The Economy | A 'solution' on insurance has problems

President Bush's sweeping new proposal for health insurance may or may not fly through Congress.

Either way, however, it ought to make us reexamine the current health-insurance setup and how it evolved.

The president's plan, unveiled during his State of the Union speech this week, would radically alter the tax treatment of health-insurance plans.

No longer would health insurance from an employer be treated as untaxed income, giving it a tax advantage over health plans bought by individuals on their own.

Instead, every American would be eligible for an annual tax deduction, capped at $7,500 for individuals and $15,000 for families, to cover the cost of buying health insurance.

Leveling the playing field this way has its pluses and minuses. On the plus side, people who leave a job or work for themselves would no longer be socked for the full cost of their policies - a situation that leaves many families struggling to pay premiums and forces some to go without any insurance at all.

The current setup also aggravates Americans' anxiety about their jobs, making many people reluctant to move or start a new venture for fear of losing coverage.

On the other hand, it is possible - some analysts say likely - that Bush's proposals would tempt some employers to drop health insurance from the package of benefits they now offer employees.

If workers can buy their own individual health insurance on the same terms as employers, then some firms might logically decide it's simply not their responsibility to offer insurance at all.

Would that be a problem? Yes - because the tax subsidy is only one of the reasons employer-based insurance grew to dominate the American health-care scene over the last half-century or so.

According to Wharton health-systems expert Mark Pauly, Americans who get coverage on the job enjoy several benefits over those who buy insurance on their own.

For example, when an insurer sells a policy to a large employer, the cost of marketing and administering that policy might add 5 percent to 10 percent to the price.

But when a family or an individual buys health insurance, Pauly said, those overhead costs might add 30 percent or 40 percent to the premium.

It's easy to see why. When an employer writes the check, insurers get hundreds or thousands of customers without having to make multiple sales calls or send out scores of monthly statements.

At the same time, insuring people in large groups can be more efficient because risks are spread out. In effect, healthy individuals subsidize sick ones.

Ideally, the same thing happens when people buy insurance on their own. Insurers balance the risks by signing up many individuals, expecting that only some will need health services at any given time.

But there's a catch. In a competitive market, some insurers can focus on attracting people more likely to stay healthy - say, by offering lower rates to the young and affluent.

That makes it harder or more expensive for those with higher risks to obtain coverage - a phenomenon economists call "adverse selection."

Employer-based health insurance basically evolved because it offers a solution to this adverse-selection problem. The workplace brings together people with random health risks, and the tax code gives them an incentive to buy insurance as a group.

So if the current tax incentive goes away, what then?

One alternative, of course, would be to put all Americans into one big insurance pool. That's the basis of the so-called single-payer idea: Have the government insure everyone, as Medicare does now for people over 65.

Another - which you don't hear about as much - could involve channeling health coverage through other "random" groups - such as religious, ethnic or fraternal organizations.

In fact, that's largely the system we had 100 years ago.

Could it be time for a revival?

More on this in a future column.