Fall 2009Vol. 4, No. 3

This article is from TOS Vol. 4, No. 3. The full contents of the issue are listed here.

How the Freedom to Contract Protects Insurability

Suppose you ran a restaurant that offered an all-you-can-eat lunch buffet. For a modest price, customers could help themselves to as much as they wanted from a variety of your dishes. But you also set certain restrictions—for instance, customers were forbidden to share their food with other customers or take food off the premises (no “doggie bags”). Most people would find such rules completely reasonable.

Now suppose the government passed a law forbidding restaurants from setting such restrictions on buffet meals. What would happen? Your costs would skyrocket as customers shared buffet food with others who had purchased only a cup of coffee, and stuffed food into Tupperware containers to take home for dinner. Soon you would either have to raise the price of the buffet drastically or simply discontinue it.

Although most people would be outraged at a law forbidding restaurants from setting such rules for their buffets, some Republicans are proposing laws that would forbid health insurance companies from setting similar rules with respect to their offerings.

Currently, most health insurance policies cover medical problems that patients develop after they have purchased the policy, but not expenses arising from preexisting medical conditions. To remedy this alleged injustice, Republican governor Tim Pawlenty of Minnesota and Republican Congressman Mike Coffman of Colorado propose to forbid insurance companies from denying coverage on the basis of preexisting conditions.1 They argue that because individuals currently find it difficult or impossible to purchase insurance after they develop serious medical conditions, such as heart disease or cancer, the government should force insurance companies to accept such customers and to cover their preexisting conditions.

It is true that patients today with preexisting medical problems can have difficulty purchasing health insurance. But forcing insurers to cover such patients is not the solution. On the economic level, such coercion would create many new problems. For instance, under such legislation patients would have a strong incentive to delay purchasing insurance until they got sick, knowing they could not be denied coverage at that time. Why pay for insurance before you need it if you can wait and purchase it when you need it? Thus, many people would simply go without insurance until they needed medical care, at which time they would purchase an insurance policy and receive immediate coverage far in excess of the price paid for the policy. Such laws would legalize plunder.

To cover their increased costs, insurers would have to raise rates for everyone—as they have already had to do in states such as Massachusetts, New York, and New Jersey, where insurers are currently saddled with such legislation.2 And, of course, as insurance prices rose, politicians would demand that everyone be required to purchase insurance to “spread the costs more equally”—as politicians in Massachusetts have already done and as politicians in the Democratic-controlled Congress are currently proposing. The result would be mandatory insurance—with its associated problems of long waits for care, skyrocketing costs, and economic hardships for patients and doctors.3

Moreover, in conjunction with these economic problems, such legislation is immoral. Requiring insurers to cover preexisting conditions violates the rights of both insurers and customers to contract according to their own judgment. As the Founding Fathers so eloquently put it in the Declaration of Independence, the proper purpose of government is not to violate individual rights but “to secure these rights.”

Medical insurance does not grow on trees. It is a complex financial service created by businessmen seeking to make a profit. This service enables a pool of individuals to voluntarily share the risks of unlikely but expensive adverse events, such as a serious accident or illness. Willing participants pay premiums to the insurer in exchange for the assurance that if a covered accident or illness befalls them, they will receive payments from the insurer according to contractually agreed-upon terms. Insurance thus creates voluntary “risk pools” in which customers can combine and share their risks to their mutual benefit.

To make money organizing and managing these risk pools, an insurer must carefully analyze the likelihoods and costs of possible adverse events; he must calculate the proper prices to charge customers in exchange for the promised payments; he must set these prices at levels that enable him to make a profit while offering a value to customers; and so on. In short, to establish and maintain a profitable insurance business, the insurer must think rationally and act accordingly—and, to do so, he must be free to enter or refuse to enter contracts according to his own best judgment.

Likewise, a potential customer must decide whether the benefits offered by a prospective insurer are worth the price of the premium. He must consider his personal health, lifestyle, financial situation, and future plans. He too must think rationally and act accordingly—and, to do so, he too must be free to enter or refuse to enter contracts according to his own best judgment.

A free market in health insurance (which does not currently exist) would respect the rights of both insurers and customers to voluntarily contract to mutual benefit. In such a market, individuals who do not desire coverage for preexisting conditions would be free to purchase plans without such coverage from any insurer willing to sell such a policy. Likewise, those who do desire coverage for preexisting conditions would be free to purchase such coverage from any insurer willing to sell this kind of policy, which would likely and reasonably be more expensive—just as a buffet plus the dessert bar would be more expensive than a buffet alone. There is no such thing as a free lunch or a free dessert—or free insurance coverage.

