Focus On: Mark V. Pauly

Insurance: The Most Misunderstood Industry

Posted on February 13, 2013

kunreutherbookIn a new book titled, Insurance and Behavioral Economics: Improving Decisions in the Most Misunderstood Industry, authors Howard Kunreuther and Mark Pauly, both professors at Wharton, and Urban Institute researcher Stacey McMorrow analyze the behavior of individuals, insurance industry leaders and policy makers, all of whom bring certain behavioral biases to their understanding of the insurance industry. The result, say the authors, is an overall failure to grasp how insurance can fulfill the roles it is designed to play: reducing future losses and financially protecting those at risk.

In the following essay, Kunreuther and Pauly elaborate on some of the key findings presented in their book.

Insurance is an extraordinarily useful tool to manage risk. When it works as intended, it provides financial protection to individuals and firms who pay insurers a relatively small premium to protect themselves against a large loss. But insurance is broadly misunderstood by consumers, insurance executives and regulators.

Many consumers do not voluntarily buy coverage against potentially risky and serious losses. Case in point: Fewer than half the residents in flood and hurricane-prone areas were insured against water damage from Hurricane Katrina and Hurricane Sandy. And a significant fraction of the population does not have health insurance today, despite the large premium subsidies currently offered in the form of Medicare and Medicaid and tax breaks for employment-based health insurance. A principal reason for this is that many people tend to view insurance as an investment rather than a protective measure. If, after several years, one doesn’t make a claim, there is a feeling that one’s premium has been wasted.

Insurance firms also behave strangely. After they suffer a severe loss, they may decide that a risk is completely uninsurable rather than determining whether they should increase their premium. For example, prior to 9/11, insurers did not price terrorism risk when providing coverage against damage to commercial property. After 9/11, most carriers refused to offer terrorism insurance because they feared catastrophic losses from future attacks.

State regulators often constrain insurance premiums because they are concerned that insurance will not be “affordable,” especially to those who are at higher risk. In Florida, the state set up its own insurance company called “Citizens” that offers highly subsidized premiums to residents in hurricane-prone areas. Private insurers could not compete against these prices, and Citizens became the largest insurer of homeowners’ coverage in the state. All taxpayers in Florida will be required to help pay for Citizens’ losses, should the state be hit by a devastating hurricane.

Similarly, the Affordable Care Act (ACA) health reform legislation requires sellers of individual and small group insurance to sell coverage to all comers at premiums that do not take into account the buyer’s medical risk, given age and local prices for health services. These policies assist those in the high risk category but impose additional costs on lower risks in the form of higher medical premiums.

Why do consumers, insurance firms and regulators behave as they do?

There is a tendency for those at risk to assume that disaster losses or major health related expenses will not happen to them. Given this view, they feel no need to purchase insurance protection. Only after suffering a loss will consumers voluntarily buy insurance. After a disaster, insurers may decide to restrict coverage, and state regulators are likely to prevent private insurers from charging premiums that reflect the actual risk.

Behavior of this kind defeats the three principal purposes of insurance: to provide information via premiums as to how serious your risk is; to provide motivation for undertaking financial protection against an event that could produce a significant loss but has a low probability of occurrence; and to offer incentives in the form of premium reductions to reward people who invest in risk-reducing measures.

Incentives, rules and institutions that encourage a constructive role for insurance will ultimately improve individual and social welfare. Several recent pieces of legislation have set the tone for appropriately dealing with risk.

In light of the private insurance industry’s refusal to provide sufficient amounts of terrorism coverage following 9/11, Congress passed the Terrorism Risk Insurance Act (TRIA) in 2002. It provided taxpayer-backed protection to insurers against catastrophic losses from future terrorist attacks if they agreed to make coverage widely available. As a result, businesses are now able to purchase reasonably priced terrorism coverage. To date, there has been no need to call on taxpayers to fund the guarantee. TRIA is up for renewal in 2014, and there is an opportunity to re-examine the appropriate roles of the private sector and the federal government in providing coverage.

The Biggert-Waters Act, passed in July 2012, proposed major reforms to the National Flood Insurance Program (NFIP) over the next five years. Future premiums will reflect risk (tied both to specific location and expected climate change) so individuals are aware of the hazard they face. They can also be rewarded with lower insurance rates if they undertake protective measures. FEMA is in the process of developing more accurate flood maps to set these rates. The Act authorizes $400 billion per year for this purpose over fiscal years 2013 – 2017.

