What some consider President Obama’s singular achievement, the Affordable Care Act (ACA), and its individual mandate came under intense scrutiny this week at the Supreme Court hearings. Unsurprisingly, much of the extreme skepticism came from the Court’s three conservative Justices—Roberts, Scalia, and Alito. Though the fourth conservative, Justice Thomas, remained silent during the proceedings, it is almost certain that he too harbors serious misgivings regarding the constitutionality of the individual mandate. The fundamental question that the Justices wanted answered was very simple: What makes health insurance so different from a standard market commodity like broccoli or a Chevy Volt that the government has the right to compel individuals to purchase it? Needless to say, they did not receive a satisfactory answer.
Not unexpectedly, blogging economists of the liberal/progressive stripe, e.g., Paul Krugman of Princeton and the NYTimes and Henry Aaron of The Brookings Institution, bemoaned the utter lack of understanding by the Justices of what we call market failures and how they are related to the functioning of insurance markets. A big one that is often cited is called “adverse selection”. Here’s how it goes. If relatively healthy people are allowed to opt out of health insurance coverage, then the insured pool will consist of relatively sick people needing greater levels of health care services. This, in turn, raises premiums causing even more people to opt out leaving even sicker individuals in the insured pool raising premiums further, so on, so on, and so forth. This is what is known as the “death spiral” with premiums rapidly escalating, more people choosing to become uninsured, and some insurance coverage disappearing.
A number of conservative economists, however, take issue with this market failure story, and frankly, they have a legitimate point. Their argument is that the market failure in this instance is created largely by the government because of its insistence on “community rating” in setting insurance premiums. With community rating, all those insured pay the same or close to the same premium. Differences across individuals in terms of health status, demographics, lifestyle, and expected health care utilization are (largely) ignored. The young and healthy subsidize the old and sick. If you let the young and healthy opt out, then you’re in big trouble—hence, the mandate. But hold on. The problem can be substantially ameliorated by using “experience rating” in setting insurance premiums. People pay different premiums based on differences in health status, demographics, lifestyle, and expected health care utilization. So, my premium is the same as those in my particular risk pool. If I’m in a lower than standard risk pool, my premium is lower than standard; if I’m in a higher than average risk pool, my premium is higher than average. People pay a price for health insurance that is targeted to the cost of the health care services they are expected to consume. Of course, there is the unavoidable redistribution from the lucky to unlucky in a particular risk pool but there is no cross-pool subsidization. There is no redistribution from the young and healthy to the old and sick and hence, no death spiral to worry about. Problem solved, no mandate required. Understand, however, that under experience rating, a healthy individual who gets sick will likely pay a higher premium or be deemed an “uninsurable risk” and dropped from coverage. Individuals with pre-existing conditions will be targeted as uninsurable or will be subject to high premiums and/or exclusion clauses. The same will hold true for higher risk groups as well.
The two sides offer different views of health care. From the experience rating perspective, health care is treated as a normal market commodity. Those who are willing and able to pay the market price get to enjoy the commodity’s benefits. A system of non-group tax credits is usually recommended to address the problem of uninsured individuals and families. In contrast, from the mandate/community rating perspective, health care is a fundamental right of citizenship and those who need it most should have affordable access to it.
Interestingly, a 2008 paper in the Journal of Economic Literature by Jonathan Gruber of MIT, the architect of Romney care in Massachusetts and a proponent of the ACA’s individual mandate, is quite useful in comparing the possible consequences of the two approaches. The status quo plus non-group tax credits yields a net decrease in the number of uninsured of between 5 and 10 million people at a total cost of between $22.6 and $79.1 billion or between $4,400 and $7,900 per newly insured individual, depending on the generosity of the non-group tax credit program. Going with community rating and the individual mandate, Gruber estimates a net reduction in the uninsured population of 45 million, a total cost of $124.1 billion, and a cost per newly insured of $2,700. All cost figures are in constant 2006 dollars. Bang-for-buck, the mandate/community rating alternative wins out.