In a free market, profit-seeking businessmen would likely sell insurance coverage to individuals with preexisting conditions for an appropriate price, just as they would seek to meet substantial demand for any service if profitable. However, in the unlikely event that some individuals sought to purchase a policy that covered preexisting conditions, and no insurer would sell them such a policy, they would still have a viable alternative. They would be free to form their own risk pool with other like-minded individuals willing to share those risks. They would be free to create their own insurance company.

In fact, many Americans have already formed private pools in which members voluntarily share each other’s health-care costs. For instance, more than 100,000 American Christians are members of “health-care sharing ministries”—arrangements whereby members pay a monthly fee to the ministries, which in turn distribute that money to other members facing expensive medical bills. Such groups typically accept members who meet certain religious and lifestyle requirements regardless of preexisting medical conditions.4

Unfortunately, these health-care sharing ministries currently cannot guarantee payments to their members, because the government would then treat them as insurance companies5 and subject them to myriad onerous state and federal regulations that specify what prices they may charge, what benefits they must offer, and which customers they must accept.6 The only thing preventing individuals from creating their own contractually binding risk pools today is the government.

The problem with health insurance in America today is not that insurance is not free (a literal impossibility), but that the insurance market is not free. Government regulations prevent interested parties from contracting to create and join risk pools on terms that would satisfy the demands of the marketplace. Hence, the proper solution is not to add more government regulations (such as requiring insurers to accept patients regardless of preexisting conditions), but rather to eliminate the existing regulations and move toward a fully free market in health insurance.

A free market would not only help those with preexisting medical conditions; it would also help those who currently have insurance but who could find themselves unable to maintain their policy in the future if they develop a serious health problem. The New York Times reports that—where permitted by law—the UnitedHealthcare insurance company offers a “future insurability” option to its customers purchasing individual insurance plans.7 This “UnitedHealth Continuity” option guarantees that customers will be able to retain their United insurance plan regardless of subsequent medical problems. This option is a form of insurance on future insurability and is an example of what University of Chicago professor John Cochrane calls “health status insurance.”8 (The option was initially available in twenty-five states, and at the time of this writing United was seeking approval from insurance regulators to offer it in the other states where it does business.) Freeing the market and thus legalizing such innovative options would not only make them more widely available; it would also bring down their cost, as other insurers would seek to provide willing customers with similar, better, and less-expensive options.

The problem with the proposals set forth by Republicans such as Pawlenty and Coffman is the same as the problem with the proposals set forth by the Democrats: All such proposals violate the rights of insurers and potential customers to contract with each other according to their own best judgment. If Republicans wish to offer a genuine alternative to the Democrats (and to the status quo)—if they want to offer a real solution rather than further problems—Republicans must fight for a genuinely free market in health insurance. To do so, they must recognize and uphold the principle on which such a fight depends: the principle of individual rights—including the right to contract.

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1 Tim Pawlenty, “To Fix Health Care, Follow the States,” Washington Post, August 3, 2009; Mike Coffman, “Coffman: Dems’ Legislation Won’t Accomplish Stated Goals,” Denver Post, July 30, 2009. Pawlenty and Coffman’s proposals are unclear regarding whether they would forbid insurers from denying specific claims due to preexisting conditions, or from declining to accept patients with preexisting conditions, or both.

2 “The Truth about Health Insurance,” Wall Street Journal, August 12, 2009.

3 Paul Hsieh, “Mandatory Health Insurance: Wrong for Massachusetts, Wrong for America,” The Objective Standard, vol. 3, no. 3, Fall 2008.

4 Adelle M. Banks, “Faith-based Mutual Insurers Worry about Health Care Reform,” Christianity Today, vol. 53, July 2009, http://www.christianitytoday.com/ct/2009/julyweb-only/130-51.0.html.

5 “What Is a Health Care Sharing Ministry?” Alliance of Health Care Sharing Ministries, 2008, http://www.healthcaresharing.org/hcsm/.

6 Lin Zinser and Paul Hsieh, “Moral Health Care vs. ‘Universal Health Care,’” The Objective Standard, vol. 2, no. 4, Winter 2007–2008.

7 Reed Abelson, “UnitedHealth to Insure the Right to Insurance,” New York Times, December 2, 2008.

8 John H. Cochrane, “Health-Status Insurance: How Markets Can Provide Health Security,” Cato Policy Analysis, no. 633, February 18, 2009.