The ACA requires insurers to offer insurance to all residents in the United States who do not currently have coverage through either their job or a public plan. It also levees a tax penalty on those who choose to be uninsured. To deal with the affordability issue, premiums are to be subsidized for some low- and middle-income households. However, with the exception of offering premium discounts for those who engage in a limited set of less risky behaviors (such as not smoking), premiums after 2014 no longer reflect individual medical risk factors. There is thus some concern that the penalties specified by the ACA may not be enough to encourage low risk individuals to buy insurance because of the high premiums they will have to pay.

What can be done to make insurance a better policy tool and to avoid adverse side effects of the well-intentioned programs already in place?

One way to convince people of the long-term benefits of insurance is to stretch the time horizon over which the event can occur. Studies have shown that people are much more likely to buy insurance or invest in protective measures if an event, such as a hurricane, that has a one in 100 chance of occurring next year is presented as having a greater than one in five chance of happening at least once in the next 25 years. And if the disaster does not happen – well, the truth is that the best return on an insurance policy is no return at all. One should celebrate not having a major loss!

Insurers should construct worst-case scenarios for rare events. They can then determine a premium that reflects their best estimate of their expected future risks, factoring in the uncertainty of the event’s happening. Insurers could also consider offering multi-year policies if state regulators allow them to price coverage that reflects risk over that period. A multi-year insurance policy with risk-based premiums coupled with a multi-year home-improvement loan to pay for risk-reducing measures may enable policyholders to reduce their overall costs.

State insurance regulators should be appointed rather than elected so they are less prone to being influenced by special interest groups and lobbyists. Regulatory decisions should make transparent who stands to benefit from a subsidized insurance program, and who will be paying part of that cost to protect others. State insurance programs, such as Citizens in Florida, should indicate to all residents in the state that property insurance on homes near the ocean (including second homes) is likely to be highly subsidized, and those living elsewhere may bear the expenses of the clean-up following the next severe hurricane.

These concepts, if followed, will increase the chances that insurance is better understood so it can fulfill the roles it is designed to play: reducing future losses and financially protecting those at risk.

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Inaugural Speech, Part II

Posted on January 22, 2013

When President Obama delivered his first inaugural address four years ago, he was speaking to a nation mired in two wars and facing the worst financial crisis since the Great Depression. Yesterday, his second inaugural address focused less on economic issues and foreign policy, and more on social issues, ranging from gay rights to global warming to gun control.

He made clear his intention to help the middle class, including strong resistance to cutting entitlement programs – Medicare, Medicaid and Social Security. As an article in The Washington Post noted, “He embraced more clearly than he has in the past a liberal view of government activism” – which includes protecting policies and programs that “have reflected essential Democratic priorities for generations of voters.”

Obama’s tone suggested more partisanship and less willingness to compromise with Republicans during what will likely be a hard-fought effort to pass his agenda before leaving the presidency for good in four years.

Obama’s address has inspired a variety of reactions, depending on individual perspectives. For example, “as an economist focused on policy,” says Olivia Mitchell, Wharton professor of business economics and public policy, “I thought this was a key section: ‘We recognize that no matter how responsibly we live our lives, any one of us, at any time, may face a job loss, or a sudden illness, or a home swept away in a terrible storm. The commitments we make to each other – through Medicare, Medicaid and Social Security – these things do not sap our initiative; they strengthen us.’”

This statement, notes Mitchell, “emphasized only the benefits of social protection. But the President never acknowledged many programs’ negative influences on a variety of important economic outcomes. For instance, research has confirmed that the Medicaid program discourages most people from taking steps to save and insure against long-term care expenses. The structure of the Social Security program discourages private saving, and the program’s impending insolvency threatens retirement security for millions. The Disability Insurance program has made deep inroads into the nation’s labor market. Higher tax rates discourage people from working and encourage early retirement. In sum, I would have liked to have seen the President indicate his awareness of these counterbalancing factors.”

Wharton professor of health care management Mark V. Pauly says he was “a little disappointed in the treatment of health care and the Medicare and Medicaid programs. The President seems to want to defend them not only as programs that will provide benefits to those who need help, but to protect them from privatization of any sort.”

