Sunday, January 8, 2017

What we stand to lose: the ACA approach to the "uninsurables"

Health insurance is poorly understood, but pretty damn important, so I'm taking a whack at breaking it down into comprehensible terms.

In my first post on the subject, I introduced the key concepts of insurance but looking at other things we insure. (If you don't want to bother with that post, you can skip to the bottom of this one to see those items summarized.)

In the next one, I looked at what happens when you apply those concepts to health insurance. The main takeaway is that if we're thrown into the health-insurance market as individuals, rather than as members of largish groups, many of us will turn out to be effectively uninsurable - nobody will sell us a policy at a price that is remotely affordable for us.

The solution we've relied upon - employer-based health insurance - is better than all of us being out there as individuals, but it still leaves a lot of people uncovered. Hence, the Affordable Care Act.

The core of the act is three interrelated pieces:
  1. A ban on discriminating against pre-existing conditions (that is, you have to sell insurance to people with pre-existing conditions, and you have to charge them the same as you charge other people);
  2. A mandate for individuals to have insurance, whether through their employer, their spouse's employer, or bought on their own;
  3. Subsidies to less-wealthy households who are buying insurance on their own (plus an expansion of Medicaid eligibility to take care of another group of lower-income households).
This is the natural order to walk through these pieces, because the first one addresses the problem directly, and the next two each address a problem created by the one before.

As explained in the previous post, the root cause of people being uninsurable is a situation in which actuarial fairness is applied to individuals, rather than to groups. So the ACA takes a very direct route and tells insurance companies, "You can't do that."

"But this woman has arthritis, and she's already had two cancerous lesions removed from her skin and is at high risk of developing more."

"Doesn't matter. She gets the same price as everyone else."

And so she does. Since the root cause of the problem is the application of actuarial fairness to individuals, the law simply forbids it.

But in doing so, it opens up the mother of all adverse-selection problems. For adverse selection, it doesn't matter whether the insurer knows relevant information; rather, it matters whether the insurer is able to act on relevant information. In most cases of adverse selection, the problem is that there's information the insurer doesn't know. With Obamacare, the insurer can know whatever it wants, but the law forbids it from acting on that information.

Insurance is expensive - especially if it has to include relatively sick people within its standard price. That makes it relatively unattractive to healthy people, so they stay out.

Before the ACA, that was a calculated risk: I might develop cancer, or I might get hit by a truck, and if something like that happens I'll be straight outta luck, because at that point my cancer will be a pre-existing condition, as will any injuries resulting from the truck accident. But I'll take my chances.

After the ACA, the calculus changes. The truck accident is still going to be a problem, because insurance doesn't kick in the day you buy it, so even if you worked it out over the phone in the ambulance from the site of the accident, you'd still be on the hook for the first few weeks of expenses, which are probably the heaviest costs.

The cancer's another story. That takes months or years to treat. So as soon as you learn you've got cancer, go right to the insurance company and get signed up. ACA says they can't say "no." You're golden.

This is clearly a completely untenable situation for insurers. You can't just sell insurance to people who are already sick. That's not insurance. The product only works if you have people paying in who aren't sick. Remember one of the principles of insurance: the lucky pay for the unlucky.

So we have the second part of Obamacare: the individual mandate.

If insurers are required to sell to any interested customer without charging a different price, then, just as night follows day, it follows that consumers must be required to buy. You could think of it as a dual mandate: one to the insurers, the other to the customers.

The adverse selection problem goes away. Insurers know that healthy people aren't disproportionately staying away from insurance, because they're not allowed to.

In the case of "mandatory" home insurance, you can get out of the requirement by not buying a house (or having enough money that you don't need to borrow to buy a house).

In the case of "mandatory" car insurance, you can get out of it by not owning a car.

There is no similar way of escaping the health-insurance mandate, except by paying a penalty tax, or by dying. In the next post, I'll look at alternatives to the dual mandate, but for now the important point is that if you take away the customer's responsibility to have insurance, you also have to release the insurers' mandate to disregard pre-existing conditions, and we're right back to where we were before the ACA with a large number of uninsurables.

OK, so we have the mandate to the insurance companies to sell to all willing customers at the same price, and to make that work we had to have a mandate to all households to actually go and buy something.

But just like insurers couldn't afford to sell at a single price in the presence of adverse selection, many households aren't in a position to afford insurance, which brings us to the third part of Obamacare: the subsidies.

According to the Kaiser Family Foundation, the average cost of health insurance in 2014 was $6,025 for single coverage and $16,834 for family coverage.

As mentioned in the previous post, the median household income in the U.S. in 2015 was $56,500. The single-coverage premium is manageable, at 10% of the median. The family coverage is 28% of median household income. It could easily be more than people pay for their mortgage, or their rent. And the median means that half the country's households make less than that.

So if you're going to require everyone to buy insurance, you're also going to have to provide subsidies to make it viable for people to follow the mandate.

There's the whole core engine of Obamacare: an insurer has to sell to all customers at the same price; households have to buy; and there are subsidies for lower-income households, getting larger as your income goes down.

Some people object to the subsidies, saying their tax money shouldn't go to people who don't deserve it. If you take away the subsidies, the customer mandate falls apart.

Some people object to the customer mandate on its own terms, saying it's wrong to compel people to buy a product, and they have a point. But if you take away the customer mandate, the insurer mandate falls apart.

In another post, I'll discuss alternatives to both mandates, but for now, remember the core question: should actuarial fairness be applied to individuals? If health insurance is left up to the market, the inevitable answer is "yes." If you think the answer should "no," then you need something like Obamacare, or something with even more government involvement in health insurance.

Key concepts of insurance, in summary:
  • Risk pooling: the average outcome for a group of people is far more predictable than the specific outcome for any individual. So when we pool a bunch of people, there's a lot less uncertainty about the average cost associated with that group than about the specific cost associated with any individual in the group. Risk isn't merely transferred by pooling; it's actually reduced.
  • The lucky pay for the unlucky: if you never "get" to file a claim on your insurance, it's because nothing bad ever happened to you.
  • Mandatory insurance: under certain circumstances, the government or some private entity might require you to buy insurance as a condition of something else.
  • Moral hazard: when you are spared from the bad possible outcomes of risky behavior, while benefiting from the good outcomes, you'll take more risks than you should.
  • Actuarial fairness: when the premium you pay is proportional to the cost you are likely to represent.
  • Adverse selection: when an insurer is unable to make use of information about characteristics of its customers, that affect how costly they're likely to be. The insurer charges higher premiums to protect itself, the less costly people drop away even more, and the pool falls apart.

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