(Im)perfect Information in Insurance Markets

I met with my economics professor today to go over a draft of my thesis on health care reform in rural China. “Prospective payment…what is that?” he asks me critically. “You’ve put a lot of good content in here but I think you need to go through and clearly define your technical terms, flesh out your examples, and make this more readable for someone who’s not an expert in the field.”

Later in the day, I’m listening to a podcast from WBURFM on the future of elder care in this country, where a major topic of discussion is the complexity of private health insurance contracts. A caller tells the story of how he and his wife had chosen a long-term care insurance policy and were surprised to find recently that the terms of their contract allowed their company to increase premiums by 70%.

He’s an economist.

This series of observations led me to conclude one of two things. Either economists are not as smart as we thought, or the intricacies of health insurance are too convoluted for the common citizen to fully understand.

One of the most basic assumptions of economics and of free market theories is that everyone has perfect information. IF insurance companies were completely clear about their services, and IF people fully understood the fine print of their contracts, and knew how much they would have to spend before reimbursements actually kicked in, or which of the cascade of requirements and conditions excluded them from reimbursement…then maybe we could step back, let the market do its job, and people would be willing to pay exactly how much they feel the contract was worth. (My guess is, probably a lot less than they currently sell for, given the myriad of conditions they come with.)

Here’s a clear sign that something’s wrong with the system: a New York Times article from two years ago describes an insurance company that denied a man’s claim for chemotherapy charges, but couldn’t explain the grounds for denial when pressed by a member of the state government—because “they needed more time to figure it out.” Even insurance companies themselves seem to be having a little trouble here.

The good news is, starting in August 2010, Rhode Island became the first state to mandate readability requirements for all health insurance policies, requiring a readability score of 65 on the Flesch scale. The bad news is, the requirements for most other states (when they exist) range from 40 to 50, corresponding to 10th to 13th grade levels—two grade levels above that of the average American adult.

Perfect information in any market is an extremely difficult assumption to make, especially in one as convoluted as health insurance. And as long as we are looking at what is inherently a market failure, it’s worth thinking about what measures we could take to help address those shortcomings.

I’ll leave you with some advice from Howard Gleckman of the Urban Institute, who was a guest on the show: “My advice is before you do one of these [private long-term care insurance], make sure a lawyer or an independent financial advisor—not the one who sells you the insurance—actually looks at this with you and helps you understand what it is you’re getting.”

Well, at least we’re creating a bunch of jobs for the legal industry.

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