Using Social Networks to Form Health Insurance Buying Groups

This is from an email to a friend (Erem) about the pros & cons of buying health insurance with a group of your friends (i.e. as opposed to a group of your coworkers).

There are certainly reasons to buy health-insurance in large groups, but I don’t think they work unless you force everyone in the group to buy health-insurance. As I understand it, the benefit of buying insurance in a large group is that individuals in that group who become expensively ill don’t suffer a massive upward shock on their health-insurance premium. For instance, say I buy a year of health-insurance on my own. During that year, I get cancer and cost the company $500k. They are going to jack up my premiums tremendously at their next opportunity. If I’m in a company of 100 people, the insurer will still jack up the premium for the company, but it will be spread across all of the employees–and all of the other employees are forced to pay this new premium, because you can’t tell the company “I want to be paid $500 extra per month instead of having health insurance.” The practice of spreading the premium across all members of a group is called “group rating” or “community rating”, and it crucially depends on the fact that everyone in the group is required to have insurance–no opting out. If people can opt not to purchase, then you run into the problem of adverse selection, where healthy people don’t insure, so it’s only the ill buying insurance–and their premiums go way up. In effect, community rating means that healthy people subsidize the care of the ill; whether or not this is desirable is a question of ethics, not economics.

One upshot of this is that you, I, and our 1000 closest friends could opt into a lifetihme contract where we all say, “We are going to buy health insurance as a group, and no one can ever opt out.” Now, wouldn’t really trust that contract unless I really trusted the other people involved, or if there were some penalty for leaving the group. A possible incentive would be that you are in debt to the group for $20k at zero-interest with payable in full when you leave the group. Note that no money actually changes hands and a member isn’t actually given $20k on joining; the debt just serves as a disincentive to leave.

I guess joining a group like this would be mutually beneficial for you and me. We would have more negotiating power when buying insurance, and we would have some statistical guarantee that our premiums are going to be less volatile than if we were each buying insurance individually.

So what do the groups look like? Is it desirable to have people all of similar ages & similar social class in a buying group? Or is it desirable to have a mix? For young people, it seems desirable to be with other young people, so that we aren’t subsidizing old people. It’s also desirable for us to group with other people who don’t smoke, exercise enough, won’t get fat & depressed, etc. There is a subtlety here, however. Even in a group/community rating system, it is okay to base premiums upon a number of factors as long as they are observable at the beginning and predictable as to their evolution over time ( e.g. age, sex, possibly even preexisting conditions). The goal of community rating is to decrease the variability of premiums–not to be communist and have everyone pay the exact same amount regardless of age, etc. This way, members have better insight into their future health expenditures, and are less exposed to catastrophic premium increases. And of course, there is a viable continuum between group rating and community rating; i.e. I pay 10% of the total increase in the entire group’s premium due to me. This could mitigate problems of moral hazard.

That is how I could imagine something like this working. I don’t really know how to organize health-insurance buyers groups using facebook, because it seems like joining such a group would involve a level of trust above that implied by linking someone as a facebook friend. Another problem is taxes: currently the US tax code favors health insurance provided by employers, because that type of compensation is not subject to income tax. Basically all economists agree that is really dumb, and that employer-purchased health insurance should be taxed the same way as individual-purchased health insurance. There is plenty of talk among the ‘08 presidential contenders of doing exactly that, but for the moment, the tax-issue is a huge problem.