Efficient Resolution of Moral Hazard in Health Insurance Industry

February 22, 2010

Sankarshan Acharya
Pro-Prosperity.Com and Citizens for Development

February 22, 2010

To:       Honorable President Barack Obama

Cc:       Honorable House Speaker Nancy Pelosi

Honorable Senators Harry Reid, Richard J. Durbin and John McCain

Honorable Chairman, House Oversight and Government Affairs Committee

Honorable Chairman, Financial Crisis Enquiry Commission

Sub:     Efficient Resolution of Moral Hazard in Health Insurance Industry

Dear President Obama,

The current health insurance debate bares an important issue that I have been researching on: efficient resolution of moral hazard.

The current system of health insurance has effectively “blackmailed” the taxpayers as the spending on Medicare and Medicaid has exploded.  But it has also “blackmailed” employers and producers of globally competitive goods and services with higher insurance premiums.  

The persistent trade imbalance shows that the nation has become less competitive with the dollar poised to fail as the global reserve currency.  The total direct export of the healthcare industry as a percent of its total annual sales within USA must be miniscule.  The direct contribution of the healthcare industry to national competitiveness is thus very negative. 

Does the healthcare industry contribute to national competitiveness indirectly?  Despite our claim of the best healthcare system, Americans have become the most obese in the world.  The healthcare system may have increased American life expectancy.  But a longer life with little savings or income is a nightmare for a nation aspiring to stay at the top, globally.  Despite an increase in life expectancy, large trade imbalances have persisted with new fears about dollar losing its global reserve currency status. 

Everyone now admits that preemptive healthcare reform is urgently needed.  But urgency must not lead the nation to a greater financial catastrophe.    

                                               

The government now wants to regulate health insurance premiums and impose other health insurance reforms.  Are we headed for a health insurance trap akin to the one laid out by the idea of regulating banks due to deposit insurance?  When people panicked about their deposits in early 20th century that led to the Great Depression, the Congress offered government guarantee of bank deposits and taxpayers are now wallowing in the too-big-to fail banks.  Will the health insurance panic of the early 21st century lead to too-big-to fail insurance companies with even a greater burden on taxpayers than the Medicare and Medicaid? 

Fortunately, there exists an efficient resolution of moral hazard in health insurance industry akin to my Safe Banking Policy.  It is Safe Health Insurance Policy, which is optimal from the point of view of taxpayers. To see the contours of this policy, let’s consider the paradigm of optimal governance used in my paper on efficient resolution of moral hazard in banking.[1]  The foundation of this paradigm comprises three elements:

1.      Firms with goals to maximize their long-run profits and market values.

2.      A market environment that grants entrepreneurs (insurance companies) the freedom to issue insurance policies anywhere.  This prevents the government from deciding whether or not a failing insurance company or other companies will operate based on largesse in form of new money printed on the back of the vast majority of people.  Failed insurance companies can be freely (without government intervention) bought by others with resources through trading in free markets. This free market environment is scripted in the Constitution of the U.S. Everyone including CEOs of companies, the President and Members of Congress has sworn to uphold the Constitution.

3.      A not-for-profit government that upholds the Constitution and serves the best interests of the vast majority of households, at least those who innovate and produce globally competitive goods and services.  The assumption is that the prosperity, stability and security of a nation depend on these households and that they have a proclivity for charity to support the non-producers. 

The equilibrium in this model will be a Safe Health Insurance Policy which I have not written elsewhere but in this memo.  It comprises of the following elements:

1.      No government guarantee of any insurance company including the ones that become too-big-to fail.

2.      No regulation of health insurance premium by the government.[2] 

3.      A Safe Health Insurance Company to cater to the panic-prone insured.  I believe this is like the Public Option that was rightly presented by the president, but unfortunately not accepted by the Senate. 

The prevailing confusion among policymakers and pundits stems basically from the fact that the current economic paradigm is based on just the first tenet of governance: maximization of profits of firms.  This tenet is fundamentally important.  But a paradigm of governance will be unstable with rules based on just the first tenet.  Skipping the other two tenets amounts presumption of irrationality or stupidity of people who have chosen to be governed through democracy of the people, by the people and for the people. 

It is unconstitutional to adopt policies that are not based on a paradigm of governance that allows free trading and a not-for-profit government serving the best interests of people.  

My paper portrays a Safe Banking Policy of the kind stated above as the uniquely efficient (first-best) resolution of moral hazard for the banking industry.  It is constitutional. The same can be argued for the Safe Health Insurance Policy.  In the first-best equilibrium, the government does not bailout firms, but maintains equilibrium as per constitution. 

If we artificially restrict the environment within the above model to only maximization of profits by firms, then we can obtain a second-best equilibrium. The second-best equilibrium is obviously not stable in a democracy in which people do not want to be restricted by a lack of trading.  Lack of restriction means free trading (purchasing) of failing firms like banks and health insurance companies without government intervention. 

