The Health Insurance Demand Problem

A family friend was recently admitted to the hospital after a traumatic motorcycle accident in Colorado. He’s not in great condition, but he’s hanging in there. In light of having just written this post about the cost of highly acute care, I couldn’t stop pondering about his health insurance.

Health insurance is a bizarre creature. Unlike other forms of insurance, people actually want to consume what they’re insured against, defying the very premise of the insurance model!

Confused? Let’s dive in.

No one wants to consume traditional insurance

People never file claims for traditional forms of insurance unless something bad has happened, like car or home accidents, natural disasters, or death (covered by life insurance). In some of these cases (like minor fender benders), the insured customer often elects not to file a claim in order to avoid a premium increase. When people do file traditional insurance claims, that means something sufficiently bad has happened, and the insurance system kicks in place to recoup the damages.

People do want to consume healthcare insurance

Healthcare insurance is a wildly different animal. Only a small percentage of total hospital admissions are highly acute, catastrophic cases. A large majority of the care delivery system services non-catastrophic cases, from preventive care to counseling, scheduled (and elective) surgeries, and skin rashes, for example. Patients want as much (non-catastrophic) healthcare as reasonably possible, and they want their insurance companies to pay for it.

This is a classic principal-agency problem. The person making financial decisions isn’t bearing the cost of those decisions; in fact, the person making financial decisions is empowered to blindly spend without thinking. To make matters worse, many healthcare providers encourage patients to consume costly diagnostics and procedures with little regard for value, knowing that insurance companies will pick up the tab.

Realigning incentives

As it currently stands, this system breaks most of the basic assumptions of capitalism: the principal-agency problem, pricing information, and ability to compare producers/providers.

Reducing demand and utilization of healthcare resources is impossible. Since patients are currently incentivized to demand unlimited care without caring about cost, supply will always find a way to satisfy demand. So, how can we realign the incentives to fix the system?

The only way to reduce demand is to make patients accountable for their own healthcare expenses. With the insurance customer suddenly conscious of the cost and value of their subacute healthcare consumption, providers will be incentivized to compete and offer lower costs.

Thus, insurance companies should provide patients “catastrophe-only” plans. These plans would fully and generously cover highly acute care needs, like trauma, cancer, or stroke care. However, like a vehicle insurance plan without comprehensive coverage, the cost of treating the medical equivalent of a keyed car (e.g. a purely speculative blood test) would fall to the individual.

As CEO of a company in the healthcare space, it pains me to know that I’m contributing to the healthcare incentive problem by providing employees with a traditional healthcare plan. But until healthcare insurers offer catastrophe-only plans, patients will continue to blindly consume. In fact, even the Affordable Care Act failed in this light; the national and state-based exchanges don’t offer a single catastrophe-only insurance plan. They are all bundled and are ripe for unbundling.

About the author

Kyle Samani

Kyle Samani

Kyle is CoFounder and CEO of Pristine, a VC backed company based in Austin, TX that builds software for Google Glass for healthcare, life sciences, and industrial environments. Pristine has over 30 healthcare customers. Kyle blogs regularly about business, entrepreneurship, technology, and healthcare at


  • Kyle,

    I certainly hope your friend makes a full recovery.

    I agree that health insurance is a different animal. Reminds me of the old saw: there is accounting and then there is accounting for railroads.

    However, I have to disagree with you on several points.

    Healthcare costs in our system have many causes. For example, the pharmaceutical companies’ patent and marketing policies, fraud, and our fee for service system, not to mention incompatible systems, etc.

    I think putting the burden on patients, as the solution to rising healthcare costs is to make a bad situation worse.

    There are three major problems with trying this market approach: Price disclosure, medical quality and practical options.

    Price. It is a rare physician or hospital that discloses their prices. Even if they do, it is impossible to compare them in any meaningful way. What they charge an individual may not be what they charge or accept from Medicare, Medicaid or other third parties. Even if they disclose, who will insure that the patient can make a meaningful comparison among providers?

    Quality. Quality of care is a major issue in medical care. Would price disclosures also include a rating of provider quality? If so, who sets this and insures it’s accurate? Would you send your child to a pediatrician whose prices were low, but whose quality was only mediocre?

    Options. Then there is the problem of selecting a provider. In many cases, your community may only have one hospital that you can go to or only one that has the specialist you need.

    As to only providing catastrophic coverage, this ignores the public health interest of having all children get their immunizations, have well baby checkups or for older persons to have a colonoscopy and similar preventive measures that are both effective and cost saving. Under the ACA, these are all part of insurance and free.