While that is a legitimate viewpoint, Pauly adds, “it seems more limiting than need be, though obviously congenial to the liberal base. [Obama] did imply he was going to control Medicare cost without recourse to any of the alternatives favored by his opponents. I don’t know how that can be done. We can hope and pray for lower rates of spending growth, but we still search for mechanisms that can bring it about without doing more harm than good.” At this point, Pauly adds, “I do not know of any magic in the pipeline of either party.”

Obama also emphasized the importance of all citizens participating in efforts to support his second-term agenda. Along those lines, he has endorsed the establishment of a nonprofit group called Organizing for Action, which will focus on reform in such areas as immigration and gun control.

One of the most oft-cited sections of Obama’s inaugural address was his comments on equal rights for women, African Americans and the LBGT community. “We, the people, declare today that the most evident of truths – that all of us are created equal – is the star that guides us still, just as it guided our forebears through Seneca Falls and Selma and Stonewall…. It is now our generation’s task to carry on what those pioneers began. For our journey is not complete until our wives, our mothers and daughters can earn a living equal to their efforts … until our gay brothers and sisters are treated like anyone else under the law – for if we are truly created equal, then surely the love we commit to one another must be equal as well. Our journey is not complete until no citizen is forced to wait for hours to exercise the right to vote….”

In comments directed to a large majority of Americans, Obama also noted that “our country cannot succeed when a shrinking few do very well and a growing many barely make it…. We are true to our creed when a little girl born into the bleakest poverty knows that she has the same chance to succeed as anybody else, because she is an American, she is free and she is equal, not just in the eyes of God, but also in our own.”

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Health Rates to Rise, but the Expected Impact Is Unclear

Posted on January 11, 2013

Health-Care-ReformSmall businesses and individuals without employer-provided health insurance will be the most hurt as some insurers move to sharply increase health care premiums in reaction to the implementation of the Affordable Care Act. But the hikes may not have as broad an impact on those groups as they seem to on paper, Wharton experts say.

Insurers such as Aetna and Anthem Blue Cross have sought increases of between 20% and 26% in California, Florida and Ohio, and have secured approval for some of those, The New York Times reported last week.

The 2010 Affordable Care Act (ACA), which survived a legal challenge last summer when the U.S. Supreme Court upheld most of its provisions, requires health plans to cover more services. “But it does very little to control costs and adds taxes in some sectors that will likely be passed through as higher prices and premiums for health care services,” says Wharton health care management professor Patricia Danzon. “Higher health care premiums cannot simply be passed through as higher prices for goods and services that are sold in global markets. So, these costs will likely be borne by employees [through] lower cash wages, cuts in other benefits, fewer jobs or longer work hours per employee.”

For small firms, the above-average premium increases will be harder to pass on to workers if and when the labor market recovers, notes Wharton health care management professor Mark V. Pauly. “If this minority of small employers has been singled out for large increases, it will increase their labor costs relative to those for other employers.”

But Pauly notes that the examples of double-digit premium increases are anecdotal and not based on aggregate data. Even if such increases are truly representative of how the ACA will impact a certain segment of small businesses, they wouldn’t impact overall health care spending growth, he adds, because they apply only to individual and small group insurance, a minority of the private insurance market.

But the increases could mean that small employers and people buying insurance as individuals will not find many bargains on the ACA-mandated health insurance exchanges, says Pauly. The exchanges must begin enrolling people next October for coverage to begin on January 1, 2014. “My guess is that insurers are starting to increase premiums for these markets in expectation that they will be selling to higher-risk [customers] after the reforms kick in, and are trying to get ahead of the pricing curve,” he adds.

In any event, the increases will likely be offset by “huge subsidies” that most people in the small group market are expected to receive, Pauly says. Overall, health care spending trends are still moderate for Medicare, Medicaid and large group private insurance, he notes.

And federal officials say that overall health care spending remains steady, at least according to the most recent figures. “A number of provisions in the health care law that will help control costs and spending are still being implemented, but the statistics show how the Affordable Care Act is already making a difference,” U.S. Secretary of Health and Human Services Kathleen Sebelius said Monday in a blog post on her agency’s website. She pointed to the latest government data released that day, which showed that in 2011, overall health care spending as a percentage of GDP was 17.9%, the same as the past two years. In all three years, Sebelius added, spending grew more slowly than in any other year in the report’s 51-year history.

