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“Everything happens at the margin”

The aphorism “everything happens at the margin” directly applies to the health insurance crisis.  In the health insurance market, that margin is the low end of the market: individuals who buy coverage on their own and the small group segment — those employing less than 50.  This is the most troubled region of the health insurance market where the risk spreading mechanism that is the core principle of insurance is the weakest.

That’s why the Patient Protection and Affordable Care Act (PPACA) includes a mandate that all individuals have some form of health coverage.  This controversial requirement is the focus of Congressional misgivings over the PPACA and some federal court rulings finding the mandate unconstitutionally compels people to engage in commerce.

Modeled after reforms enacted in Massachusetts several years ago, the mandate essentially creates a government enforced pool of insureds so there are more “lives” as they called in the insurance business across which to spread risk of claims.  Too few people and the pool tends to fall into a death spiral called adverse selection, leaving only the highest — the most adverse — risks remaining.  Too many dollars end up going out to pay claims and too few are replaced in the form of premiums.

The PPACA also addresses the troubled individual and under 50 employee group market by establishing state health benefit exchanges.  The exchanges will begin operating in 2014 and are designed to aggregate purchasing power among insurance buyers in these market segments.  Compared to the large employer group market, individuals and small businesses have little or no purchasing clout that can help them bargain with insurers and health plans for lower premiums.

But even midsize and large employers are seeing their premiums rise nearly ten percent in 2011.  Due to their weak purchasing power, the increases are far steeper in the small group and individual markets, rising so rapidly in the latter they now nearly equal the amount of a mortgage payment for people in their fifties and early sixties.

If premiums driven by rising medical costs keep increasing at their current rate, it calls into question the utility of the health benefit exchanges.  By the time the exchanges set up shop in 2014, premiums could be so high that few employers of less than 50 people will be able to affordably provide health coverage.  That would leave primarily individuals buying coverage through the exchanges.  That raises the question of whether premiums will be affordable for these individuals, even with income-based subsidies.  If not, that could lead many of them to conclude it’s a better deal to go bare and pay the penalty for not having coverage.

  1. February 1, 2011 at 9:45 AM

    Interesting article. What is your take on Richard Thaler’s suggestion to replace the mandate with a ‘forfeiture’ of the right to buy health insurance? It could actually work, in my opinion. Yes, the cost issue will continue to be an issue, however I believe the subsidies will be set at levels that could assist the majority of purchasers.

  2. February 12, 2011 at 6:44 PM

    I would expect the idea would be resisted by health insurers. The individual mandate was the insurance industry’s sine qua non as the PPACA was being crafted. Insurers want a government enforced insurance pool to bring in more premium payers to cover rising health care costs as well as to counter adverse selection and to achieve a better spread of risk across people of various ages and health conditions. Forcing people to give up their ability to purchase coverage runs directly counter to that notion.

    That said, achieving an optimal spread of risk in the health insurance market is inherently difficult given the risk of claims rises with age. It could be argued that the pool naturally tends toward adverse selection with the young invincibles forgoing coverage because they view it as unnecessary and middle aged and older seeing it as essential. Accordingly, forcing younger people to forfeit their ability to buy coverage won’t likely measurably increase the likelihood of their buying coverage.

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