Health Insurance “Innovation”

The This American Life crew, once again proving that they can cover any topic they want better than anyone else in the media,* has a segment in this weekend’s episode on rescission of health insurance policies – insurers’ established practice of looking for ways to invalidate policies once it turns out that the insured actually needs significant medical care. (The segment is around the 30-minute mark; audio should be available on that page sometime on Monday.) The story describes a couple of particularly egregious cases, such as a woman who was denied breast cancer surgery because she had been treated for acne in the past, and a person whose policy was rescinded because his insurance agent had incorrectly entered his weight on the application form.

The legal basis for rescission is that when you sign an insurance application, you are warranting that the information on the application is true; if it turns out not to be true, the insurer can get out of your insurance contract. It’s particularly nasty in practice because the insurer does not immediately investigate your application to determine if it is accurate before selling you the policy (that would be impractically expensive); instead, the insurer waits – years, in many cases – until you actually need expensive health care, and then does the investigation, which at that point is worth it because of the payments the insurer could potentially avoid. Also, you can lose your coverage for innocent mistakes, which are easy to make since the application form asks you if you have ever seen a doctor for any one of a long list of medical conditions that you are certain not to recognize or understand. (In a Congressional hearing, the CEO of a health insurer admitted that he did not know what several of the conditions listed on his company’s application were.)

This reminded me of nothing so much as all of those “innovations” created by credit card companies, such as universal default, penalty rates, and double-cycle billing, which are really just ways to generate fees that you are unlikely to accurately estimate at the time you sign up for the card. It’s legal; it makes more money for the insurer (or credit card issuer); once one company does it, other companies have to, or they won’t be able to compete; it’s disclosed in such a way that customers don’t understand what they are getting into; it nails you when can least afford it; and it even has a plausible economic justification. Credit card issuers claim that their arsenal of hidden fees makes the cost of credit more closely reflect the riskiness of the borrower, and without the fees they would have to charge higher interest to everyone; health insurers claim that rescission is necessary to deter fraudulent applications, and presumably without it they would have to charge higher premiums to everyone.

Also, it’s definitely an innovation. I’m sure health insurers have always had fraud investigation units, which looked for red flags on new insurance applications to identify suspicious customers. But the idea that you should (a) target customers precisely because they get sick and need health care and (b) go after them for innocent mistakes is not an inherent part of the insurance business, and is something that some clever person came up with as a way to make more money – not a way to provide more coverage or better service to customers at lower cost.

And it’s terrible. Basically, anyone who had to fill out a medical underwriting application to get health insurance (this is basically the individual market, not the group market that people are in if they get insurance through their employers) is at risk of finding out that that insurance doesn’t actually exist precisely when he or she needs it most. The insurers claim that rescission is very rare; at the Congressional hearing, two of three industry representatives said it happens to less than 0.5% of policies per year. But that is a deeply misleading number. That means that if you are in the individual market for twenty years, you have a 10% chance of your policy being rescinded; 30 years, and it goes up to 14%. There is a big difference between health insurance and a 90% chance of having health insurance. And remember, insurers only try to rescind policies if you turn out to need them; so the percentage of people who lose their policies when they need them is even higher. (The denominator should exclude all those people who never need expensive medical care, at least not before 65 when they go onto the single-payer system.)

I know that rescission does not logically prove that some private health insurance system cannot work. For one thing, Congress could simply pass a law banning the practice except in cases of intentional misrepresentation (although the free marketers would complain about increasing government interference in the “free market”). But it is evidence that the private health insurance system we have does not work. Yes, it’s just the individual market, but it’s the individual market that’s growing, not the employer-based market. And the system we’ve got, like the credit card industry, is one where the name of the game is finding ways to make the product you sell worth less to the customer than the customer thinks it is worth. (The more common way this is done is by burying exclusions and limits in the fine print.)

This is the system that the politicians who are dug in against health care reform – and everyone knows who they are – are defending. I’d like to see them try to defend it openly, instead of hiding behind the tattered banner of fiscal responsibility.

* OK, that may be a bit of an exaggeration. I am really a huge fan, so I get carried away sometimes.

About James Kwak 133 Articles

James Kwak is a former McKinsey consultant, a co-founder of Guidewire Software, and currently a student at the Yale Law School. He is a co-founder of The Baseline Scenario.

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