    Even if catastrophic costs were covered that would not really meet the demand for financial aid. What the insurance company thinks is catastrophic and what is personally catastrophic can greatly differ. What is catastrophic for someone making $25,000 a year is a lot different than for someone who makes $50, 000 or $100,000. How will your solution deal with this?

    This is not a small issue. Historically, medical costs are the main reason for personal bankruptcy. The recent recession has reduced the percent, but it still is a major cause. How would your approach improve this situation?

    I agree that there should be increased disclosure of costs and that there should be standards that allow meaningful comparisons. However, given the practical setting that most of us find ourselves in, it is unrealistic to think that essentially eliminating most health insurance will help matters. Simply put, healthcare is nowhere close to being a free market. Price disclosure alone would be useless until there is true competition among available and effective providers for all of us.

  • Good luck also to your friend — been there, done that… and with a motorcycle many moons ago in Maryland.

    I enjoyed your analysis, but you only came up with a partial solution.

    What you call the “principal-agency problem” is certainly valid, but we mortals merely refer to it as the “third party insurance problem”. During WWII in 1943, the government instituted wage and price controls. Since thereafter, employers could not increase wages, they initiated other benefits including health insurance for their employees. And like daylight saving time, this thing never went away. (Btw, my mother showed me her bill for the several days she was in the hospital to deliver me — just under $11 in 1944 dollars.)

    The only sensible solution is for the government to allow Health Savings Accounts (HSAs), which are portable and somewhat like IRAs. You (and your employer) can contribute to your personal HSA, you use the money only for direct health care or insurance premiums, and you “roll over” money not used and apply to future use. And like a personal bank account (which it is), you are more careful about how you spend your money — including shopping around for health care services.

    The hospitals’ “ChargeMaster” problem that Steven Brill outlines in his “Bitter Pill” TIME article took a while to develop, and would not go away overnight, but would have to adjust to accommodate the free-market solution that HSAs offer.

    The political problem is that unsustainable “entitlement” programs such as MEDICARE are government programs, and eliminating the need for these is anathema to politicians, so HSAs must not be allowed because it frees us from dependency on them. They will attempt work-arounds to current problems rather than address the original problem.

  • Hope your friend recovers.

    One problem we have is terminology. People generally don’t have health “insurance”, they have health “coverage”.

    They may have catastrophic health insurance, and that you’ll see most people have zero desire to use.

    Until people feel the pain of paying, they won’t care much about cost. When all you pay is a co-pay, who cares (or knows) what the real cost is.

    @Carl: I was talking with a physician friend who told me they are forbidden by the insurance companies to post procedure costs. Seems odd.

    @David: I also think the only way to get medical costs under control is to have an HSA plus some sort of catastrophic insurance.
    Until people know what a visit costs, and have to pay, things just won’t change.

  • John, how are you?

    As it stands most healthy people want and need catastrophic coverage and that is essentially what ACA does now unless you get full subsidies for Gold.

    The other issue not addressed is that under this ACA pool system (everyone is in the same pool), a small % of unhealthy/chronic disease swimmers consume a high % of resources. Let’s say it is 10%/90% just for argument.

    Of course, nobody really knows when they might end-up in a catastrophe or one of the 10%’ers.

    The best approach IMO is to throw away the terminology, “insurance policy”, “insurance coverage”, etc. to stop some of the political wrangling and just call it what it is, “universal/national health care”.

    Now for this new system to work, what will we need in order to not break us?

    Draconian behavioral controls for sure. No more riding motorcycles without a helmet while smoking pot. In fact, no more dangerous behaviors at all — just can’t afford it.

    Rationing? For sure. Let’s take care of the kids first.

  • Feel the pain of paying? Wow. Since the only job I can get these days is in retail, I depend on ACA for coverage that even with subsidy I can’t afford. One of my kids has T1D, and only has a really poor college policy; her monthly insulin purchase at the highly inflated price costs us a fortune we can’t afford either. One med I need is not ‘covered’ – I had to beg for some coverage, but the policy covers only a tiny percentage of its costs. But alternates that the policy allows nicely don’t work for me and actually cost the drug plan a lot more. My allergy coverage is ‘nice to have’ – but the insurance company pays the allergist less then I did when I paid my own way.

    When you really get down to it, our system of health coverage is horrific. It allows drug companies to charge far more in the US then anywhere else in the world. You have to pray you don’t get sick or need a specialist; if I do, I have to get a referral which means a useless but expensive copay to my PCP before I go to my specialist. I could go on but I completely disagree with the premise of the column.


