Wednesday, October 7, 2009

Incentives and asymmetric information

So rather than harping on the many problems with the health care system, here is one company that has found a solution. While the rest of the country has seen health care costs spiraling out of control, Safeway has kept their costs flat for the last five years. The catch? Incentives, of course! Safeway gives discounts, in the form of lower premiums, to non smokers, those who have a BMI lower than 30, and those who meet other "healthy" guidelines. Full story here.

Why does this work? Economists will tell you one of the problems with the health care system is that of asymmetric information similar to the problem facing potential buyers of used cars. The issue is that one side (the insured) has all the information while the other side (the insurance company) has none (or very little). Therefore, in the case of health insurance, the insurance company must assume everyone is at a baseline, "average" level in order to mitigate risk and because it has no way of telling if one person has a better chance of costing more than another. What Safeway has done, on the other hand, has given its insurance company additional information about the people it is insuring. This allows those that are healthier, and therefore lower risk, to be charged less while those who are higher risk are charged more.

Naturally, the counter argument to this is that this is essentially a tax on those who are deemed "unhealthy". However, this is where the incentives kick in... they are determined by indicators that individuals have control over. Want to smoke? Fine, but you'll have to pay more for that privilege. Want to eat junk all day? Thats OK, too, Safeway's CEO will tell you, but you'll have to pay the price.

Free markets work effeciently only when both parties are privy to the same amount of information. Additionally, healthier people are cheaper to insure. Combining these principles, as Safeway has done, leads to cheaper, equally effective, health care.


Stephen Jeffrey said...

Great share Andrew, you think your employer would go for a program like that? haha.

I work at a larger community bank, we have a couple good wellness programs, but nothing like that. I forwarded the Safeway Article to my HR dept.

Andrew said...

Yeah... that policy certainly wouldnt be popular around here!