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Faculty Perspectives on the Election

Posted on November 7, 2012

In the wake of President Barack Obama’s victory over challenger Mitt Romney in the 2012 presidential election, K@W Today asked Wharton faculty for their perspective on a number of issues that will take center stage in the days and months ahead.

We posed a number of questions, including:

  1. What do you think was the biggest reason for Romney’s loss? What should he have done differently?
  2. What was the biggest reason for Obama’s victory?
  3. An editorial in The Wall Street Journal suggested that Obama got a big boost in the election from two men: Ben Bernanke and his quantitative easing, and John Roberts, who joined four other Supreme Court justices in upholding Obamacare. Do you agree?
  4. The election raised interesting demographic questions. Romney appealed to many white males, while Obama appealed to many Hispanics, Asians, women and African Americans. Does this suggest that Republicans need a better strategy to attract these groups going forward?
  5. What should Obama’s strategy be for dealing with the key issues of unemployment, the fiscal cliff and the deficit?
  6. Is there any reason to think that the Republicans, who control the House of Representatives, will be more willing to work with Obama to get some of these issues resolved? Can the two parties hope to work together?

Here is what we heard:

Peter Cappelli, director of Wharton’s Center for Human Resources:

“Aside from the tactical issues, the fundamental issue in the election was the role of government. The vote was basically split between those who did not think government did much for them economically and those who thought government either did, or should do, something for them. The Democrat/Republican divide always reflects this issue, but it was much starker this time because the Republican position was more extreme, particularly in the proposed cuts for social services.

“The Romney campaign suffered because its proposals seemed to frighten too many voters who feel they need government protection. The Romney ticket also could not shed the baggage from the primaries on social issues – women’s rights and immigration, in particular – that hurt them with those voters.

“The biggest reason for the Obama victory in my mind was that Governor Romney’s various gaffes shifted the contest from being a referendum on President Obama and the poor state of the U.S. economy to being more of a referendum on Governor Romney. Much of the energy on the Democratic side seemed to be [directed] to voting against the Romney ticket.

“There are a hundred things that made a difference to the election. Certainly if Obamacare had been turned down by the Supreme Court, things would have been bad for the President, but then it was bad for the Democrats when the Supreme Court upheld Citizens United. Quantitative easing appears to be helping the economy, but it has been bad news for the President that none of the other treatments before helped much. A lot of other things could have gone differently that would have affected the outcome….

“The big question seems to be how the Republican party, especially in the House of Representatives, will see their effort over the last four years to obstruct anything that would appear to give the President a legislative victory. The goal of that approach was to prevent the President’s reelection. That did not work. So what do they do now?”

Mark V. Pauly, professor of health care management:

On why Romney lost: “The economy recovered enough to take away his main argument for change.”

On The Wall Street Journal editorial: “I do not see that the court decision on health care reform meant more votes for the President. It kept an issue alive — you need to vote Republicans [into office] to get rid of Obamacare — but that was obviously not an important enough issue, nor should it have been since in the short run, relatively few people gain or lose from health care reform.”  

On dealing with the issues of unemployment, the fiscal cliff and the deficit: “Republican control of the House of Representatives will keep us at the same point in discussing these issues as we were before the election.”

On whether the two parties can work together: “Now that the House knows it will have to deal with the President, I expect they will try to get some things resolved that were held hostage to the election. I think the President has used most of the ammunition he has in terms of executive orders and the like, so I expect the House will pull things their way. We will have some tax increase on millionaires and billionaires, but of course we do not have enough [of them], so that will not help the deficit that much. It will just make Democrats feel better.

“I am hoping this will set the stage for bipartisan tax reform along the lines of the Rivlin-Domenici or Bowles-Simpson [debt reduction plans]. Both have big health care parts to them. I think the election gives cover to Republicans to go along a little.”

Kent Smetters, professor of business economics and public policy:

On why Romney lost and Obama won: “Obama had a better ground game — more regional offices, more effort to get out the vote. Romney also focused solely on jobs without painting a broader picture. He should have channeled Reagan a bit more.”

On The Wall Street Journal editorial: “I don’t agree with it. Money injected by [the third round of quantitative easing] is basically just sitting on bank balance sheets. I think that the [Supreme Court decision on health care], if anything, helped mobilize conservatives behind Romney.”