  • Ron,

    I didn’t say the current system does or will work.
    If we want to give it a realistic chance, we need at least …

    – severe discretionary behavioral controls
    – rationing
    – cost/price controls

    Let’s say again just to assign some numbers that ACA currently costs a family of four on average, $2,000/month (directly and indirectly). That’s $240,000 over 10 years.

    My back of the napkin projection is for $5,000 per month in the not too distant future. Or, $600,000 over a ten year period.

    The old system, or the new system, could bankrupt anyone and any time.

  • hi everyone

    Nice lively discussion.

    This post was not meant to present a solution, rather highlight the basic problem with US health insurance.

    I like to discuss catastrophic care specifically because it highlights true insurance. I agree that catastrophic insurance isn’t for everyone, but for young healthy males such as myself, it’s exactly what I want and need.

  • Yes insurance does not begin until that is an unexpected expense above what could be paid by an individual or family. And yes, the insurance system is not a proper vehicle for maintaining a budget to pay for expected expenses like routine health care. A medical saving account is a great way to solve that problem and in places where that is done universally and everyone has an account that is fully funded the cost and quality of health is twice as good as here in the USA. Singapore is an example. However, we can do this for the willing by making local cooperatives between patients and physicians in which the cost of the routine care is prepaid and within the real budgets of the patients and the expectations of income of the providers. You don’t insurance for that and it works very well and well support your notion of the proper place for insurance.

  • Don,

    My coworkers and I are getting at or just above minimum wage and can’t afford a medical saving account. And in the past my employers gave me ‘adequate’ coverage that cost me plenty in premiums and lots in copays or the like. I was very sensitive about waste since I had to pay. Medical savings accounts fit into the world where everyone earns plenty – and most people in this country don’t.

    BTW, in countries with universal coverage (which you get separately from employment), medical costs are actually far lower and it is easier for most to get the health care they need, while excess use of health care is far less of a problem.

    The biggest problem in the US is the idea that the free market should rule. Results; my kid’s insulin cost has gone up 20% in the last year on a drug that has been around for decades but which costs little to make but is extremely profitable. Kind of like my one allergy med, or my emergency asthma inhaler. If I go to my one eye specialist, he gets $300 for a 2 minute look at my eye preceded by a bunch of not needed ‘tests’ that have nothing to do with my ‘condition’ – it’s just a way to jack up the price. I’m not paying for eye care, I’m paying for his retirement and vacation funds. Don’t blame the patient – sure, some waste. But most these days skimp on care to save money, and in the end have worse health as a result.

  • In other countries there are controls that limit or prevent the massive overcharging for medical services that is so rampant in the US. In the US, a few ounces of cheaply made chemicals that have been made for decades suddenly become many times more expensive because of a tiny change in delivery system. There’s no free market given the ability to charge any price for nearly any med as long as there’s a way to keep a patent intact long beyond its real life or pay other firms not to make it. Most asthma meds, for instance, can cost pennies to make but firms can charge hundreds of times their costs. In the US – other countries don’t tend to put up with this. When a doctor’s time costs a hundred dollars per minute for a quick look at a chart, one body part – oh, and to say hello, that’s badly overpriced. Fix those problems, plus the tendency to order unneeded but expensive tests, and medical costs would be a lot lower.

  • Great post – I appreciate when people point out how such systems create incentives for counter productive behaviors. It’s nearly a given in the federal programs that consumers are disconnected from suppliers and their decisions do not shape the marketplace. But it’s mind-bending when you realize that the private sector has embraced the same disconnected model with employers providing health insurance. Without market feedback there are no natural breaks on rising costs.

    As an aside, it also gives rise to Hobby Lobby cases where 2 reasonable ideas – a person should be able to decide how they spend their money and; a person should be able to decide what birth control to use – are pitted against each other.

    While it’s true that there are no catastrophic only plans in the exchanges, I’m hopeful that the creation of a robust individual market place will give employees the opportunity to acquire insurance that is best for them and for employers to return the premiums to the wage pool. Aligning the tax treatment of employer benefits and individual expenditures will be important to accomplishing this.

    Allowing consumers more direct control of the insurance they buy would be a good start to correcting the broken incentives.

  • Other types of insurance should not be overlooked. Younger workers or families may not have much in the way of savings. They will need disability insurance to cover long term injuries or illness. Workers comp covers on the job injuries. However, non work related injuries or long term illness can wreck havoc.

