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Why Is the ObamaCare Tax/Penalty Needed at All?

Wednesday, September 5, 2012

When you have to force people to buy something as obviously valuable as protection against becoming uninsurable or paying astronomical premiums, it means you have some serious design flaws in your product.

Whether it is dubbed a penalty or, as the Supreme Court decided, a “tax,” an important question remains about the levy assessed on the uninsured in the 2010 Patient Protection and Affordable Care Act (a.k.a. ACA or “ObamaCare”): Why was either a penalty or tax necessary?

There are two stories about the necessity of a penalty/tax. The first is that without sufficient government incentives to buy health insurance, people will wait until they get sick to buy it. The primary purpose of health insurance, like all insurance, is to provide protection against the risk of uncertain events like illness, death, fire, or flood. If people waited until they were sick to buy insurance, then there would be no risk, and thus no possibility of true insurance. For example, if all consumers waited until they got cancer to buy health insurance, then the actuarially fair “premium” for that “insurance” simply would be the cost of cancer care. The ability of true insurance to protect consumers from the risk of needing cancer care would disappear. Prior to ObamaCare, preexisting condition clauses prevented people from waiting until they were sick to buy insurance. Since ACA prohibits preexisting condition clauses, so the story goes, some other incentive like a penalty or tax is required to force people to buy health insurance before they get sick.

The second story is that if people are allowed to go without insurance, then they will show up at the hospital or emergency room unable to pay their bills, and insured people will have to pay for that care through higher insurance premiums.

On the face of it, these two stories are logically inconsistent. If people without insurance are able to get care anyway (that insured people then pay for) then why are preexisting conditions a barrier to sick people receiving care? Conversely, if people without insurance are denied access to care, then why isn’t the threat of being denied care sufficient to frighten people into purchasing health insurance prior to getting sick? Perhaps the real problem is the sheer cost of health insurance; perhaps the majority of healthy people who don’t buy health insurance simply can’t afford it. 

The problems associated with being uninsured are not limited to people who choose not to buy health insurance. The recent recession brought virtually everyone to the realization that even if they have generous large-group insurance through their employer, they are only one layoff with a preexisting condition away from potentially being uninsurable, and that for people who don’t qualify for Medicaid or have large savings accounts, a major illness without insurance will mean reduced access to care or financial ruin. Consumers in the individual insurance market face similar risks.

All the government really needed to do was to facilitate the offering of such long-term protection, sit back, and watch consumers currently in both the individual and group insurance markets line up and sign up.

So it seems obvious that large numbers of people would like to buy protection against becoming uninsurable or facing dramatic premium increases if they have a serious illness or lose their group insurance. However, they also would prefer not to be locked into a single health plan in case the service is bad or the premiums are higher than competitive market levels. The problem is that a product offering this type of protection—including a seamless transition from group insurance into a pool with competing health plans—doesn’t exist in today’s market. A single health plan can’t provide the competition and choice components that consumers value.

Large employers who offer multiple health plans to their employees provide protection against becoming uninsurable or facing dramatic premium increases, and many also offer a choice of plans, but only as long as the employee remains with the firm or until the employee’s COBRA benefits run out. If a product offering this type of “long-term” risk protection plus a choice of health plans were offered to all consumers, one would expect them to show up in droves.

So all the government really needed to do was to facilitate the offering of such long-term protection, sit back, and watch consumers currently in both the individual and group insurance markets line up and sign up. In fact, ObamaCare does include insurance pools referred to as “exchanges” that, in theory, could provide an organizational basis for long-term protection.

However, both the federal and state governments that try to run exchanges soon will discover the difficulties involved. Exchanges need a risk adjustment system so that plans that enroll sicker people do not have to charge higher premiums for that reason alone. There also needs to be an incentive for healthy people to remain in the exchange when other consumers get sick. The problem is not that the healthy will go without insurance, but that they will be offered lower cost coverage outside the exchange. ObamaCare tries to prevent this by requiring insurers to charge the same premium for the same product inside and outside the exchange, but insurers do not have to sell policies in both markets, and the difficulty of determining whether two insurance products are “the same” is likely to make that part of the law difficult to enforce.

A better approach would have been to make sure that the policies in the exchanges are a good buy for all enrollees. From a purely statistical perspective, healthy people are more likely to be young and poor, while sick people are more likely to be older and wealthier. If we had designed exchanges that limited the extent to which younger, poorer enrollees were asked to subsidize the premiums of older, wealthier enrollees—while still providing protection against being uninsurable or astronomical premium increases—the mandate and all its accompanying baggage might have been unnecessary. Penalties for late enrollment (as in Part D of Medicare) or discontinuous enrollment in the exchanges provide another fair and workable alternative to compulsory coverage.

The primary problem with ACA’s mandate or tax is not the label we give it, but why it is needed at all. Its existence suggests that our central planners in Washington knew that they had failed to design an insurance product that people actually would want to buy. When you have to force people to buy something as obviously valuable as protection against becoming uninsurable or paying astronomical premiums, it means you have some serious design flaws in your product that still need to be corrected.

Bryan Dowd is a professor in the Department of Health Policy and Management in the School of Public Health at the University of Minnesota.

FURTHER READING: Dowd also writes “Getting Ryan-Wyden Wrong.” Lee Harris contributes “More than Just Broccoli: The Real Slippery Slope of ObamaCare’s ‘Must-Buy’ Provision.” Joseph Antos and Michael R. Strain ask “If You Don’t Buy Insurance, Will You Really Pay the Tax?” Antos also discusses “Healthcare Reform After SCOTUS: Hard Decisions Needed To Avoid Health Sector Meltdown.” James C. Capretta offers “What To Say about Healthcare.” Christopher J. Conover outlines "How Romney-Ryan Should Use States To Reform Healthcare."

Image by Darren Wamboldt / Bergman Group

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