Thursday, 9 May 2013

Obamacare and increasing insurance premiums

One of the big problems with US health care is the large number of uninsured people. A lack of insurance is costly for the state given that someone has to pick up the bill for all necessary treatment on uninsured patients. And its costly for society given that ill health can cause personal bankruptcy for anyone uninsured.
   To fix the problem you need to know what is causing it. There are three basic causes. In looking through these its useful to have the following figure to hand. On the horizontal axis we plot the publicly observable health of the person, which might include things like weight, age, illness in the family etc. These are things the insurance company will take into account when assessing risk. On the vertical axis we plot the privately known health of the person, which also takes into account things like diet and exercise. These are things the insurance company would like to know but cannot, only the person knows. Each dot in the figure is a particular person. Most people will be near the 45 degree line, but not all. For example, Fred is very healthy, exercises regularly etc, but looks very risky, because of say a genetic condition in his family. John, by contrast, is very unhealthy, eats fast food every day etc., but the observable characteristics make him look healthy.

   Now, to the causes of people being uninsured:

1. Some people look such a high risk that no insurance provider is willing to provide insurance. In the figure I have drawn a cut off point at N. No person beyond this will be given insurance. That's clearly harsh on Fred who is perfectly healthy. The problem is, the insurance cannot know that Fred is healthy because everyone can lie about taking exercise and eating healthy etc.

2. Adverse selection. Suppose the insurance company offers a standard price on insurance to anyone left of N. The price will be based on average health and so will look unfairly high to someone like Sarah who knows they are healthy. Sarah exercises regularly, eats healthy, and objects to paying a high price because others take less care of their health. As such, Sarah may choose to not buy insurance. This can push up the price of insurance even more given that those left buying it are the relatively unhealthy. In the figure anyone below H is assumed to not buy insurance because the premiums are too unfair. (This story assumes a standard price for everyone and the insurance company might charge according to risk. The basic logic, however, still follows through.)

3. Some people are risk loving. John, for example, might just risk that he can avoid ill health. Of course, a little bit of over optimism and present day bias is likely.

All three of these potential causes are surely at work in the US. So, how to fix them? Europe has a relatively simple answer - force everyone to get insurance. This can be done implicitly as in the UK through taxes or explicitly as in the Netherlands. Obamacare essentially tries to bring this philosophy to the US. How does this work? It solves problem 1 by guaranteeing everyone access to insurance. It solves problem 2 by forcing people to pay even if prices are unfair. It solves problem 3 by forcing people to buy insurance whether they want it or not. It is these last two sentences that capture a lot of the hostility towards Obamacare we see in the US. Why should people be forced to buy insurance against their will?
    Problem 3 is almost certainly due, in large part, to cognitive bias. Many people who risk no insurance may subsequently regret that decision. So, it is not unreasonable that the government forces people to make the right decision, particularly as the government picks up the bill. Problem 2 is a market failure. Forcing people to buy the insurance solves the problem. It has the advantage of lowering prices because healthy people are bought back into the market. Prices still remain unfair for people like Sarah, but they are less unfair than they would have been otherwise. And note that everyone benefits from the lower prices including those who were buying insurance previously.
    So far, so good. Fixing problem 1 is where the problems start. Morally, it seems easy to justify everyone having access to insurance. The drawback is that it brings the least healthy people into the market. Which can increase premiums for everyone, offsetting the gains from solving adverse selection. Recently, the Society of Actuaries predicted that insurers costs will jump by 32% by 2017. This increase is partly due to the increased risk for insurers of bringing less healthy people into the market. If that increase in costs is passed on in premiums in the private insurance market then there will be many unhappy people.
     Remember, however, that a lack of insurance has big costs. The savings the government makes, if everyone has insurance, should be enough to reduce insurance premiums through direct subsidy. In short, if the amount of treatment remains the same, there is no reason total health care costs should increase. All that's happening is a redistribution of the costs. The previously uninsured are paying where they did not before, and the government has savings that could be put back into the system. Compulsory insurance is not, therefore, as bad as the critics would suggest. And it is surely a fairer system? It forces people to buy insurance, but also means taxpayers are not forced to bail out the uninsured.    


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