October 11, 2015

Why The Insurance Industry Is Not Wrong On Individual Mandates

At the risk of weighing in on a highly controversial and emotional issue, I want to comment on the insurance industry report that the Senate Finance Committee proposal would add $4,000 in insurance policy costs per insurance policy holder per year by 2019. Not surprisingly, many elected officials are extremely angry about what appears to be a last minute attempt to undermine support for the Committee proposal, which will be the subject of a vote on Tuesday, October 13.

One could question why the insurance industry waited until the eve of the vote to release these findings. Their motivation appears to be solely that of defeating health reform legislation. However, I have gone beyond the politics of their position, and have concluded that, based on what they said, their argument is a legitimate one, and elected officials will have to confront the problem they are presenting if the legislation gets enacted in its current form.

How could coverage expansion partially financed by an individual mandate result in higher costs? If I were an elected official, I would find it hard to understand how it is possible that adding many policyholders into the system could increase costs, especially since the Joint Committee on Taxation has found otherwise.

The answer is actually relatively simple. Imagine two populations that are currently uninsured, one of which is young and healthy and spends almost nothing each year on health-related costs, and the other of which is older and less healthy and, with proper health care, would spend $5,000 per year per person. If the insurance coverage specified in the proposed legislation costs $2,500 per year per person, the older person will want it, and the younger person will not.

If the legislation proposes an individual mandate, which is a requirement that the individual buy the $2,500 per year insurance or pay a penalty, the level of the penalty has to be very close to, or preferably, the same as the cost of the insurance policy, which would make it economically advantageous for a healthy young person to buy the insurance. Under most calculations, adding most of the healthy young population, along with other taxes and fees, achieves the President’s stated goal of making health care reform cost-neutral for the federal budget. I understand that the insurance industry did not look at all elements of the Senate Finance Committee proposal, and that the Committee attempted to address the problem in other ways, but I do believe that there is a significant risk of having more sick people enter the insurance system, and fewer young, healthy people.

The problem with the individual mandate is the penalty has been reduced from being very close in dollars to the cost of the insurance policy to a much lower number. The Committee leaders reduced the mandate because of objections from Republicans, who criticized it as a disguised tax on the middle class, and from Democrats, who felt that it created real economic hardship for the middle class. By reducing the penalty to a much lower number, the Committee almost guaranteed that most healthy and currently uninsured young people will opt for the penalty rather than the insurance.

On the contrary, the less healthy older uninsured people will always opt for the insurance, but they will cost the insurance plan far more than the premiums they pay. Unfortunately, because of the low penalty, their incremental costs to the insurance plan will not be offset by premiums paid by healthy young people, because the young people will pay the penalty, which will be inadequate to offset the cost of the older people.

So what does the insurance company do? Very simply, it has two options: first, raise the cost of the insurance plan for everyone currently participating in it; and second, try to reduce what it pays to health care providers. The cost of insurance is likely to rise for everyone. The burden of lower provider payments is most likely to fall unevenly on the provider universe. Major academic medical centers, like Yale-New Haven in Southern Connecticut, have sufficient bargaining power, so insurance payments to them will not decline. Specialists who have unique skills and market power will not see declines.

On the other hand, primary care providers and financially fragile community hospitals and outpatient centers will get squeezed, because insurance companies will have the power to do that. By the way, the situation does not improve because government is the payer, because governments have annual budget challenges that have caused them to reduce Medicaid payments whenever they get into a financial crunch.

This legislation is a deeply flawed product, but I can empathize with elected officials who feel a need to expand coverage to people who do not have it today. I can debate whether the uninsured are driving up health care costs, but elected officials hear a lot of horror stories from voters who are either uninsured or underinsured, and feel like they have to do something.

Why do I make these points when the Committee is very likely to pass the bill, and some form of legislation is increasingly likely to be enacted into law? Very simply, I do so because, once the legislation passes, we will need to figure out how to contain the damage it has the potential of doing. This legislation is the beginning of a long process of transforming our health care system, not the end of it. Although President Obama would like to be the last President to have to address health care, I do not believe his goal will be achieved. This is too complex a set of problems to be addressed with a single piece of legislation.