Posted December 19, 2006

*A shorter version of this post appears on the New Vision blog, Foresight.

During the 2004 presidential campaign, John Kerry made reinsurance a cornerstone of his health care reform plan. Now, Harvard School of Public Health Professor Katherine Swartz has published a new book, Reinsuring Health: Why More Middle Class People Are Uninsured and What Government Can Do, which is clearly designed to put reinsurance back on the political agenda in time for the 2008 elections.  Swartz's book offers a deft analysis of the problem of the uninsured in America today, and proposes an incremental but important solution.  It's not perfect, as I will argue below, but it would go a long way toward helping to slim the ranks of the uninsured.

At the most basic level, reinsurance is exactly as unglamorous as it sounds; it means, literally, "insuring again." If "insuring again" doesn't sound like a great way to help people with no insurance in the first place, consider the basic logic.  Reinsurance is insurance which is purchased by insurers themselves, rather than individuals.  Why do insurers want more insurance?  The insurance business is predicated on the idea that a certain number of people will get very sick each year on average, and it sets premiums for care based on the probability of that event occurring.  But, while these expectations are right on average, some years will be very bad, and a few extra people will get very sick. 

The result is that the insurer may not be able to afford the costs of care in that particular year, which ultimately means that one bad year is enough to bankrupt an insurer, even if they have properly calculated their average annual risk.  This is where reinsurance steps in.  If a "reinsurer" covers the risk of bad years for a large number of insurers, then it can prevent any single insurer from going bankrupt in a bad year, and its own expenditure should be relatively smooth, since the probability of all insurers having a bad year in the same year is relatively low.

Okay, so if you have followed me until now, you may be thinking: reinsurance sounds like a good idea, but how is it going to help the problem of the 46 million uninsured in America? This is where Swartz's book makes a key contribution.  That contribution is to redefine our understanding of the uninsured.

The first part of her book demonstrates what I will call the problem of the "missing middle."  The missing middle is both the middle-class, and the middle demographic range, adults between 25 and 44 years old.  Swartz documents an important trend in the demographic profile of the uninsured: the precipitous decline in the percentage of the uninsured who are children (under 19) and the rise in the proportion of 25-44 year olds without insurance.  The likelihood of being uninsured has risen for all age groups since 1979 except for children and the elderly.  In other words, while government programs like the 1997 Children's Health Insurance Program (CHIP) and Medicaid/Medicare have expanded to cover the poor, the young, and the elderly, it is the middle-aged, middle class that represents a growing fraction of the uninsured. 

America has always assumed that this demographic would get coverage from its employers, or purchase it on their own.  But, as Swartz demonstrates, the decline of traditional unionized work and the rise of contracting for services means that employers are much less likely to provide such care, and the costs of purchasing it in the individual market have been rising very fast.  Middle-aged, middle class workers cannot afford health care at current prices.

Since the labor market is not going to change anytime soon, the main solution to the problem of the uninsured is to reduce the costs of purchasing health insurance in the private market for individuals.  According to Swartz, the way to do this is to reduce the fears of insurers that the individuals who are purchasing their insurance products are those that are likely to be sickest and costliest for them.  This problem is known as adverse selection: when insurance coverage is voluntary, there is a tendency for those who think they are most likely to use the insurance to be willing to pay for it, while the healthiest will stay away.  Fears of adverse selection lead insurers to do everything they can to avoid covering the sickest, which means those who most need coverage may end up without it.  Adverse selection also leads to rising premiums.  If insurers take on costlier patients on average, then they end up having to charge higher premiums to cover their care.  But this makes healthier patients even less inclined to purchase insurance, which further biases the insurer's risk pool towards the sick, which makes providing coverage even costlier, which can lead to a spiral of increasing premiums.

Here, finally, is where reinsurance connects to the problem of the uninsured.  If the federal government reinsures private insurers for their costliest patients, insurers no longer have to fear adverse selection, because they are insured against it.  Swartz's preferred reinsurance plan would cover the costs of any insured individual's care once it exceeded a certain threshold.  As a result, two things would happen which should reduce health care costs for the missing middle.  First, there would no longer be a need to jack up premiums because of fears of adverse selection.  Second, insurers would no longer spend administrative resources trying to target the best risks and avoid the worst risks. This saves them money, savings which should also result in lower premiums.  These lower premiums, in turn, would encourage the missing middle to sign up for insurance in the first place.

Swartz's plan is not a panacea.  She also calls for further expansions of government programs to deal with the poor and young which would not be helped by her scheme.  But her core argument is that reinsurance will help the problem of the missing middle, which now makes up a substantial fraction of the uninsured.

So will it work?  Reinsurance is not a new idea.  It was first proposed by the Eisenhower administration in 1954, but never enacted.  More recently, in 2001, New York state introduced the Healthy New York program, which is a health insurance option for individuals and small employers.  The program, which uses state reinsurance to cover expensive care, has been credited with substantially reducing premiums relative to the individual market.

Reinsurance suffers from four problems.  First, it will not eliminate the adverse selection problem entirely, because insurers still have incentives to seek out the cheapest patients (insurers still make more money on cheap patients), which means that savings on the administrative side will be relatively small.  Second, it will not affect one of the biggest cost drivers in the American health system, technological innovation, which is not a shock to individual insurers, but causes premiums to rise across the board.  Third, reinsurance assumes that the only reason people do not sign up for insurance is cost, but there are low risk individuals who will not sign up at any price unless they are forced to.  Swartz has nothing to say about making insurance compulsory, but universal coverage will ultimately necessitate some kind of mandate.

But perhaps the idea's greatest weakness is political: reinsurance is not exactly an inspiring concept.  It does not elicit passionate support the way that an improbable reform like national health insurance does.  Since the estimated cost of such a program is between $5 and $20 billion per year, some political commitment is needed to pass funded legislation.  Does reinsurance have the sex appeal to generate excitement on the campaign trail?

Perhaps the right way to sell reinsurance is not simply as a mechanism for achieving universal coverage, but as a way of reducing premiums for everyone, even those who have coverage already.  Robert Blendon, an expert on American opinion about health issues, argues in a recent Health Affairs article that the rising cost of coverage is as important to most Americans as the uninsured.  An October Kaiser Family Foundation poll found nearly half of voters were concerned about rising health care costs. Rising costs are undoubtedly at least as important to businesses as well. And we know from the Clintoncare debacle that if insured Americans are afraid of losing coverage or seeing their premiums rocket, they become far less inclined to support increased coverage for others.

America's attempts to provide expanded health insurance coverage have come in two flavors.  There are, first, the soaring, idealistic big bang plans to reform the system and cover everyone at a go, such as Clintoncare, which have engendered great expectations, and uniformly resulted in great failures.  And then there are the incremental plans which slowly augment the ranks of the insured, such as the Children's Health Insurance Program, which have quietly succeeded at far less ambitious tasks.  Approximately 6 million children have been covered by CHIP, according to the latest government figures.   

If reinsurance isn't a sexy idea, it is squarely in the camp of the incremental policies which have succeeded in America in the past.  The beauty of the reinsurance solution is how little change it requires in the nature of the American health system.  The private insurance market remains the primary insurer for the middle class, the system remains voluntary, choice of insurer is preserved, and the federal role is no greater than in the catastrophe reinsurance or secondary mortgage market.  It may not elicit passionate support, then, but is unlikely to elicit passionate opposition either.  And the historical record suggests that avoiding passionate opposition may be more important than exciting passionate, but ultimately impotent, support. The greatest weakness of reinsurance may also be its greatest strength.