marginal benefit is greater than zero, [00:57:30] regardless of the cost. It’s almost like environmental policy. Can we reduce air pollution a smidgen at a great experience? Yes. We can.

Trevor Burrus: Do it. 

Peter Van Doren: Same thing with healthcare. It’s very hard to say no.

Trevor Burrus: Here is a good final question on that. How much should we spend on healthcare? How would we know the answer to that question?

Peter Van Doren: Wow.

Trevor Burrus: Is that a big enough one for you?

Peter Van Doren: Yes. Believe it or not, [00:58:00] there is a literature that tries to say what the price of a statistical life year ought to be. The answer is about $100,000 now in the United States. That’s the economist answer.

Trevor Burrus: The Kip Viscusi model…

Peter Van Doren: Exactly. This comes from how much do people in high risk occupations accept in wage rates to deal with [00:58:30] the possible mortality risk? It’s no $9 million per statistical life saved. Then when you work it out to a year, it’s about $100,000. That’s one way of … I mean, if you want to use market indicators …

Trevor Burrus: Based in people’s choices about the value of their lives and the risk they put forward …

Peter Van Doren: Then we should never spend in a public sense, when taxpayer’s money [00:59:00] is at stake, we should never spend more than $100,000 per statistical life year saved. There is a literature that talks at length about what cures and do and do not pass those tests etc. etc. 

Aaron Powell: Thanks for listening. This episode of Free Thoughts was produced by Tess Terrible and Evan Banks. To learn more, visit us at