The notion that sick people are more prepared to pay for health insurance is fundamental to how governments set health policy – and how insurers price health cover. But Professor Michael Keane’s award-winning research suggests it may not be the sick, but the smart, who are the insurers’ best customers.
Economic theory suggests that people who are in the worst health should want to buy more health insurance. After all, they are most likely to use it. It’s known as the theory of ‘adverse selection’. But until now, research into who actually buys health care has failed to support this theory. On the contrary, it seems that healthier people tend to buy more health insurance than the less healthy. This is known as ‘advantageous selection’.
There have been a lot of theories about why this may be. One is that healthier people are richer and simply have more money to buy insurance. But even if you look across a group of people with the same wealth, it is the healthier people in the group who buy more insurance, not the sicker ones.
The explanation became clear following research into data on US senior citizens. This is a group about whom a lot is known, thanks the to the Medicare administrative records that were made available for the project. They are insured under the government-sponsored Medicare insurance scheme. They also have the opportunity to buy supplementary insurance to cover considerable gaps left by Medicare. Medicare keeps detailed information on health and expenditures for individuals. The research project was able to access data on an individual’s healthcare costs, and a list of hundreds of possible health conditions.
The project married the facts and figures from Medicare with data about less tangible traits that might be relevant to a decision whether or not to buy health insurance. The Health and Retirement Study (HRS) is a long-term study of a large group of senior citizens in the United States, which measures risk aversion, cognitive abilities such as maths and reasoning skills and how far people plan into the future: in short it provides insight into a whole battery of psychological areas.
By combining the data from the two sources: Medicare and the HRS, the research team were able to build a sophisticated model that pinpointed expected health care costs for each person examined in the study.
They found that, other things being equal, smarter people buy more insurance. They also found that smarter people tend to be healthier. Putting the two together, you get healthier people buying more insurance – advantageous selection.
However, if you look across people of equal measured intelligence, it is in fact the case that that the sicker ones among them do buy more insurance. So the economic theory of adverse selection does apply after all.
The reason this matters, particularly at a time that healthcare reform is on the public agenda, is that the theory of adverse selection – that sicker people buy more healthcare – underlies our understanding of how insurance markets work. It is why we have insurance ‘risk pools’. Risk pools are the systems which enable, or even require, people to buy insurance as part of a group. This may be a firm (as in the US) or a whole country (as in Australia, and other countries that have some form of national insurance coverage).
If insurance is provided privately, and people do not have to participate in pools but are free to negotiate individual insurance contracts, then prices could rise dramatically, because the insurers (believing in adverse selection) would expect that mostly sick people would want to buy insurance. This could make health insurance unaffordable for those in good or average health.
There are a range of factors that impact people’s decisions on whether or not to buy health insurance. To seniors in this study, the freedom to stay with their own doctor was a key reason they chose not to buy insurance – believing that most schemes would require them to change healthcare providers. When setting healthcare policy, public bodies need to take into account the broad range of factors that influence the decision on whether or not to buy healthcare. Governments need to understand how people make choices before they can make policies aimed at influencing people’s behaviour.