I did not expect to spark mass outrage when I said this on Twitter Monday:
But I did get a lot of outrage. So let me explain why health insurance isn’t like a toaster or, more to the point, why it isn’t like other kinds of insurance.
Most insurance products are designed to turn an individual’s risk of loss into a predictable cost. For example, your premium on homeowner’s insurance should equal your expected average annual claims plus a profit margin for the insurer. If your home is in a high-crime neighbourhood or especially susceptible to natural disasters, you’ll pay more.
Because of this, we can more or less let people buy whatever kind of homeowner’s insurance they like, or none at all.
But health insurance doesn’t just allow individuals to turn risks into fixed expenses. It is also designed to shift costs across individuals, away from the sick and toward the healthy. If you have foreseeably high health costs, your health insurance premium will be less than your expected claims; if you’re likely to be healthy, it will exceed them.
This system is a kind of shadow fiscal policy, redistributing income from the healthy to the sick. It can only work if consumer choice is restricted in such a way that many people are induced to buy policies that cost much more than they can expect to get back. Obamacare contains many such inducements (including subsidies and the individual mandate) but so does the pre-Obamacare status quo in health policy.
I’ll start with the individual market, which is pretty small (about 5% of Americans get their coverage there) but is being significantly disrupted by the launch of Obamacare.
Individually-purchased health insurance is usually a one-year contract. But these insurance policies are subject to a federal policy called “guaranteed renewability.” Once an insurer covers you, it has to offer you renewals as long as you want them, and it’s not allowed to raise your premium based on new information about your health.
This rule, created by the bipartisan Health Insurance Portability and Accountability Act of 1996 (HIPAA), is basically rent control for health insurance. It benefits the sick by obligating health insurers to write policies at a loss; they make up the difference by charging more to the healthy.
In most states, there are additional regulations on the individual insurance market that promote cost-shifting. These state regulations fall into two main categories; a 2008 report produced by the Department of Health and Human Services provides a good overview.
One set of regulations requires comprehensiveness of health insurance coverage: for example, plans must cover maternity care or mental health. These regulations constitute a transfer from people who don’t need these coverages to those who do. Without these rules, insurance coverages that only some people need are likely to be expensive or unavailable.
The other set of regulations pertains to how insurers may set rates, limiting the extent they can charge people more because they are likely to make more claims. These rules are more restrictive of insurers than guaranteed renewability because they apply to people who are buying new insurance, not just those who are renewing it.
As Mila Kofman and Karen Politz noted in a 2006 paper from Georgetown’s Health Policy Institute (emphasis added):
State insurance regulation has sought to promote several policy objectives, such as assuring the financial solvency of insurance companies, promoting risk spreading, protecting consumers against fraud, and ensuring that consumers are paid the benefits that they are promised…
Rate regulation that spreads risk is, by nature, redistributive, and so not without controversy. Critics of rate regulation argue it raises premiums for healthy individuals and groups higher than they otherwise would pay in the absence of regulation. Advocates of tighter rate regulation note these rules protect consumers from dramatic premium increases when they are sick, or at renewal after they become sick. There is evidence in support of both points of view. For example, one study found that average health insurance premiums are somewhat higher in community rated markets, reflecting the relatively greater ability of older and sicker people to afford coverage. Another study of rating practices in unregulated markets found rate variation of more than nine-fold (monthly premiums of $US183 vs. $US1,765) for the same policy based on age and health status.
State health insurance regulations turn insurance into a tool of shadow fiscal policy, shifting costs from the healthy to the sick, with the extent of the redistribution depending on the state.
Redistributive public policy is even more of a theme in the group health insurance market, which is nine times larger than the individual market and the dominant source of “private” health coverage. The government massively subsidizes this market by excluding employer-provided health benefits from income and payroll taxes. Federal tax advantages for health insurance add up to $US300 billion a year.
These tax subsidies are highly coercive. Take a family with salary income of $US60,000 and a health plan worth $US15,000. If this family instead took all of its income as $US75,000 in cash salary, it would face an income and payroll tax hit of around $US4,500, or about 6% of its income. For comparison, the individual mandate penalty in Obamacare will be limited to 2.5% of income.
Employers are also limited in their ability to pick and choose who they offer insurance to. You can limit coverage to full-time workers only, but you have to offer it to all of them on approximately the same terms, without premium adjustments for claims or health status. The tax advantage combined with this universality requirement results in a large majority of full-time workers getting covered through work — and that benefit ends up being much more valuable to people with high health costs than with low ones.
That’s a summary of the “private” health insurance system we have today: Subsidise and regulate to push as many people as possible into insurance pools, and shift costs among them so the healthy subsidise the sick.
Under Obamacare, we will do the same thing, but more of it. Insurers will face more rules about what kind of coverage they must offer and to whom. Tax subsidies for insurance will be augmented with direct premium subsidies through the exchanges.
In general, the changes due to Obamacare will be positive: More people will get covered, and people with low incomes will find that coverage to be significantly more affordable. As I put it yesterday, it replaces the “thicket of subsidies and transfers” that is our current health insurance system with a somewhat more rational thicket. But there is room for improvement.
Ross Douthat made some excellent points yesterday about a problem created by Obamacare: Healthy people with moderate incomes who currently buy insurance in the individual market are likely to face significant and undesirable cost increases. People just over the income cutoff for subsidies (400% of the federal poverty line) will end up paying much more than people who make just a little less.
But there simply aren’t that many people in the situation Ross describes. Adrianna McIntyre calculates that there are about 7 million Americans aged 18-64 who have incomes over 400% of FPL and who are uninsured or insured through the individual market. That’s less than 3% of the population. Of these, just 1.5 million are 35 or younger; the older members of the group are not as likely to be made worse off by new insurance rules.
If Republicans were interested in working with Democrats to improve Obamacare and reduce the economic distortions it creates, they could fix this group’s problem. For example, they could restrict the value of the tax exclusion for employer-provided coverage (shrinking a needless tax benefit for rich people like Sen. Ted Cruz) and use the savings to extend the subsidy range above the 400% of FPL mark.
Reforms like this, needless to say, are not high on the Republican policy agenda.
I’m sure some conservatives will say that health insurance should be a normal insurance product and not a tool of fiscal redistribution. But we have this system for a reason: chronic health conditions are really expensive, and they can’t be addressed through one-year contracts. Addressing the problem of uninsurability requires either heavy-handed regulation of the sort we have now and will have under Obamacare, or some other heavy-handed non-market alternative, like a single-payer plan for catastrophic health expenses.
And anyway, Republicans aren’t willing to endorse the sorts of reforms that would turn health insurance into a normal insurance product. They co-wrote HIPAA with Democrats. When pressed on policy specifics, they talk favourably about redistribution-through-regulation provisions of the Affordable Care Act like requiring coverage of pre-existing conditions.
This reflects the fact that health insurance is not really a private product but a government program creating winners and losers, and the terms of the debate are about who will win and who will lose. Democrats want the poor and the sick to win. Republicans want people with existing coverage and high tax rates to win. Neither side is calling for a free market.
Business Insider Emails & Alerts
Site highlights each day to your inbox.