If indemnity insurance is such a great idea, why hasn't it displaced traditional medical insurance? First, because indemnity insurance creates incentives for providers to be efficient, and because providers also see patients with traditional insurance, some of the benefits of indemnity insurance will be captured by patients with traditional insurance. Any costs associated with the use of indemnity insurance "may exceed efficiency benefits for the individual, even though the benefits to all individuals exceed costs".
There is a significant private cost of using indemnity insurance - the inability to specify precisely the severity of the condition for which a payment is made. This leaves individuals exposed to the risk that they will not receive adequate compensation after developing a severe case of the condition. In contrast, traditional "cost coverage" insurance does provide protection against severity risk. Pauly proposed an alternative approach to a "pure" indemnity, combining a set payment with partial coverage of the risk that charges will exceed the indemnity level. I want to withhold further description of these "partial indemnity" systems until I get to the discussion of how indemnities might be designed for Medicare.
Interestingly, Gianfrancesco made light of the problems with indemnity insurance noted by Pauly, stating that "the information necessary to classify patient claims is, for the most part, contained in patient medical records". He also thought it would be easy to detect fraudulent submission of claims through misspecification of the information contained in the medical record. While it is too early to discuss the issue of claims verification in detail, the evidence from other insurance markets - especially automobile insurance - suggests that verification can be difficult. A cursory examination of the literature indicates that automobile insurance is rife with moral hazard. For example, holders of car insurance policies with a "total replacement" provision (the opportunity to get a new vehicle in the event of theft or total destruction of the car within a specified period) have a higher probability of theft near the end of this protection period.
Despite Gianfrancesco's assertions that it is relatively easy to design an indemnity policy, indemnities are not used in medical insurance, aside from personal accident policies that provide coverage for a few well-defined events (for example, a broken arm or loss of an eye). Instead, almost all medical insurance "pays off" by subsidizing the price of treatments obtained from licensed providers. Is this because indemnities are impractical or somehow inferior to standard medical insurance policies, or can we attribute their absence to other reasons?
To answer this question, I relied on Feigenbaum's history of indemnities for covering lost income and medical expenses. As reviewed by Feigenbaum, the evidence indicates that indemnities once existed, but they were driven out of the market by the concerted opposition of hospitals and physicians who favored "traditional" insurance for financial reasons. Changing medical technology might have played a role in the disappearance of medical indemnities, but it was not the primary explanation.
Although some insurers provided similar coverage for medical costs, only 1 percent of the USD 97 million in "sickness" benefits paid in 1914 went for medical care. The income loss from illness and accidents was much larger and more threatening to a worker's livelihood than the paltry cost of medical care, which was largely ineffective, in any case.
Feigenbaum offered two possible explanations for the decline of sickness insurance. The first was the rise in cost and complexity of medical care, which surpassed income replacement as an important insurable event. Feigenbaum was skeptical of this explanation. She observed that even in 1930, only 10 percent of benefits under then existing "health insurance" plans were spent on medical care, while 90 percent went toward replacing lost income.
Feigenbaum's second explanation relied on a political-economic argument: Sickness insurance declined because providers had a vested interest in developing their own insurance plans that linked benefits to subsidized medical care. The story of provider-sponsored health insurance has been told elsewhere, so I don't need to repeat it in detail here. Quite simply, medical providers (first hospitals and later physicians) sponsored their own insurance plans, which divided up the geographic territory into noncompeting areas, with one Blue Cross and one Blue Shield plan in each area. The admitted goal of the "Blues" was to stimulate demand for hospital services and to reduce payment defaults. At the same time, the providersponsored plans pursued political protection from state legislatures in the form of favorable regulations and exemption from state premium taxes. To compete with the "Blues," commercial insurers reluctantly adopted similar payment practices. Favorable tax policies - first an exemption of health insurance from wartime wage controls and later favorable income-tax treatment of employer-paid premiums - cemented the link between health insurance and costly subsidies for medical care. Indemnity insurance survives today only in personal accident policies, some dental insurance plans, and "dread disease" policies that offer lump-sum payments in the event of diagnosis of certain diseases, such as cancer.
George and J. C. Herbert Emery offered a third explanation for the decline of sickness insurance, focusing on the role of the voluntary societies that offered this type of policy in the early part of the twentieth century. These organizations once were a major source of such insurance in Canada and the United States. Medical costs associated with illness were much less important than lost income, as Feigenbaum had explained; and because neither commercial insurance companies nor the government provided disability insurance, voluntary fraternal organizations such as the Independent Order of Odd Fellows (IOOF) provided income replacement when an individual was sick and unable to work. The Emerys attributed the decline in the importance of fraternal insurers to diminished demand by their members for incomereplacement insurance as Canadian and U.S. households accumulated wealth and developed the capacity to self-insure. The Great Depression and subsequent poor labor market conditions in both countries in the 1930s hampered this ability, which led in the United States to the passage of government income-replacement programs, such as Social Security Disability Insurance and workers' compensation.
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