Memo to presidential candidates: The problem with health care is that people don’t shop for health insurance

We now have an idea of how three of the seventeen or so Republican candidates would move beyond Obamacare.  Gov. Bobby Jindal, Sen. Marco Rubio and, most recently, Gov. Scott Walker have all outlined in varying levels of detail a plan to repeal and replace Obamacare.  

Each candidate leads with a proposal to reform the tax treatment of health care spending and they all do so under the banner of lowering costs.  That is indeed the right place to start.  However, none of them adequately explain why health reform must start with the tax code.  This is unfortunate because that in turn means none of them adequately explained one of the fundamental problems health reform must solve.

They all highlight the need for tax equity.  Health care costs paid by employers are excluded from income.  This provides substantial tax savings to their employees that is not available to people who must buy health coverage on their own in the individual market.  Yes, the inequity isn’t fair and it should be fixed, but inequity isn’t the underlying problem.

The candidates do hint at the problem.  Walker explains how tax credits for individuals will lead to “expanding options and lowering costs for health plans offered outside the workplace.”  Jindal comes closest when he says “true reform would provide incentives for consumers to serve as smart shoppers, saving money by engaging in healthy behaviors and taking control of their health care choices.”

So what is the problem?

Simply put, people do not shop for health insurance.  Due to the tax preference for employer-sponsored health insurance, employers do the shopping for nearly everyone with private coverage.  Everyone else takes what they can get from the government.  Without people shopping for health insurance, there is no competitive health insurance market putting pressure on health insurers to deliver better value to shoppers like we experience across nearly every product and service individuals purchase.

At a gut level, most people understand how competition works to enhance value and contain costs.  Competition gives us better vacuums, tablets, grocery stores and health clubs. Competition works because the individual buying the products directly benefits from their choice and, critically, their choice sends a direct and immediate message to competitors about what people want.  When there is no choice or, in the case of employer-sponsored insurance, when someone else makes the choice, competition suffers.  Competitors do not get direct information on what people want.

In contrast to traditional employer group coverage, individually-owned health coverage promotes cost transparency, portability, choice and competition.  These are all key features of a high performing health insurance market and so it’s no surprise that numerous health reform proposals adopt various recommendations to strengthen and expand individual ownership and choice. 

So, to enhance value and keep costs down, any future health care reform must empower individuals to shop for their own health care, especially individuals with employer-sponsored insurance. 

Each candidate would try to equalize the tax treatment of health insurance between individuals and employers.  It does make the tax code fairer, but much more important it increases opportunities for people to shop.  Rubio would establish tax credits that gradually increase to the size of the tax preference for employer-sponsored coverage. Walker also claims to “level the playing field” with his tax credits.  Jindal would move to giving everyone “a standard deduction for all forms of health insurance, regardless of where they are purchased.” 

When there’s no tax advantage to getting insurance through an employer, more and more individuals will likely start shopping for health insurance outside the workplace.  And each new shopper will grow the market and increase the competitive pressure necessary to improve value and contain costs.

There is one possible problem with equalizing the tax treatment of health care purchases.  Employers may undermine competition in the insurance market right now, but they also play a powerful role in keeping people insured, especially healthy people.  This is very important to a stable insurance market.

A healthy individual can drop individual coverage and save the entire cost of the premium minus any tax credit or deduction under each candidate’s proposal.  This leaves healthy individuals with a decent incentive to opt out.   In contrast, employer-sponsored premiums are heavily subsidized through both the tax code and employer payments, which substantially reduces the incentive for healthy risks to opt out, creating a more stable risk pool.  Any policy movement away from the status quo employer-sponsored insurance needs to be mindful of this fact.

With that in mind, equalizing the tax code may be a good start, but it may not be complete.  Future proposals need to better answer how to keep healthy risks in the insurance pool.