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Friday, August 23, 2013

Obamacare's "Individual Mandate": Part 2 - What's the economic rationale?

Obamacare's 'Individual Mandate'
(Part 2 - "What's the economic rationale?")

In my last post, I explained WHAT that "Individual Mandate" thing you've been hearing so much about actually is. Read that post, and you'll have a pretty good idea of what the law requires you - yes, YOU - to be doing right now. 

 Now that you understand what the law actually is, today's post explains WHY it was put in place.

And so, Economystified proudly presents, PART TWOO!  The economic argument behind the Individual Mandate.


The problem with the US's current healthcare system is that there is no system.  Healthcare is acquired through innumerable channels, with no structure, plan or organization.  Its a free for all.

Now, don't get me wrong economists love a good free market.  But in 'free markets' only develop in the right circumstances. In the presence of asymmetric information, transaction costs, misaligned incentives, issues surrounding economies of scale, the free market prescription - 'just sit back and let things play out' - produces wasteful, economically inefficient outcomes.

And when it comes to healthcare markets, you have all of those hindrances, plus umpteen more.

I don't think there's any American that's satisfied with the old system. Medical bills are the leading cause of personal bankruptcy in the US.  17% of all wealth produced in America is consumed by healthcare expenses, more than any other developed nation (The Netherlands comes 2nd at 12%).

There's been plenty of fighting about how to address the problems of cost, but as of right now, the Obamacare is the plan we're going with.

Will Obamacare last 100 years?  50?  10?  Its much to soon to even be guessing.   But what we can do today - and should do! - is understand the rationale behind the new healthcare laws, particularly the 'Individual Mandate,' which affects every single one of us.

This is the reality you live in...why not understand it?

How health insurance works

Keep in mind, Obamacare is a set of new regulations and reforms regarding, health insurance, not healthcare, or medical provisions, or hospitals, etc.

You can't understand how forcing everyone to buy insurance is being offered as the solution to what ails us, you MUST understand how health insurance works.

If you 'have health insurance,' you pay a monthly fee called a premium to your insurer.  Think of it as a subscription to their service.  And what does this subscription get you?

Whenever you require some medical service, the provider bills your insurer for the expenses, as opposed to you.  The insurer may or may not pay the entire bill, but if they short the hospital, its on their head, not yours.

Some subscribers will pay $2,000 a year in premiums and consume $10,000 in healthcare.  Some will put up $4,000 and consume only $500.

But as long as the insurer collects more money in premiums then it pays out to health care providers, it makes a profit.  The subscriber benefits by getting healthcare, yes, but also from getting peace of mind in knowing they'll be ok if something terrible happens to their body.

Most Americans get their insurance through their employers.  Employers, who can enroll their workforce en masse in a particular plan, can negotiate a lower price with insurers.  In other words, they can buy in bulk.

A lone individual doesn't have the negotiating power to talk an insurer down from their price, they just aren't offering enough business to the insurer for the insurer to be able to cut their price and still make money off the guy.

There's tons of problems with this arrangement.  I'm not going to go into the little peripheral problems it leads to, because the headaches they cause are dwarfed by one major issue, the issue that the Individual Mandate is indented to correct.

Its one of the best named economic concepts out there.  Honest to god, the Individual Mandate is designed to address:

"The Free-Rider Problem"

There's tons of people out there who say "Hey, I'm healthy.  Insurance costs so much, its unlikely I'll really use it, so in the end, its a waste of money.  I'm not going to insure myself."  So they 'exit the market,' they choose to be uninsured until their health worsens, or until some big medical cost appears on their horizon (a surgery, or a pregnancy, for example).

The wacky thing is, this is a perfectly rational chain of thought, economically.  The individual feels the costs outweight the benefits, and makes the decision that's best for him.

The problem is, when people exit the health insurance market, in a nation where healthcare is mostly funded by the private, 'free market,' the effects are public.  

The individual is considering only the cost and benefits to them of being insured, not the cost and benefits of everyone having insurance.

How are these people "free-riding"?

In a couple of ways.  "Free-riders" are people who are getting more value out of the system they aren't paying for (conversely "people who others have to pay for").

It gets to be a question of fairness.  TO BE FAIR, we want everyone to put in to the healthcare system as much as they get out - for everyone (who can) to pay their share.  

The kicker is though, that they don't necessarily need to be paying their fair share year in year out.  You can overpay now, as long as you underpay later, and still be paying your part in the long run.

Imagine a young fella, about 25.  He's likely in good health.  He's also likely to not have much of an income.  So he opts out of insurance, and doesn't pay anything into the healthcare system.

BUT EVEN SO, he reaps benefits from the healthcare system around him:

With everyone around him consuming healthcare, he gets to live in a (relatively) disease-free environment, and will be exposed to fewer things that could negatively affect his health.

When his partner gets pregnant, they might buy insurance just for the year they know they'll need it.  If they pay $2,000 for a year's of insurance, and get a $15,000 procedure, the $13,000 will be paid by everyone else.

When he turns 50, and has tricky knees and a gall bladder that has to be removed, there will be trained surgeons, developed medicine, an established hospital, tested procedures, and refined protocols - an entire medical infrastructure - all for which he's never contributed a dime.  

When he gets older, buys insurance, and starts paying into the system, he finally starts contributing financially.  But its too late for him to pay in as much as he could toward the benefits he receives.  