    As to medical savings accounts, there are two problems. First, you need money to put in them, not a small problem. The need to cover medical bills can short change long range goals such as college savings or a home purchase.

    Second, their benefit is inverse to need. Money you put into an HSA is money that would have been taxed at your highest bracket rate. So, the higher the income, the bigger the MSA’s tax savings. Conversely, those who make less and who need the help the most get the least benefit.

  • @R Troy:
    It may not feel like it, but supply and demand works in medicine also.
    Not in every single part, but most medicine.

    The pharma world is wacky.
    I don’t claim to fully understand it, but I reckon if you can buy the same pharma product in another country for much less than the US, you might also have the FDA to thank.

    Wierd example: a buddy owns an airplane built in 1967. Back then they only put lap belts in the planes.
    To have a safer airplane, for him to add shoulder harnesses, will cost over $1000.
    Why? The manufacturer had to jump through all sorts of hoops to get the shoulder harnesses certified by the FAA.

    That isn’t in defense of pharma, just a guess on the reality of the system.

    Also, I’m confident that if we removed the layers of medical coverage BS that goes on, and had the ability to pay cash-money for certain medications, we’d see the price reduced quite a bit.

  • John B.,

    Some good points there. Seems to me that the primary function of the FDA is to make drugs already vetted by like agencies in Europe far more expensive, and delay their availability by many years, while still missing problems in new and old drugs. But also, US patent law is easily manipulated so that with a tiny change an old drug becomes a new one, and despite very low costs to a manufacturer, will now be priced at exorbitant levels for an extended period. Albuterol, for instance, costs pennies when the form for a nebulizer. Add a very old technology pump bottle, even generic costs $60 or so for a 30 day supply. A nasal spray with nearly identical ingredients is easily the same price even though costs to the manufacturer are extremely low. An ADHD drug – generic, of course, is quoted at about $120 for a 30 day supply even though it’s been around for decades, but heavy digging found that one pharmacy allowed for a coupon to bring it down to $34.

    A few years back, when Claritin went generic, a single pill cost about $1. The generic version cost about 9 cents. Thank Costco for that one.

    Now consider the results. Imagine someone earning minimum wage in a high cost area like Long Island, where earnings don’t even cover rent, in a part time job (so the employer can avoid benefits), shift schedule changes every week so he can’t work a second job, maybe has Medicaid or ACA coverage, but the meds he needs are not formulary. Does he pay his rent, for his meds, food, gas? He’s got no money for a health savings account or the like. He may not have the money to pay the premiums that ACA does not cover.

    Welcome to life in the US these days!

  • @R Troy:
    I agree the FDA may be re-doing work already done by other country’s gov’t agencies, but I’m guessing it is like many things: concern about liability that the FDA maze must still be traversed…kind of like the FCC and electronics.

    I’m a Costco fan, but I don’t think they single-handedly made the price of a pill drop…I could be wrong.

    Life in the US these days is largely what you make of it.

    To a person living in a large city barely scraping by I say move.
    Sure there are a million excuses not to move.
    But look at North Dakota. Lots of good paying jobs up there.
    And guess what? Since people don’t want to move up there and work hard, those jobs are not all filled.

    Again, one can make lots of excuses not to move, but the more excuses one makes to stay in their current situation, the less valid their argument.

  • John,

    The FDA needs to exist, but the quality and timing of its work seem to leave a lot to be desired. It could care less about what other testing has been done already. And it has no power to prevent price gouging.

    What Costco did was important because it has huge buying and selling power. Meds going generic often have no effect on their pricing. In this case Costco did.

    Life in the US these days has become far more difficult for what used to be the middle class. I’m one of tens of thousands who had high skilled reasonably well paid jobs in financial services. Now,every time I apply for a job, I’m going up against numerous other applicants, many of whom I know and may be my friends – so many jobs were exported or cut or filled with H1B or like visa holding imports. We live where we live for 2 reasons; the hope that I might get decent employment, and because we live in an area where a certain family member of mine hopes to get the best care for her illness. Moving to most other areas would permanently rule out my getting back to the work I used to do, something I was very good at. And living in an area as cold as North Dakota would both leave us far from other family members, it would also kill that sick family member.

    It’s really not so simple as so many try to make it look. And there are huge reasons for viable health care reform, including separating basic health care from employment and putting an end to the huge overcharging in some sectors of health care, and cleaning up so much of the waste – which is a big part of why I so much believe in the power of EHR’s (connected). I’d work in it, except the hospital and related communities will not generally hire people from outside their community regardless of what they can bring to the table.


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