On the demographics question about Obama’s popularity with minorities: “The election raised interesting demographic questions. Romney appealed to many white males, Obama to Hispanics, Asians, women, African Americans and other ‘minorities.’ Does this suggest that Republicans need a better strategy to appeal to these groups going forward? Romney also appealed to married females. But, yes, the Democrats are effective at class war politics. Republicans need to do a better job of explaining how prosperity is better than envy.”

On a strategy for dealing with unemployment, the fiscal cliff and the deficit: “The ‘fiscal cliff’ is a horrible term. Minus five for Bernanke for coming up with it; minus 10 for still being an old school Keynesian. Otherwise, I like him.

“The real cliff is if we keep focusing on the short run without also addressing the huge budget deficit. The problem with the U.S. economy is not the lack of consumption. We have plenty of it. The problem is the lack of investment. We need to address the fiscal cliff by removing some of the uncertainty about future tax rates and returns to investment. Any proposed solution to the fiscal cliff can’t be short-term and [can't work without] comprehensive reform of the tax code and spending side that improves the long-run situation as well.”

On whether the two parties can work together: ”No, they will continue to play chicken. Hopefully, however, it will lead to a grand compromise, like the 1986 Tax Reform Act where Reagan and the House Democrats hammered out a deal that was tenable to both sides.”

Mark Duggan, professor of business economics and public policy:

On why Romney lost and Obama won: “A key reason for Obama’s victory is that the economy has been gaining more momentum over the last few months, with unemployment falling below 8% and job creation relatively strong. This may have given voters more confidence that his policies, such as his help for the auto industry — an important issue in arguably the most important state of Ohio — were working. His handling of Hurricane Sandy also probably helped to give him just a bit more support so that he pulled out wins in pretty much all of the states that were deemed battlegrounds.

“While Florida has still not been called, the races in states like Ohio, Virginia and Colorado were sufficiently close that even a small boost might have helped lead him to victory. Plus his victory margins in Wisconsin, Iowa, New Hampshire and Nevada were somewhat bigger than expected. On the foreign policy front, I think most people felt he won the third debate; that may have helped to tip the balance for many voters, too.”

On issues like the fiscal cliff, taxes and unemployment: “As for big things that are coming down the pike, the President will be negotiating with Congress on what to do about the upcoming fiscal cliff. Effective January 1, 2013, there are a set of spending cuts and tax increases taking effect that will lower the deficit by about $600 billion, which is close to 4% of GDP. While reducing the deficit is important, many think that a change in government policy of this magnitude could put the economy back into recession. Thus, it will be very important for Obama to work with Congress to make the right tradeoff between starting to tackle the deficit and stimulating economic growth.

“Certain parts of the fiscal cliff, like the payroll tax holiday (a 2 percentage point cut in this tax for all workers on their first $115,000 in earnings), are very unlikely to be renewed, but others — like the spending cuts and increases in income taxes — are likely to be negotiated. Long-term deficit reduction is also hugely important, with changes needed to the tax code and to entitlement programs.

“The fact that Obama will now be a second-term President may make it easier for him to confront these challenges as he does not need to worry about being re-elected. Indeed, that is why many support term limits.”

 

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When Insurance Buyers and Sellers Speak Different Languages

Posted on October 23, 2012

The often oddly illogical behavior of insurance buyers and sellers has long fascinated Wharton health care management professor Mark V. Pauly and his colleague Howard Kunreuther, Wharton professor of operations and information management.

During their decades-long collaboration on market studies, the two compiled notes on the ways that insurance companies, consumers and regulators get it wrong — Pauly describes it as “a rogue’s gallery of insurance anomalies.” That collection ultimately became so substantial that they turned it into journal articles and then into a book titled, Insurance & Behavioral Economics: Improving Decisions in the Most Misunderstood Industry, to be published in December.

Why “misunderstood?” In an interview in the LDI Health Economist, a publication of the Leonard Davis Institute of Health Economics at the University of Pennsylvania, Pauly identified some of the reasons insurance buyers and sellers misconstrue each other’s intentions and responses so frequently. Topping the list is consumers’ widespread uncertainty about predicting risk or estimating probability, and a time-lag sense of entitlement to things that weren’t actually purchased in a transaction.

