What’s Wrong with This Statement?
This is Kevin Outterson, writing at The Incidental Economist:
If a healthy person doesn’t buy insurance, the average cost of the risk pool goes up. This is unique to insurance markets. If a healthy person doesn’t buy broccoli, the average price goes down.
Answer below the fold.
If the market is allowed to price risk in an unfettered way, a healthy person’s decision to buy to not to buy insurance in no way affects the premium charged to other members of an insurance pool. Each entrant into the pool will be charged a premium that reflects the expected extra cost and risk that person brings to the pool.
A healthy person only helps others in an insurance pool if he is overcharged. If he is charged a premium greater than the actuarial value of his insurance, the extra payment he makes can be used to subsidize everyone else’s insurance and make their premiums lower than the actuarial value of their insurance.
But if all we are doing here is looking for people to plunder so that we can subsidize the premiums of above-average-cost enrollees, why pick on young healthy people? Why not tax old sick people? Or people who are left handed? Or people with blond hair?
Or here is a novel idea: why not fund the subsidies from the government’s general revenue.
As I have said many times before, I think the IQ drops about 15 points when people start talking about health policy.
Hold on, while the statement is misleading, isn’t it still actually true that the average price (per person) goes up if healthy people don’t buy insurance.
If healthy Joe should be charged $100/mo for insurance and unhealthy Sally should be charged $900/mo for insurance, if they’re both in the pool, the average price is $500/mo/person, if it’s just Sally it’s $900/mo/person.
It’s a self-evidently dumb statement.
Bret, good catch. But what is being implied here is that other people in the pool gain when the healthy join and lose when they don’t join. Not so, if the healthy person’s premium is actuarialy fair.
They are pretty much eliminating actuarial fairness.
I’ve heard numerous progressive types proclaim that… health coverage will not be affordable until everyone is covered. What they really mean is health coverage will not be affordable for sick people unless healthy people are forced to sign up and pay premiums far above their expected cost of care.
Kevin Outterson should have clarified that what he really mean was the average cost of premiums rise unless healthy people are coerced into joining and paying far more than their actual costs. This is a very different point.
John, I think you demolished the argument.
I concur. This makes no sense.
There’s no “actuarial fairness” in Medicare either, and yet nobody is questioning its constitutionality. I’m not sure I see what the big problem is from a constitutional perspective if an insurance program is not “actuarily fair.” This is how a lot of health insurance presently works. I imagine that even the most sophisticated attempts at actuarial adjustment likely overcharge the healthiest people and undercharge the sickest.
You are spot on.
Recommend all to learn “Law of Large Numbers” pertaining to insurance.
Also, the concept of “Adverse Selection”
http://www.econlib.org/library/Enc/Insurance.html
According to the Law of Large Numbers, the larger the population size, the smaller the variance from the mean. Smaller variance results in less uncertainty. Less uncertainty (due to large population size) would result in slightly lower premiums given the level of risk in the pool. But, I believe what Kevin Outterson is suggesting is using an individual mandate to coerce young, healthy people into a market where they pay premiums far above their expected cost of care so others get a better deal.
There is less opportunity for adverse selection when people are charged actuarial fair premiums.
@Bret:
A source of confusion is Mr. Outterson’s statement that “…the average cost of the risk pool goes up”. That is a meaningless phrase. The risk pool has a total cost; and the total cost per total risk are unchanged if the government allows actuarially fair underwriting.
But also recall that in a functioning insurance market Sally would not be paying $900 a month because she had every incentive to buy her insurance for $100 a month a few years ago before she became ill.
The premiums were front-loaded to pay for the risk of future illness (i.e. her medical spending in previous years was significantly less than $100 per month). This allows guaranteed renewability, so that her premiums do not get jacked up when she falls ill. Rather, her premiums go up the same as everyone elses’ do.
Gven the artificial fragmentation of health insurance due to the grojp-based system forced by the government, it’s surprising that this pooling in the individual market is as good as it is in the U.S. But Prof. Mark Pauly and colleagues have demonstrated convincingly that it occurs.
However, I think we should give Mr. Outterson a break. In the comments to the original post, he clarifies that he is describing a system of guaranteed issue and community rating, not an actuarially fairly underwritten market.
