No Private Health Insurance?
Smeal College of Business, Jun 10, 2010,
http://research.smeal.psu.edu/news/no-private-health-insurance
In the wake of the federal health care overhaul, large companies are investigating the advantages of dropping medical care as an employee benefit. A recent article in Fortune magazine, for example, notes that internal documents subpoenaed by Congress indicate that AT&T, Caterpillar, John Deere, and Verizon all were considering eliminating the health care coverage they currently provide to their workers and paying a penalty fee to the government instead. They are doing the math and beginning to recognize that there are cost savings associated with the dropping of health care as a benefit.
Keith Crocker, William Elliott Chaired Professor of Insurance and Risk Management, sat down to discuss further the reasons behind these decisions and to provide a glimpse into the future he foresees for the health care industry in light of the recent reforms.
What is medical underwriting and what are your thoughts about eliminating it?
The big issue here is that the recent health care reform legislation will eliminate medial underwriting beginning in 2014. This will be implemented through the elimination of the preexisting condition exclusions and the result will be to destroy the individual market for insurance. The argument is that “an insurance company shouldn’t be allowed to reject you just because you’re sick, ” and everyone says, “Oh yeah. They shouldn’t be able to do that.” The problem here is that if you don’t allow insurance companies to tailor the premium to the cost of the risk that they are assuming, then the result will be adverse selection where only the sickest people will buy insurance.
As an example, think about life insurance. Suppose there was a prohibition of preexisting conditions on life insurance, meaning the insurance company had to accept all applicants for the same premium, no matter what they looked like. Well, as it turns out, one preexisting condition is age, so, in this setting, insurers would have to charge everyone the same price for life insurance independently of how old they were. Young folks would find the insurance to be too expensive and would exit the applicant pool, while older folks (for whom the chances of their heirs collecting on the policy are higher) would go ahead and purchase the insurance. As a result, the applicant pool would end up consisting of older high-risk individuals and the premiums would have to increase to reflect that high-risk pool. The only way to get younger folks to buy life insurance would be to charge them a lower premium that reflected their lower actuarial cost. But, then, insurers would be classifying applicants based on a pre-existing condition—their age.
It’s the same with medical insurance. If insurers have to take everybody, then only the sickest people will find it useful to get insurance, so the premiums will have to rise to reflect the costs associated with the sickest people. When the premiums go up, the young and healthy and the smaller businesses will drop out of the insurance market because they cannot afford the premiums, and they will join the ranks of the uninsured.
Prohibiting pre-existing condition exclusions destroys an insurance market because risk classification through medical underwriting is what eliminates adverse selection and adverse selection is the poison that kills insurance markets.
So what happens if only sick people are getting insurance and premiums increase?
The market is gone. While I am not an expert on the dynamics of Washington politics, I do suspect that when that problem arises, and folks have trouble finding health insurance, there will be an attempt at some sort of government intervention, so the public option will raise its head again. The trouble with the public option is that the premiums get set for reasons of political expediency and not for actuarial reasons reflecting the underlying costs.
Had it been included in the reform legislation, the public option would likely have driven private insurance from the market because it would undoubtedly have been underpriced relative to its cost. And, if you don’t think that would have happened, I point to Medicare, which currently has an unfunded liability in the neighborhood of $38 trillion. That’s the difference between what Medicare is forecast to take in from premiums and what its liabilities are forecast in terms of paying out.
We’re not talking about rocket science here. It’s basic economics, and it fails Insurance 101, particularly the elimination of medical underwriting. That will be catastrophic.
Discuss the mandates and fines associated with the reform.
Well, let me say that, on a personal level, I have no problem with doing something to help people who want insurance and cannot afford it. In this country, when we thought we had a problem with hunger, we taxed those of us who were better off and we provided food stamps to give people access to food. We didn’t nationalize the grocery stores, nor did we implement a public option in grocery stores. We attacked the problem and we provided access.
There is, beginning in 2014, a mandate that all individuals must purchase health insurance, or pay a fine of $695 (or 2.5 percent of one’s taxable income, whichever is higher). In addition, employers with more than 50 employees who do not offer health insurance as a benefit face fines of $2000 per employee, although smaller firms are effectively off the hook.
Given these incentives, individuals may find that their best strategy is to not buy insurance until they are sick and actually need it, since they cannot be denied coverage because of the prohibition of pre-existing condition exclusions. Small firms may save money by eliminating health care as a benefit, giving the employees a raise composed of a portion of the resulting savings, and sending them off to the highly subsidized “insurance exchanges” to buy their own coverage. And, large firms are likely to figure out that they can pay the penalty, dump their health care coverage, give the employees a big raise, and send them out on their own to get their own health care coverage from these federally subsidized health exchanges. Indeed, this is precisely the strategy that AT&T, Verizon, and other firms have been investigating.
The result is that the mechanism by which the vast majority of us have health insurance through our employers is going to get torpedoed by the elimination of medical underwriting and the trivially small fines that are associated with not offering insurance in this bill. To argue, “if we like our current insurance, we can keep it,” is disingenuous, especially if the reform sets in motion changes in the market that result in our current insurance no longer being offered.
Would raising the fines for the mandates be a fix?
Well, larger fines would result in more firms offering health insurance as a benefit, no doubt. But the availability of highly subsidized coverage through the proposed insurance exchanges is likely to make employer-sponsored insurance less attractive. Why pay the full cost of covering one’s employees when they could instead be subsidized by the taxpayer?
It is important to keep in mind that the cost of the medical coverage and wages come out of the same bucket. If mandates force firms to provide health insurance and the price goes up, then employees get less of a raise. They are mutually exclusive.
Why are several states filing suits against this legislation?
The states don’t want the unfunded mandates because a lot of the access is going to be accomplished by pushing more people into Medicaid and the states end up paying all the freight on that after 2016.
What happens if the courts strike down the mandate as unconstitutional?
Then we’re back to square one—again. The question, at the end of the day, is how much gets struck down. The mandate, as it is now, has been implemented as an excise tax because it seems clear that the government doesn’t have the ability to require you to buy health insurance just because you are a citizen. Otherwise, that is what the reform would have done. This is all going to be implemented by the IRS and how it is going to monitor who has health insurance is anybody’s guess. I’m not a constitutional scholar, so I can’t give opinions on whether it will end up in the Supreme Court or what the decision might be, but it is going to be very interesting to watch this sort out.
Keith Crocker, William Elliott Chaired Professor of Insurance and Risk Management, joined the Smeal faculty in 2003. He previously served as Waldo O. Hildebrand Professor of Risk Management and Insurance and Professor of Business Economics and Public Policy, at the University of Michigan Business School. In addition to his research in the health insurance field, Crocker focuses his research efforts on contracting issues, with a particular emphasis on the role of transaction costs, adverse selection, and moral hazard in the design of agreements. He holds a bachelor’s degree in mathematics and economics from Washington and Lee University, and a master’s degree and Ph.D. in economics from Carnegie Mellon University.
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