“Insurance is a contract where you pay your money up front and then whatever you’re going to get from it, you get later on,” Pauly said. “But just like a pre-paid vacation, that can be a recipe for frustration: People arrive at the hotel and believe they are entitled to free Mai Tais even though the fine print of their confirmation says they’re not. The thing I think people do understand — but want to pretend they don’t understand about insurance — is that if you didn’t pay for it and it was not specifically in the contract, you’re not entitled to it. Once consumers have paid their insurance premiums, many really do want to think they’re entitled to be paid for anything bad that happens to them.”

Insurers, Pauly said, “have just the mirror image. They see themselves as promising a certain number of things for a certain amount of money; and if you didn’t pay them for it, they shouldn’t be required to deliver it to you.”

However, he pointed out that the book doesn’t just target consumers’ foibles. “There’s plenty of blame, stupidity and irrationality to go around” for insurers and government regulators as well, he noted.

“We’re aiming this book partly at scholars and partly at people in the insurance industry who are sometimes inept in explaining what they do and why,” Pauly stated. “We say, ‘You’re often as irrational as consumers even though you have much more at stake.’ Hopefully, the book will make insurers think more carefully about what they do and also give them a little bit of defense for some of the things that need to be explained to consumers, regulators and policy types.”

Another goal of the book is to establish a benchmark for good insurance performance, then explore how various markets succeed or fail at meeting that benchmark.

“The majority of insurance dollars spent in the U.S. are spent in markets that are functioning fairly reasonably, but there are some markets where it’s totally nuts,” he said. The book makes an effort to compare the two different kinds of markets to identify characteristics that predict potential problems…. The book not only discusses anomalous insurance markets, it also discusses non-anomalous insurance markets because it wants to identify the characteristics that tend to predict anomalous behavior.”

One of the markets the authors scrutinize is health insurance, and their conclusions may surprise many.

“I don’t feel as bad about health care insurance after writing this book as I did before,” said Pauly, “because compared to a lot of other insurance markets, it’s not nearly as messed up. The kind of insurance sold even before the Affordable Care Act [ACA] provided pretty good coverage against low probability catastrophic events, which, in this case, is the potentially bankrupting circumstance of becoming a hospital in-patient.”

Health insurance performance behavior “was better than other kinds of insurance,” he said. “For instance, in terms of flood insurance, a consumer could say, ‘It will never happen to me because I haven’t seen a flood in my neighborhood in quite a while.’ But they do see catastrophic health events often enough to know that these aren’t that low a probability. So, from that point of view, health insurance looks better than average.”

One of the things the ACA is trying to address is that “if you buy your health insurance as an individual, there are really high administrative ‘loading’ and selling costs,” Pauly pointed out. “But the percentage of that for health insurance is about the same as other kinds of insurance people buy as individuals, like auto collision or homeowner coverage. That doesn’t mean it’s either bad or good. It just means that the imperfection and waste in the individual insurance market isn’t something unique to health insurance. It seems shared by virtually all insurances that people buy on a one-on-one basis.”

Pauly notes that many economists have their doubts about the ACA’s health insurance exchanges – competitive marketplaces designed to allow patients to buy insurance directly from a pool of different health plan options. He tells an economist joke to make his point: An economist and non-economist are walking down the street when the non-economist says, “That looks like a $20 bill over there. Why don’t you go pick it up?” But the economist keeps walking. The non-economist asks, “Why didn’t you go pick it up?” The economist says, “Don’t be ridiculous. If it was a $20 bill, somebody would have already picked it up.”

The moral, said Pauly, is that economists often suspect that if something isn’t happening, it shouldn’t; if exchanges were a good idea for individual insurance, wouldn’t there already be automobile insurance exchanges and homeowners’ insurance exchanges and life insurance exchanges? So how much can they add for health insurance?

But he is keeping an open mind. “I try not to be an economist one day a week,” he said. “Then I say there might be some good new ideas in the exchange concept, but they will have to be invented from scratch.”

Another focus of the book is “deductible aversion” — consumers’ tendency to automatically select insurance plans with the lowest out-of-pocket costs, despite the premium reductions from reducing coverage a little.

“The typical homeowner’s policy,” said Pauly, “will have a $500 deductible. It turns out that if you bumped up that deductible to $1,000 or $2,000, the amount of premium you could save is generally much more than anything close to the average amount more you would lose in benefits. But people just like low deductibles.”

