Health Care and the Free Rider Problem

Why does the Federal Government want everyone to have health insurance? Trust me; it has nothing to do with trying to turn this into a Socialist or Totalitarian state. The reason is actually an artifact of Capitalism; it’s what is known in economics as the “Free Rider Problem.”

A Free Rider is basically someone who doesn’t contribute to the welfare of the group but enjoys all of the benefits. The name comes from the example of people who sneak onto public transportation without paying the fare.

Let’s consider a simple hypothetical example involving a town’s health care. Note the word simple. For this example I’m going to make the assumption that the health care provider and the health care insurer are the same people called the Health Care System (HCS).

Now the way things work in this town is people pay for health coverage and when they get sick or injured, they receive treatment at no additional cost. In any given year around 10% of the people need treatment and, on average, treatment costs $100.

If there are 1,000 people in town then typically 100 will need treatment at an average cost of $100 so that’s $10,000. The HCS is also taking some risk here so let’s also assume that it needs to make at least $1,000 profit to make it worthwhile to remain in business in that town.

That means that the HCS needs revenues of R = $10,000 + $1,000 = $11,000 so it would have to charge each person in town $11 a year. But let’s assume signing up is voluntary and 10% of the people choose to exercise their “freedom” and refuse to participate.

So now there are only 900 people in the pool and, using the same assumptions as above, 90 will need treatment at a cost of $100 so R = $9,000 + $1,000 = $10,000. So the HCS would have to charge each person participating $11.11.

There’s the first problem; the rates just went up by 11 cents. But there is another problem. What happens if one of the 100 people that aren’t participating gets sick or injured? The HCS can’t simply ignore them, and, by law, they aren’t allowed to anyway.

That means that the HCS will treat not 90 people, but 100 at a cost of $100 each for a total of $10,000 in cost. But that would wipe out the $1,000 profit that the HCS needs. That means the HCS has three choices. It can break the law and ignore uninsured people that get sick or injured. It can pack up and leave, or it can adjust premiums and charge each of the 900 $12.22 to cover the 100 that aren’t buying health coverage, the Free Riders.

Now the rates have gone up by $1.22 and that causes a possible second problem. If you believe supply and demand, the increase in premium costs is going to drive even more people out of the market, so now maybe 120 people choose not to buy coverage which causes another increase in premiums, which may cause even more people to take the risk and not buy the health coverage. Luckily, for most people, the demand for health coverage is fairly inelastic so small premium increases are unlikely to make people drop out wholesale and force HCS to shut down. But it will mean people will have to make do with less somewhere else.

The same thing happens if it’s not a matter of choice but necessity. If the 100 people without health coverage don’t have it because either they have no access to it or can’t afford it, the exact same thing happens. It costs everyone else more money.

Yes it’s more complicated than I’m making it and one could pick apart some of the details of the example but the basic theory is sound.

Making health insurance available to everyone is not only the right, as in moral, thing to do; it’s the economically smart thing to do. Making health insurance accessible, affordable and MANDATORY will not only improve the well being of the entire country it will most likely reduce, or at least help get under control, health care costs.

So that’s the objective. Now, we can argue this on two levels. Either you can disagree with the objective of everyone has health coverage and everyone contributes to the cost or you can disagree. That’s one conversation.

A totally different conversation is you can agree with the objectives but disagree with the methodology, strategy or process being employed to get there. Note that “you can’t MAKE me buy health insurance” would not be part of this conversation but the other one.

So, for those of you so violently opposed to Health Care Reform, which is it? I’ve never been able to get a straight answer to this question.

Now, for those of you that are already jumping up and down screaming “it’s because they’re gonna raise my taxes,” I want you to consider two things. First, if everyone is paying their fair share, there’s no need to raise taxes and, second, raising taxes would be the worst possible solution to the Free Rider problem because it is, by definition, inefficient, and even Democrats know that.

For those of you that are already jumping up and down screaming “it’s because they’re going to use my taxes to subsidize someone else’s health care,” if you are in the top quintile of household income, you’re probably right. So what else is new? The top quintile always subsidizes everyone else in a progressive tax structure.

If you’re asking so how is this different from paying higher premiums in the Free Rider example, it’s different because it’s a progressive distribution, and if some people need to be subsidized, those doing the subsidizing are those that can most afford it.

If you are not in the top quintile, then it’s far more likely you’re being subsidized than you’re subsidizing.

I have problems with some of the Health Care Reform provisions, or perhaps more accurately, lack of provisions, but nothing I’m going to get overly excited about. Specifically, I’m disappointed that tort reform and the ability of insurance companies to compete across state lines didn’t make the cut.

So, for those of you that appear to be so violently opposed, why?