Well yeah sick people are going to be overcharged compared to the price they would get in an free market. I don’t think proponents of the law would deny that, they just dont emphasize it when making their argument.
You ask why pick on healthy young people, and why not fund from general revenue. Well that would be close to single payer, and again would probably be the solution that most proponents would prefer. the mandate however achieves the same effect through changes to the existing insurance industry which is the only politically feasible way and is better in terms of path dependence.
What I think John Goodman has been saying over several years (and good for him!) is that the Obama plan reeks of ‘private sector socialism.’
Dr. Goodman agrees with the left that a large of number of sick people and just about anyone aged 55-65 cannot afford health insurance at free market prices. I am age 64 and make a decent income, and I can barely afford catastrophic health insurance
($500 a month for a $4,000 deductible.)
The private-sector socialism of the Obama plan would regulate the insurance industry, regulate employers, and regulate the young and self-employed (through the mandate),
all in an effort to give me more affordable insurance.
Instead, what I think Dr. Goodman prefers is that we leave the insurance industry alone. We leave employers alone, and we leave young people alone.
Instead we just give people like me a voucher or similar subsidy from general revenue.
Now there would still be a collision between Dr Goodman and the hard core libertarians like Ron Paul.
Dr. Goodman’s preference for honest socialism would require at least $40 billion in new subsidies– but frankly, that is less than one per cent of payroll, and would cost the nation a heck of a lot less than the ACA will cost with its exchanges and subsidies.
Bob Hertz, The Health Care Crusade
The issue of whether or not we can fund this from general revenue (we can) is irrelevant at this point because the question is can the ACA with the individual mandate be Constitutional? This is a program to be implemented in the private sector with government regulation under the commerce clause. There must be an individual mandate to make it work. And the basis of the mandate is that the Constitution begins with the words, “We the People…” and we the people mandate you to do things that increase the general welfare of everyone else. By failing to participate you make the costs of everyone else be higher, because there are fewer persons across whom to share the total cost.
Furthermore, if you do not have insurance when you have a major medical crisis
costing you much more than you can afford, then someone has to assume those
costs. Usually hospitals and clinics spread such costs to the patients who can pay, if they have insurance or means. So, you have an obligation to others by not covering yourself with insurance or wealth. Furthermore, by participating in the insurance, while you are healthy, your premiums as you note, are used with other
healthy policy holders mostly to share in deferring the costs of the unhealthy. But that builds up obligations in others over the years for them to assume shares of your medical costs when you have them. So We the People mandate that you participate along with everyone else on the basis not just of the general welfare, and necessary and proper means, or regulation of commerce but by a power retained by the people in law (10th amendment) that the people may coerce people to fulfill their obligations to others. When your behavior harms others, you have obligations to make it right. By not behaving properly, you may inflict harm, even if indirectly.
Why else does the government have the right to make you “join the militia’ in the common defense. Suppose you and others like you don’t. What then? Why do motorcyclists have to wear helmets? Why do people have to wear seat belts in cars? That is not a power of the state, but a power of the people toward other people that both the Federal and State governments recognize sometimes implicitly.
I’m not sure I understand the principle of “actuarial fairness”. I suppose it concerns in any policy year what the probability of an individual incurring certain costs is.
But the ACA is a different kind of insurance (I think) in that it is something one must participate in throughout one’s life. It is not something you can drop out on your own at any time. Funds must be collected from everyone, and mostly the healthy will end up paying the most for the claims of the sick. But the actuarial problem, if I understand it, should consider the lifetime probability that one will have $X of costs, and if those are roughly the same for everyone, I think trying to adjust for age, sex, religion, etc. is irrelevant. It is not just the individual who gains benefits. He will not if there are no obligations for others to share in his costs if he has not likewise shared in their costs. So premiums must be based on the expected costs in any policy year divided by the number of policy holders.
(A little profit can be added in).
The more interesting question is suppose we permit persons to defer getting insurance until they feel a need to. What percentage of their claims can be paid for by the insurance that represents N years of participation? And how much are they still obligated for? It’s probably best not to consider things like this because it makes the program too complicated.