Ditto in health insurance, he said. “Many consumers and most policymakers are wary of increasing deductibles. But there’s a camp that believes that a more rational health insurance system would be one with high-deductible health plans of the kind that are, at the moment, winning the marketing battle in the group market. We will have to wait and see what kind of rationality or irrationality wins out.”

ISBN: 0521608260

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Dealing with Natural Disasters, and Beyond

Posted on August 1, 2012

Last month, Congress renewed the National Flood Insurance Program (NFIP) for another five years and authorized a study on the role that risk-based premiums and means-tested insurance vouchers can play in the future.

For Howard Kunreuther, Erwann Michel-Kerjan and Wharton’s Risk Management and Decision Processes Center, this is a very big deal, and relates directly to principles articulated in their book, At War with the Weather, published in 2009.

“This is such an important piece of legislation from our vantage point,” says Kunreuther, Wharton professor of operations and information management, and co-director of the Center. “It is the first time that Congress has really indicated that a program such as the NFIP should consider risk-based rates as a basis for selling insurance while recognizing that one needs to address the concerns of low-income people by considering the possibility of means-tested vouchers.”

The recommendations coming out of Congress “are ideas that Erwann [managing director of the Center] and I have been talking about with Congressional staff, FEMA (Federal Emergency Management Agency) and others for the past several years,” he adds.

The first principle, outlined in At War with the Weather, addresses risk-based rates and states that: “Insurance premiums should reflect risk to signal to individuals how healthy and safe they are, what preventive or protective measures they can undertake to reduce their vulnerability to illness and/or property losses, and whether buying insurance really reflects efficient risk spreading. Risk-based premiums should therefore also reflect the cost of capital that insurers need to integrate into their pricing to assure adequate return to their investors.”

The second principle – on equity and affordability issues – states that: “Any special treatment given to consumers at risk (e.g., low-income uninsured or inadequately insured individuals) currently residing in hazard-prone areas should come from general public funding and not through insurance premium subsidies.”  

A report titled Disaster Resiliency: A National Imperative was released today by the National Research Council (NRC), an arm of the National Academies of Science. Among their recommendations, the NRC study calls for investment in risk reduction through insurance and other financial instruments that enhance resilience by encouraging mitigation of properties and infrastructure. More specifically, the report indicates that one way to achieve resilience is to tie multi-year insurance policies to the property with premiums reflecting risk. Risk-based pricing can serve as an incentive that communicates to those in hazard-prone areas the level of risk that they face. Use of risk-based pricing could also reward mitigation through premium reductions and should apply to both privately and publicly funded insurance programs.

The report, says Kunreuther, a member of the committee which met for 18 months, included specific mention of insurance vouchers, one of the approaches that the Wharton Risk Center has long advocated.

Kunreuther and his team at the Center elaborate on the issue of vouchers: Low-income families in hazard-prone areas would pay a risk-based insurance premium and then be issued an insurance voucher to cover a portion of the increased cost of insurance. The amount of the voucher would be determined by the family’s income and the magnitude of the increase in the insurance premium. Several existing programs could serve as models for developing such a voucher system: The Food Stamp Program, the Low Income Home Energy Assistance Program and the Universal Service Fund.

Whether the legislation passed in July will make a significant difference in the treatment of natural disasters “is an interesting question,” says Kunreuther. “It’s clearly important to sustain the momentum coming out of the NRC study, and we are doing that, along with other centers and universities. These issues also have an impact on climate change when you think about sea level and flood risk threats, which is another area our Center is working on.”

Kunreuther notes that a book to be published this fall co-authored with Wharton health care management professor Mark Pauly — Insurance and Behavioral Economics: Improving Decisions in the Most Misunderstood Industry — advocates the same general principles as At War with the Weather, but “is a much more general book on insurance,” dealing with insurance issues related to property and health care.

Noting his delight over the passage of the NFIP renewal, Kunreuther also says that “the champagne will come out only when people start doing the next steps, such as making everyone aware of the fact that better flood maps are needed in order to highlight risk. It will also be crucial to figure out ways to deal with the affordability and equity issues, which is why the insurance vouchers have such an important role to play going forward.” But overall, he adds, Congress’s action last month “was definitely a cause for celebration.”

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Unneeded Medical Tests: Is It Time to Just Say No?

Posted on April 16, 2012

Nine medical societies, in a campaign dubbed Choosing Wisely, have identified 45 common medical tests and procedures that they are encouraging doctors to use less often, and patients to demand less often. The societies say these tests are frequently unnecessary and can, in some cases, cause more harm than good. 

