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The healthcare bill will mandate adverse selection

March 23, 2010

After noting that Princeton seniors are busily scrawling away at their theses, the House has graciously released a seven-page summary of the thousands of pages of healthcare bill that passed earlier this week.  Of note is how small the effects will be early on – early provisions focus on things like “cutting waste, fraud and abuse” and and “improving consumer assistance” – things with relatively small budget impacts.  There was significant pressure to keep the cost of the healthcare reform bill under $1 trillion, which explains why the early years focus on relatively small research grants and taxes on various rich folks.

The real kicker starts in 2014:

Reforming Health Insurance Regulations. Implements strong health insurance reforms that prohibit insurance companies from engaging in discriminatory practices that enable them to refuse to sell or renew policies due to an individual’s health status.  Health plans can no longer exclude coverage for treatments based on pre‐existing health conditions.  It also limits the ability of insurance companies to charge higher rates due to heath status, gender, or other factors.

Promoting Individual Responsibility.  Requires most individuals to obtain acceptable health insurance coverage or pay a penalty of $95 for 2014, $325 for 2015, $695 for 2016 (or, up to 2.5 percent of income in 2016), up to a cap of the national average bronze plan premium.

The problem with the first provision is that it basically ensures that adverse selection will happen on a massive scale. If everyone can buy the same level of insurance, regardless of their health condition, the people who are most likely to buy it are those with preexisting conditions who expect to undergo expensive procedures.  As high-cost patients sign on, the insurer must cover these costs by increasing its rates, thus making health insurance a worse and worse deal for relatively low-cost healthy people.  As healthy people drop out, premiums must rise further.  After several iterations of this, the equilibrium is a series of very expensive insurance pools covering the sickest and most costly-to-treat patients, with everyone else priced out of the market.  What this really means is that the winning strategy is not having health insurance while you’re healthy, and then signing up for it when you come down with an expensive ailment – there’s no way the insurance company can turn you down, and they have to foot the bill.

Paul Krugman has argued that if you ban differential pricing based on preexisting conditions, then you must have a mandate to avoid adverse selection.  I agree with this argument – you can’t have one without the other – though I disagree on the aims (he wants both; I’d prefer neither).  But the second provision – theoretically a mandate – imposes a puny penalty for not having health insurance.  The penalty for employers who do not offer insurance are correspondingly puny.  There is no way, with adverse selection operating at full blast, that a penalty of this size will induce healthy folks to sign up for expensive insurance policies that they are virtually guaranteed to lose money on.

Of course this turn of events will hardly go unnoticed.  As David Henderson imaginatively explains, it is unlikely that people will make the connection between the nice-sounding anti-discrimination provision and skyrocketing insurance premiums.  Most likely this will be a target for demagoguery about those Greedy Insurance Companies gouging their customers, and politicians, avoiding blame for their own actions that precipitated these conditions, will turn around and use this populism to push through even more regulation.  Plausibly, this second stage of reform will involve raising the penalties for not having government-approved health insurance, or the creation of a public option, which will look much more attractive after the private insurance market has been trashed.  In this way, although the recently-passed bill is more modest than House’s initial offering, it leaves a backdoor to a public option.

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