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The Real Consequences of Health Insurance Overhaul

Tuesday, December 22, 2009

Why we will see increased health insurance costs and a radical shift toward expanded government control of health insurance and medical care.

Authors of the House and Senate healthcare bills claim that their insurance reforms would achieve near-universal coverage and make it significantly more affordable. In reality, the proposed reforms would likely increase health insurance costs, and could produce a radical shift towards expanded government control of health insurance and medical care.

The bills would significantly expand health insurance coverage beginning in 2013 (in the House version of the bill) or 2014 (in the Senate bill) through a mandate for individuals to have health insurance, Medicaid expansion, and premium subsidies to persons with incomes up to 400 percent of the federal poverty level for coverage purchased through a new insurance exchange (or exchanges). The bills would substantially restrict health insurance underwriting and rating and create a government-run health insurer to compete with private plans.

As I elaborate in a new American Enterprise Institute working paper, an individual mandate would have four important consequences.

An individual mandate would put upward pressure on health expenditures and premiums.

First, it would reduce the amount of premium subsidies needed to expand coverage. The greater the penalties for non-compliance, the lower would be the cost. A “weak mandate” would either require larger subsidies, result in more uninsured than a “strong mandate,” or both.

Second, the mandate’s terms would affect the ability of proposed insurance market restrictions to provide implicit premium subsidies to older and/or less healthy purchasers of individual and small group coverage, which would be financed by higher premiums for younger and/or healthier buyers. The bills’ restrictions on preexisting condition exclusions and risk-based premiums would cause some younger and healthier people to delay buying coverage until they needed expensive care, increasing its average cost. The effects could be large without a strong mandate. The Senate bill in particular proposes weak penalties, increasing the likelihood of significantly higher premiums for everyone.

Third, an individual mandate would put upward pressure on health expenditures and premiums. People who obtain mandated coverage would use more healthcare. A mandate also requires prescribing the types and amounts of care that must be insured. The bills’ proposed minimums would require broader benefits and permit less cost sharing than plans many people currently choose. Increased coverage levels would produce some increase in people excessively using healthcare. Costs also could increase from higher prices for medical services until the supply of healthcare providers expands to meet increased demand for care.

Fourth, a mandate would affect decisions about specific services to be reimbursed by insurance. Along with proposed insurance market reforms, a mandate would likely be accompanied, if not initially then ultimately, by coverage determinations by some federal agency. The ultimate reach of federal authority would depend on whether it was extended to large employer plans and/or whether the proposals produced significant depopulation of large plans.

If a public plan were to reimburse at or near Medicare rates, it would shift costs to and increase crowd-out of private plans, and threaten the financial stability of some hospitals and physicians.

Proponents argue that creating a government insurer—a “public option”—would lower premiums by reducing administrative costs, eliminating profits, and lowering provider reimbursement. The main source of savings would likely be lower reimbursement. Health insurers’ profit margins typically average about 3 percent (less for non-profit insurers). Administrative expense ratios average about 11–12 percent of premiums. Medicare’s oft-cited lower administrative expense ratio primarily reflects higher average medical costs; exclusion of overhead, enrollment, and billing costs; and what Medicare does not do—negotiate with providers, engage in medical management, spend much to reduce fraud, or incur state premium taxes or regulatory compliance costs that affect private insurers.

If a public plan were to reimburse at or near Medicare rates, it would shift costs to and increase crowd-out of private plans, and threaten the financial stability of some hospitals and physicians. The bills’ proposal for the public plan to negotiate rates, with voluntary provider participation, reduces those risks, but pressure for cost control could cause reimbursement and participation rules to tighten over time.

Even with negotiated rates and other suggested safeguards, level competition between a public plan and private insurers would be infeasible. A public plan would hold less capital than private insurers and ultimately be backed by taxpayers. It would not pay the taxes private insurers pay. For these reasons alone, a public plan could have an unequal cost advantage of 5 percent or more.

Overall, the House and Senate bills’ proposed health insurance reforms would very likely increase rather than decrease the average cost of health insurance and expand government control over payment for medical care. The long-run consequences would depend in significant part on whether employer-sponsored coverage remained dominant for large employee groups, with plan design and benefits determined largely by competition and private contracting. An alternative scenario would see government authority over plan design, financing, and reimbursable care extend to all plans, a steady reduction in employer-sponsored plans, or both, with a corresponding increase in coverage obtained through heavily regulated exchanges or a public plan.

Scott E. Harrington is the Alan B. Miller professor of healthcare management and insurance and risk management at the University of Pennsylvania’s Wharton School and an adjunct scholar at the American Enterprise Institute.

FURTHER READING: In a new American Enterprise Institute working paper, Harrington discusses the healthcare overhaul debate. For THE AMERICAN, he has written “What the States’ Experience with Mandates Should Tell Us about Universal Healthcare Coverage” and “The AARP Paradox,” an explanation of AARP’s support for Medicare cuts as a means to expand health insurance coverage to the non-elderly.

Image by Darren Wamboldt/Bergman Group.

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