Some health experts estimate that overprescribed tests, procedures and treatments cost up to $250 billion every year. They range from EKGs, MRIs and brain scans to Pap smears, bone scans and the overuse of some antibiotics and cancer drugs.

The specialty groups, under the auspices of the American Board of Internal Medicine Foundation, have no objections to tests and procedures that are deemed appropriate; their target is those that are wasteful or are ordered by doctors mainly because they have a financial stake in their usage.

While some health care participants have voiced concern that these recommendations will lead to rationing of health care and new limitations on the ability of consumers to make health care choices, others applaud the move as long overdue. “To some extent, physicians are trying to move in the direction of showing concern about the costliness of the tests they recommend as well as the medical appropriateness of them,” says Wharton health care management professor Mark V. Pauly, an economist. “The idea not only of questioning your doctor about these tests, but questioning your doctor about everything, is what I would advise the sensible consumer to do.” 

Yet Pauly is concerned that the specialty groups’ advice may be ignored by many Americans. Most of them, he says, have health insurance and therefore don’t directly shoulder the cost of these tests, which, if managed properly, “won’t do you harm. They just won’t do much good.” More consumers would question the need for tests, he suggests, if they “have an economic stake in the outcome.” 

Attempts to change patient cost sharing have been one approach to creating such a stake. “The easiest way to talk about this is to say — and this has actually happened — that certain procedures everybody agrees are super high-value ought to be free, like pediatric immunizations. The mirror image of that, which people don’t like to talk about, is that some tests provide, not zero benefit, but just a very small benefit for a very high cost.” One example, Pauly says, is a dexa scan to test for bone density. “It’s a fairly rare condition,” but because many consumers have insurance to cover the test’s cost, they will opt to have it done. “Using cost sharing to guide people towards the things of high value and away from the things of low value seems like common sense. I think there is some movement in that direction, although there could be more.” 

As to whether physicians are reluctant to cut back on testing if they have a financial investment in the testing procedures, Pauly notes that this question applies whether one is talking about “physicians or auto mechanics…. If they are recommending a test or a procedure that they are going to perform themselves, you’re not sure their motives are totally pure.” Most of the time, he adds, he is confident that physicians make recommendations “based on their medical judgment alone.” 

Mark Duggan, Wharton professor of business and public policy, also applauds the Choosing Wisely campaign, noting that some physicians are finally coming forward and identifying certain procedures where overuse is especially prevalent. “To the extent that you are going to shine the light anywhere in the health care system, these 45 tests and procedures are a good place to start.” Overuse is no surprise, he adds, given that “often a person pays nothing to get a procedure, and the person doing the procedure gets more income.”  

Duggan cites three ways in which the specialty boards’ recommendations could lead to a reduction of low-value, no-value or negative value tests. One: Doctors would realize that for every five times they order a test, perhaps one of those times wasn’t necessary. Two: Patients would see these recommendations and be more skeptical about agreeing to certain tests. Three: Insurers would have “a powerful rationale for introducing slightly different co pays for these kinds of services.” Insurers “could say that for a particular type of treatment, we are going to raise our co-pay,” says Duggan. “Inevitably, whenever that happens, there is a concern it will harm access or reduce necessary care. You have to keep that in mind…. But it is so abundantly clear that in the years ahead, with the aging of the baby boom generation and anemic job growth, something needs to be done.” 

Besides raising co pays, insurers can raise co-insurance, which means, for example, that consumers pay a percentage of the cost of individual procedures. “Maybe then, people would have an incentive to go to providers who offer a test, such as an MRI, for a lower cost” than a competing service, Duggan says, adding that the hundreds of thousands of physicians in the U.S. “are doing their best to provide good care.” 

He emphasizes that the specialty groups’ recommendations do not prohibit people from getting certain tests. “It’s just saying that if you want to have them, you will need to pay a little more because medical evidence shows that these tests deliver benefits that are far below their costs.”

At some level, Duggan notes, “physicians need to make a more compelling case to themselves and their patients that a particular test is really needed, or isn’t needed. I don’t think it will lead to a sea change in American medicine, because there is so much wasteful spending in the health care system. [I see] this as one tiny step in the direction of trying to make it more efficient.”

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