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Health Insurance: Yet Another “Free Market” That Has Failed


It’s always great to hear about American “free market” capitalism when our markets are light years from being free. The United States stands as a beacon for freedom, yet in the Heritage Index of Economic Freedom we barely squeeze into the top 10 at number nine. George W. Bush was supposedly a free market proponent during his time in office, yet he was still able to increase spending on federal regulatory agencies by more than any president since Gerald Ford. (Coincidentally his father came in at a close second, though he managed to rack up his regulatory spree in only one term.) As my colleague Andrew Syrios explains:

In reality, Bush’s presidency has been an eight year long string of red tape. The Bush administration added a staggering average of 76,526 pages to the federal registry each year. In 2002, he signed off on Sarbanes-Oxley, one of the most overbearing regulations since the New Deal. The SEC alone saw it’s budget triple over eight years, which of course wasn’t quite enough to catch a 50 billion dollar, decades long Ponzi scheme. The Bush administration increased federal spending on regulatory agencies by 6.5% per year (adjusted for inflation) and staffing by 6.3%. That’s more [staffing] than any president since Richard Nixon (another president bestowed with the “free market” myth).

And this brings us to the health insurance market; yet another “free market” that has failed us, which is why we need ObamaCare, an individual mandate, and the milk police. Individuals are not allowed to purchase health insurance across state lines, limiting consumer choice and competition. You are also stuck with whatever state-level insurance mandates get forced into your policy, regardless of whether you want or need those services. In fact, state mandates can increase the cost of premiums between 30-50%.

Allowing consumers to go across state lines would allow them to avoid the mandates in their state and seek lower-mandate states which fit their needs best. Further, the state-by-state oligopoly system does nothing but make it more difficult for individuals to obtain health insurance with the adverse selection problem; while an individual mandate will do nothing but further inflate the cost of premiums and increase the moral hazard problem.

Policy makers have long argued that allowing free interstate commerce in the health insurance market would lead to an erosion of consumer protections. That is, insurance companies would base their operations in low-mandate states and sell their products to folks across the country within that regulatory environment. The fear is that certain services, like the requirement to cover adopted children and disabled adult children, for instance, would be abandoned in many states.

The Cato Institute’s Michael Cannon dismissed this complaint rather effectively in Cato’s Handbook for Policymakers:

Opponents will claim that regulatory federalism will lead to a ‘‘race to the bottom,’’ with some states so eager to attract premium tax revenue that they will eliminate all regulatory protections or skimp on enforcement. In reality, both market and political forces would prevent a race to the bottom. As producers of regulatory protections, states are unlikely to attract or retain customers—insurers, employers, or individual purchasers—by offering an inferior product. Purchasers will avoid states whose regulations prove inadequate, and ultimately, so will insurers. Moreover, the first people to be harmed by inadequate regulatory protections will likely be residents of that state, who will demand that their legislators remedy the problem. The resulting level of regulation would not be zero regulation. Rather than a race to the bottom, regulatory federalism would spur a race to equilibrium—or multiple equilibria—between too much and too little regulation. That balance would be struck by consumers’ revealing their preferences.

We have a health insurance market, and a health care industry, which is drowning in regulations. This goes a long way in explaining why national health care expenditures are spiraling out of control. A good place to start would be to not call everything in the US “free market”capitalism, because it isn’t. And that means not blaming everything on free markets, as if that’s what we’ve had all along, to curry favor for more government regulation. This takes both an honest public discourse and an understanding of economics.

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2 thoughts on “Health Insurance: Yet Another “Free Market” That Has Failed

  1. As a licensed health insurance professional for 20 years, CATO has this one wrong. Not being able to sell health insurance across state lines is not what is harming competition with health insurance. Its the fact that the large legacy insurance companies command the discounts that they get from doctors and hospitals by pushing around their volume of insurance customers/patients. No matter how lean and mean or innovative a new insurance company might be, they can’t compete in a lopsided, dysfunctional marketplace as long as this unlevel playing field exists.

    Yes, many states do have drowning regulation, but undermining states rights by circumventing the McCarran–Ferguson Act will lead to an outcry for greater Federal regulation of insurance as problems arise from rising sale of health insurance products that will not be fully-regulated at the state level. Undermining McCarran-Ferguson, which keeps the Federal Commerce Clause at bay with regard to insurance regulation, will lead to increasing federal power in health insurance matters at the expense of the states’.

    If we’re serious about restoring competition in the health insurance market, let’s actually focus on the most important issues that have been causing the number of market players to shrink.

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    • To add to your story, after the oligopoly insurance companies command the discounts from medical care providers by pushing their volume of insurance customers/patients, the medical care providers respond in kind with large-scale systematic increases of all of their supplies/services. It is a never-ending cat and mouse game. The patient is always who loses, especially the uninsured.

      You make some very interesting points about States’ rights and I appreciate your experience and perspective. I think you too easily dismiss interstate health insurance markets. To say they are “not what is harming competition with health insurance” seems to be paradoxical. Oligopolies harm competition (and when they’re formed due to legislation, all the worse). Limiting consumer choice harms competition. I’m quite sure that not being able to sell insurance across state lines is not the only thing harming competition, but it has to be one of them. Opening up competition across state lines would make the legacy insurance companies across the country compete. While lean and mean startups might still struggle to compete (which is how it currently is anyways as you recognize), you’d at least have all of the behemoths competing.

      How would you address the most important issues that have been causing the number of market players to shrink in the current state-by-state oligopoly system?

      I don’t see how the majority of patients lose by being able to cut 30-50% off their premiums, design plans that work best for them, and to no longer be at the mercy of a few huge insurance companies. I think more individuals would be able to circumvent the adverse selection problem and obtain health insurance in such a system. In 2014 and beyond, no one will be turned down for pre-existing conditions, but this is just another upward pressure on everyone’s health insurance costs, and another reason why a 30-50% cut would be welcomed. I don’t know too many people that would be crying out for Federal regulation of insurance if their premiums were cut in half. But I do recognize that any special interest group can get federal regulation passed with enough money.

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