The November 19, 2013 article in The Royal Gazette by Nathan Kowalski entitled “Make Bermuda healthcare a free-market product” highlights one of the key flaws in health insurance design. That flaw is that rather than “insurance” — ie a financial product designed and purchased to cover largely unpredictable and hopefully rare catastrophic events — many healthcare policies resemble more closely a prepaid healthcare debit card, incenting the user to perhaps spend too freely, especially when the “card” is largely paid for by someone else.

Health insurance companies and employers in the US are moving rapidly to embrace so-called “consumer-directed plans” which feature a large deductible to be met before insurance kicks in and are usually linked to a “health savings account” or “health reimbursement account” where pre-tax dollars may be used to pay down the deductible amount and where unspent dollars roll over and accumulate tax-free each year.

Such plans were in existence well before the passage of the Affordable Care Act (ObamaCare) but will increasingly be offered consequent to that legislation and the individual mandate to either obtain insurance or pay a penalty. When first introduced by this author’s employer in 2006, such plans held healthcare expenditure annual growth to less than two percent on average over the next four years with no demonstrable adverse effects on access or outcomes.

However, none of us should expect the free-market to address all of the issues driving unsustainable growth in healthcare cost. Market failures in healthcare will always demand government intervention and a taxation-based general revenue stream for funding. Markets may fail for many reasons, but let’s explore the top five reasons why they are destined to fail in healthcare.

1) According to the most recent 2012 National Health Account, Bermuda spent a little over 678 million dollars on healthcare that year. Of that amount, only 13 percent — about 91 million dollars — was collective “out-of-pocket” expense. If efficient markets require discriminating and value-conscious consumers and yet the aggregate consumer dollar at risk is only 13% their “own money”, there is a market failure waiting to happen.

2) Related to the above is a well accepted risk that insurance may create “moral hazard.” That hazard may manifest when individuals do not take care of an insured item as compulsively as they may a non-insured item. Or, when an insured item is damaged, the individual spends more freely on the repair or replacement since the full cost is no longer their responsibility. When this happens, markets fail.

3) Ideal markets require open competition with many buyers and sellers, reliable information, uniform products and freedom of entry and exit from the market. Healthcare “markets” never come close to this ideal. The unequal or asymmetric nature of information between providers of healthcare services and consumers of healthcare service is profound and increasingly so with each advance in technology. So in healthcare, market control by informed consumers is quite frankly replaced by a promise of professional ethics of beneficence, non-malfeasance and justice, which while necessary, are too often insufficient. Providers are in a position to induce demand for services and consumers are at a disadvantage by being unable to assess the actual value of those services. These facts underpin the rationale of such “managed care” tools as precertification, utilisation review, certificates of need for new technology, public reporting of quality metrics and prohibitions against self-referral in many jurisdictions.

4) Even the market for insurance products is flawed by the ability to segregate risk, deny insurance to those most in need and otherwise avoid adverse selection.

5) And finally, in all populations, the cost of healthcare is highly and consistently concentrated. Five percent of a population accounts for approximately 50 percent of cost and 10 percent account for nearly 70 percent. What this means is that even with consumer-directed plans and high deductibles, the small percentage of individuals who account for most of the cost will blow past the deductibles each year in short order and be onto insurance coverage so quickly that the impact on total healthcare spending is modest at best.

Please do not misinterpret the above as an indictment of leveraging market principles to lower healthcare costs. Price transparency, valid information regarding outcomes and redesigned insurance products that put more accountability for choices made in the hands of consumers can help moderate the cost curve.

However, the safety net backing up this flawed market will never be “free” and government and regulation will always have a role.