Health Care – Understanding Rescission

The last couple of days I have tried to focus on aspects of the debate over heath care reform that make no sense or, at least, muddy the waters. In particular I have been trying to defend the case that there can be no pure market solution since such a solution implies unacceptable social ramifications. Yesterday in particular I tried to explain why a for profit insurance system drains resources away from care towards the exact opposite: the denial of care. This perverse behavior is entirely explained, and supported by, the profit motive.

By way of pressing this argument further I want to draw your attention to Timothy Noah’s excellent summary, in Slate, of the activity known as ‘rescission’. This is the effort that insurance companies make to deny claims based upon a thorough examination, not of a consumer’s health, but of the veracity of their application form.

You can read his article to get the details, but essentially the idea behind rescission is to deny a claim based upon an error or deliberate misstatement in a person’s original application for insurance. I pointed out already that the screening of forms is very expensive, so it is typical for insurance companies to perform a thorough screening only when they are confronted with a potentially large payout. When a consumer falls ill and then submits a claim that has the potential for such a large payout, say for long term cancer treatment, it pays for the insurer to try to find reasons to deny the claim. Remember that the entire premiss of an insurance company is to avoid minimize payouts where they can in order to boost profits. This attempt to deny service even after accepting premiums and providing coverage is called ‘rescission’.

So a considerable amount of administrative cost is incurred by a private insurance system to deny claims on the basis of rescission.

There is of course a solid motive for this: any system that pays out large sums of money has to be on the alert for cheating. We would expect a government system to audit its payouts in order to avoid fraudulent activity, so we should also expect a private company to do the same.

But there is s difference: in a government system the motivation is to eliminate only fraud. It is not to deny legitimate claims as well. In a private for profit system there is an incentive to go much further and to deny perfectly legitimate claims on the basis of the flimsiest of reasons. Indeed, as Noah points out, at least one insurer bases the bonuses of its workers on the dollars of claims they can find a way to prevent being paid.

Let me repeat: this is all perfectly acceptable free market activity. Maximizing profits is the motive, not providing care in a free market system. Hence the behavior that appears bizarre: it isn’t when viewed through the right lens.

The outcome can be very odd though: the two stories in Noah’s articles have become legendary in the blogosphere because of their infuriating stupidity. Turning a woman down for breast cancer surgery because she neglected to report her acne treatment on her original application form is perverse beyond words. It defies any interpretation of reasonable. But it would have been profitable had the insurer managed to pull the denial off.

The point to take away from stories like these is not the stupidity of the examples, they are beyond the pale, but to keep focusing relentlessly on the structure of the incentives in the systems itself.

My argument against a private health care system is built upon the inherent contradiction between private profit motives and maximal social outcomes. There is no way to build a private health care system so as to align the incentives within in it so as to accomplish a maximal coverage. Markets always ration. Rationing is an unavoidable consequence of scarcity. Let’s all get over that. As a consequence of this feature of a free market there will always be a large portion of the population without coverage: the price system will settle in at a cost that many people are either unable or unwilling to meet.

The free market counter argument goes as follows:

That those without coverage have all chosen to be so. For a variety of technical and quirky theoretical reasons it is not possible in a free market system for people to end up in a condition that they did not choose. So, for instance, in the neo-classical theory that provides the backbone for the free market argument there is no such thing as involuntary unemployment. To a standardly trained economist a person is only ever unemployed because they want to be. [The reasoning runs like this: if a person is unemployed and really wants a job they would find one even if it meant taking a massive pay cut. Ergo: if a person is unemployed that can only be because they value leisure more than the pay cut. This all excludes people who are ‘between jobs’ which the neo-classical folks also regard as voluntary.]

Similarly: to a free market theorist someone who lacks health care insurance has decided to be that way. It has nothing to do with cost or some abstract [ in their view] ability to pay. This is why the defenders of the market system point to the number of uninsured and try to reduce it by excluding chunks of the population. They exclude young people – they know they are healthy and so ‘choose’ not to get insurance because its unnecessary. They exclude rich people on the basis that those folks can pay for health care out of pocket. And so on.

It is very important to remember that to a free market purist everything you see around you, everything, is the result of choice. So, to them preserving choice is paramount. And they have constructed their theory of a market to demonstrate that markets are a better way to allocate scarce goods like health care whilst still preserving choice.

It is crucial to their argument that we view preserving choice as a neutral concept. By this I mean that their theory does not account for limitations placed upon choice by things such as income levels. The distribution of income is swept aside as irrelevant by the free market folks. Why? Because their theory argues that you get paid only as far as you contribute. So, in order to preserve a neutral and yet optimal social outcome, incomes are regarded as a function of your contribution, and so your ability to consume is similarly constrained only by your contribution. Which, naturally, is a function of your free choice. And a society that is constructed around both freedom of choice and ‘you only get out what you put in’ manages to create a wonderfully powerful illusion of ‘fairness’.

You will notice that the theory includes absolutely no reference to inherited wealth, income distribution, social, racial, or sexual discrimination, or any other possible cause of involuntary distortion of wage earning capacity. It is entirely ‘what you see is what you get’.

Ultimately it can be reduced to a tautology: the outcome must represent our desired outcome because we chose it; and since we desired such an outcome we must have chosen it.

So the outcomes we observe are the outcomes we desired. And the outcomes we desired are the outcomes we observe.

Wonderful logic and impeccable math.

But silly.

Still that line of reasoning lurks behind every defense of a free market. And provides a perfectly logical defense of rescission.

To those of us who believe there are outcomes we desire that a market cannot provide, all that money spent on rescission is money diverted from providing care. To a free market purists it is simply a cost of ensuring the preservation of choice and the subsequent maximization of the insurer’s desires.

Expect much more rescission if the reform efforts fail.