What has been happening now including in the fateful year of 2008 is not free trading.  Firms have been seeking and the incumbents in government have been making too many and too large unfair (lopsided, opaque) bailouts by using new money printed on the back of people who produce, serve and create new goods and ideas to make the nation secure, competitive and prosperous.

With profound regards,

Humbly and sincerely,

Sankarshan Acharya


February 22, 2010

To:       Honorable President Barack Obama

Cc:       Honorable House Speaker Nancy Pelosi

Honorable Senators Harry Reid, Richard J. Durbin and John McCain

Honorable Chairman, House Oversight and Government Affairs Committee

Honorable Chairman, Financial Crisis Enquiry Commission

Sub:     Efficient Resolution of Moral Hazard in Health Insurance Industry (Arguments)

Dear President Obama,

The “Safe Health Insurance Policy” presented in the previous memo faxed today has the following principal components: 

i.                    Public Option.  By having this option, the public will have an option to buy the insurance policy enjoyed by the members of Congress.  This option was promised by President Obama during the election.  The public can retain their current private health insurance plans, but will have the right to choose the public insurance plan.

 

ii.                  Expansion of private health insurance plans across state borders.  This opportunity is offered to the existing insurers and to new companies willing to enter the industry.

iii.                Every individual compulsorily buys health insurance.  This is necessary to avoid the risk to the currently uninsured individuals and to avoid the cost to the insurance industry due to individuals buying insurance only after they learn about serious illnesses.  Compulsory health insurance is necessary to avoid individual moral hazard.  Low income groups can be offered subsidies to ensure that compulsory health insurance does not jeopardize their living standards.

iv.                Neither insurance premium nor healthcare is regulated by the government. 

 

The purpose of this memo is to argue that the Safe Health Insurance Policy with the Public Option is necessary to minimize the healthcare cost to taxpayers and to the insured, to maintain a high quality the healthcare system and to enhance the national competitiveness.  Regulation of the health insurance premium or healthcare will lead to a greater bureaucracy and moral hazard of the type we are facing in the banking industry. 

The Public Option is the crucial element of the Safe Health Insurance Policy that was correctly conceived to be so by the President during his campaign.  I do not understand why the President has withdrawn his election promise and is currently lukewarm towards the Public Option.  The Senate rejected the Public Option in the healthcare bill it passed.  The President now wants regulation of the insurance premiums that the Republicans are opposed to. 

 

My argument about the Public Option is not that the President should keep his election promise or that people should fairly be given the same health insurance coverage as the members of Congress have. 

My argument for the Public Option is strictly based on (i) elimination of moral hazard in the insurance industry that has crippled the national competitiveness of U.S. businesses, government agencies and educational institutions, (ii) continuance of the best healthcare system of the country with minimal government involvement and (iii) lowering of the cost of insurance without compromising quality.  These are indeed the publicly stated goals of both parties and the President. 

The question is: why did the Senate reject and the President relegate the Public Option? 

My inference is that people (1) have a common longing for the Public Option, (2) believe that the Safe Insurance Policy is the first-best (efficient) resolution of the scourge of moral hazard in the healthcare industry, and (ii) get angry with Washington for not fulfilling their common longing. 

Let’s discuss a serious point that the Public Option will somehow socialize the best healthcare system because it involves the government.  At first blush, this seems to be a very germane argument: the government bureaucracy in-charge of administering the Public Option will increase in size and cost and the quality of healthcare will spiral down as a result.  This is a very specious argument because the Safe Health Insurance Policy will not require the public to buy the Public Plan.  The public will retain their private plans if they wish to, as was argued eloquently by the President during the campaign.[1]  If the bureaucracy expands to make the quality of healthcare inferior and the cost higher than competing private plans, the public will not choose the Public Plan and the bureaucracy will become a skeleton as a result.  If the Public Plan’s bureaucracy turns out to be efficient to provide a better health insurance plan than any other private insurance company, it is something that people will desire to have.  In this case, the government running the Public Plan will prove its efficacy and survival.  But will the bureaucratic efficiency grow the Public Plan too big to kill the private health insurance industry and then turn costly and inefficient?  If so, the people will notice such growth, cost and comparative efficiency of the private and public plans.  Arguments against the Public Option thus presume that people cannot see the reality.    

I beg the honorable President and members of Congress to not assume at any moment that people cannot see the truth that the first-best (efficient) solution to the current health insurance crisis is the Safe Health Insurance Policy.  The proof that people vividly see this truth should be obvious from their anger towards Washington for the health insurance bill passed by the Senate.  They are angry that the elected representatives do not see the truth. 

To enhance national competitiveness and restore prosperity amid stability of USA, the Safe Health Insurance Policy is necessary, notwithstanding specific cutoffs for subsidies and taxes.  

With profound regards,

Sankarshan Acharya



[1]The President’s popularity was perhaps hit when he remained silent towards the specious arguments.