To be fair, he should have been underpaying in his youth (consider it an investment), and underpaying in his older age (as future youths, in their "investing years," support the elderly).

"The Market for Lemons"

I won't go into how this concept got its peculiar name (you can watch this video if you're curious),but when talking about healthcare, its the less talked about cousin of the free-rider problem, and another argument for the Individual Mandate.

Health insurance really wasn't much of a thing before World War II.  Healthcare was expensive, people paid in cash, and relied on charity for the higher end stuff.

In addition, before WWII, healthcare just wasn't as expensive.  There wasn't much out there in terms of viable surgeries, there was no MRI, CAT Scans, vaccines, or medications.  There just wasn't as much healthcare to spend money on!  

In the early days of big insurance (lets say the 70s or 80s or so), many health and unhealthy people enrolled in the plans.  Premiums were priced uniformly, and benefits pretty standard.

But in the long run, there's an incentive for healthy folks to exit the health insurance market.  And goodness, we don't want that.  The healthy people - the ones who pay more in premiums then they receive in benefits - they're are the only source of insurers profits!   Do you see what the incentive would be?

In year 1, everyone signs up for insurance.  It sounds like a great deal!  I just pay a little bit every month, and I get unlimited healthcare in return!

But in year 2, a few people realize they paid more in premiums then they got in care, so they drop out.  With out their money, the insurer loses income.  

So the insurer feels like the cost of running their business are increasing.  They respond by raising the price of the premiums.

And so in year 3, with the premiums going up, more subscribers will feel like the cost of insurance outweights the benefits.  More of them will cancel their subscriptions, and the only insurers who stay in business will be the ones that raise their prices again.

Over the years, anyone in good shape figures, "the hell with it, I'll chance it," and quits insurance.  The insurer is forced to jack up their premiums.  The only subscribers left on the rolls are those whose health is so bad, the high premiums look cheap compared to self-paying.

In its natural state, health insurance kind of drives away the only customers who make it a profitable venture.

When left to its own devices, when left to the 'free market,' health insurance eats itself.  The industry kind of has a natural gravitation towards implosion.

THEORTICALLY, forcing everyone to buy insurance will but downward pressure on the price of insurance.  When everyone is paying for insurance, the wealth in sort of redistributed - this year's healthy pay too much, the unhealthy pay to little, but in the end, it all balances out to a point where the insurer can still break even.

The bottom line

The big idea here is that if more people are buying insurance, it becomes cheaper for everyone, as the cost is distributed out across all subscribers.  By making everyone buy insurance, it at least creates the necessary environment for insurance to be as cheap as possible.  

If everyone is buying insurance, the price of premiums can reach their maximal low point.  If it works is still to be seen.  But hopefully, at this point, you at least see the logic behind the concept, and why the Individual Mandate is a colorable argument for controlling insurance costs.

For more economics

I realize these are some pretty birds-eye viewy explanations...if my explanation wasn't satisfying to you, and you want something a bit more technical, I really like this video.


Of course, the Individual Mandate is only one part of the "Obamacare" laws.  I just chose to focus on it because it seems to be the most complicated major provision.

EVERYONE seems to have an opinion on Obamacare.  I'm withholding judgment for the next 30 or 50 years.  There's just to many imponderables to know whether or not this new system is going to work.

I will say this though - trying something is better then sitting around on your ass and hoping the problem will go away.  Healthcare is not going to get cheaper, more available or better under the status quo.

If the private sector had innovate, drastic solutions to the problem, I'd be pleased.  If the govt comes up with sound solutions, I'd be pleased to.  For whoever does tackles the problem, it ain't gonna be easy!

I don't know or understand everything about Obamacare, either.  Its complex.  There's entire cottage industry springing up revolving around just doing research and making predictions about how this will all play out (just Google "health policy research".)

I get why though.  Cuturally, American's just don't view healthcare as a public good or a right.  Most other cultures I've come into contact with do.  

If Americans were to hear a nation where there are no public defender attorneys, we'd all be up in arms.  If an American was told there was a country with no public education, where the only people who could go to school were those who could privately pay for it, they would be appalled.

But we just don't feel the same way about healthcare.  I have no idea why.  But because we don't seem to feel the same urgency about healthcare provision, I kind of get why forcing everyone to contribute would be met with resistance.

Interesting side nugget: 
A note on pulling an "international comparison" out of your butt

Before Obamacare was passed, I remember people on TV saying all the time "Obamacare is socialized they have in Canda or the UK!"

First off, the Canadian and UK systems are not at all identical.  I don't know why they were always mentioned in concert.  Maybe people were just looking for "...socialized medicine like they have in other countries," and the only 'foreign' nations Americans able to pull off the top of their head English speaking ones?  

Second, I don't know why that was used as an argument against Obamacare.  I've been to Canada, and the UK.  They seem to manage the cost, and be in decent health.   The streets weren't littered with lepers, and no government bodies were panhandling in the street. 

Third, Obamacare is ABSOLUTELY NOT like Canada's or the UK's healthcare systems.  There is, as far as I know, only one other developed nation who's healthcare system is "every private citizen is required by the govt to buy private insurance."  Its Israel.

The lesson - you know...if you're gonna voice an opinion on something, at least Google or Wikipedia it before you speak - especially if you speak on TV!

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