Archives For health care

Zeke Emanuel on the ACA’s Adverse Selection Problem and Solutions to It

Thom Lambert —  7 May 2013 — 2 Comments

Ezekiel Emanuel, Rahm’s brother and former health care adviser to President Obama, acknowledges in today’s Wall Street Journal that adverse selection may prove to be a “bump in the road” in the implementation of the Affordable Care Act (ACA).  But never you mind.  He’s got solutions.  And, as usual, they all come down to messaging.

Emanuel describes the ACA’s adverse selection problem in what are, for this Administration and its surrogates, remarkably frank terms:

Here is the specific problem: Insurance companies worry that young people, especially young men, already think they are invincible, and they are bewildered about the health-care reform in general and exchanges in particular. They may tune out, forego purchasing health insurance and opt to pay a penalty instead when their taxes come due.

The consequence would be a disproportionate number of older and sicker people purchasing insurance, which will raise insurance premiums and, in turn, discourage more people from enrolling. This reluctance to enroll would damage a key aspect of reform.

Insurance companies are spooked by this possibility, so they are already raising premiums to protect themselves from potential losses. Yet this step can help create the very problem that they are trying to avoid. If premiums are high—or even just perceived to be high—young people will be more likely to avoid buying insurance, which could start the negative, downward spiral of exchanges full of the sick and elderly with not enough healthy people paying premiums.

Of course, Emanuel leaves out an important part of the story: the fact that the ACA itself encourages young, healthy people (the “young invincibles,” he calls them) to forego buying health insurance.  The statute does so by mandating that health insurance be sold on a “guaranteed issue” basis (meaning that insurance companies can’t deny coverage to people who waited to buy it until they became sick) and at prices based on “community rating” (meaning that those who are sick or susceptible to sickness can’t be charged more than the healthy).  Taken together, these provisions largely eliminate the adverse personal consequences of waiting to buy health insurance until you need medical treatment.  (You can’t be denied coverage or charged a higher premium reflecting your illness.)  They thereby decimate the incentive for young, healthy people to buy health insurance until they need it.  And since the law doesn’t (and can’t, according to the Supreme Court) require young, healthy people to carry insurance, many are likely to forego buying coverage in favor of paying a small “tax” — $95 in 2014, as opposed to the $2,480 out-of-pocket cost for an individual policy bought on a subsidized exchange by a 26 year-old earning $30,000.  As I have argued on this blog and elsewhere, the ACA is likely to generate a devastating spiral of adverse selection as the “young invincibles” drop out of the pool of insureds, causing premiums for the covered population to rise, encouraging even more of the marginally healthy to exit the risk pool, causing premiums to rise even further, etc., etc.

But don’t you worry.  Dr. Emanuel’s got it figured out.  He explains:

Fortunately, there are solutions [to this ACA-induced adverse selection problem]. First, young people believe in President Obama. They overwhelmingly voted for him. He won by a 23% margin among voters 18-29—just the people who need to enroll. The president connects with young people, too, so he needs to use that bond and get out there to convince them to sign up for health insurance to help this central part of his legacy. Every commencement address by an administration official should encourage young graduates to get health insurance.

Second, we need to make clear as a society that buying insurance is part of individual responsibility. If you don’t have insurance and you need to go to the emergency room or unexpectedly get diagnosed with cancer, you are free- riding on others. Insured Americans will have to pay more to hospitals and doctors to make up for your nonpayment. The social norm of individual responsibility must be equated with purchasing health insurance.

Finally, and most important, we should adopt some of Massachusetts’ practices. When state officials in 2006-2007 were rolling out their exchange—called the Massachusetts Connector—they mounted a sustained campaign to encourage enrollment by young people. One aspect of the campaign focused in particular on young men, even heavily promoting the new exchange on TV during Red Sox games and hosting an annual “Health Connector Day” at Fenway Park.

So we’re going to lick this pernicious adverse selection problem by combining President Obama’s legendary star power with a dollop of good old fashioned shaming and some targeted advertising during baseball games?  One is reminded of Homeland Security Secretary Tom Ridge’s 2003 statement that Americans should use duct tape to protect themselves from chemical weapons attacks.  But this is really worse.  The chance of a chemical weapons attack in 2003 was pretty small.  Insurance premiums’ rising as a result of ACA-inspired adverse selection, by contrast, is a near certainty. Let’s make sure we keep the President and HHS Secretary Sebelius on that commencement address circuit!

In health care, health care reform debate, politics, regulation, taxes
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George Will on My “Plausible Judgment” About the Future of the ACA

Thom Lambert —  21 January 2013

In his nationally syndicated column this week, Washington Post columnist George Will highlights what he termed my “plausible judgment” (I’m taking that as high praise!) that the Supreme Court’s Affordable Care Act decision “may have made the ACA unworkable, thereby putting it on a path to ultimate extinction.”

Will focuses on the first of my three major points about the ACA, as interpreted by the Supreme Court.  In finding the penalty for failure to carry health insurance to be a tax, the Court emphasized its “smallness” relative to the cost of purchasing qualifying insurance.  (That was one of three factors the Court cited in explaining why this particular “penalty” is really a tax for constitutional purposes.)  Presumably, if Congress were to raise the penalty to approach the out-of-pocket cost of buying insurance, it would cross the line from a tax to, in the Supreme Court’s words, “prohibitory financial punishment” that is not a tax.  This means that the ACA’s low penalties are constitutionally locked in, at least to a significant degree.  That’s a problem, because the penalties are currently so low that it makes sense for young, healthy people to forego insurance and pay the low penalties instead.  This is because the ACA removes the natural incentive for young, healthy people to carry insurance: the risk that they will not be able to get it at affordable rates if they become sick in the future.  That risk is eliminated by the ACA’s “guaranteed issue” and “community rating” provisions.  The former requires insurance companies to sell insurance to anyone who seeks it; the latter forbids them to charge a higher premium to one who is sick or susceptible to sickness.  If you know you can get insurance at a an affordable rate the minute you need health care (which, if you’re young and healthy, you’re not likely to need anytime soon), then why buy it now?  The ACA’s penalties are theoretically designed to motivate young, healthy people to go ahead and buy insurance (thereby subsidizing premiums for the less-healthy), but they’re way too low to be effective.  And the Supreme Court’s tax reasoning suggests that they will cease to count as a “tax” if they’re raised to the point at which they would be effective.  Of course, once young, healthy people leave the pool of insureds, premiums will rise on everyone else, causing even more healthy people to drop out.  Economists call this adverse selection, and it’s wildly pernicious.

Will lays all this out in his typical elegant fashion.  He concludes that “as the president begins his second term, the signature achievement of his first term looks remarkably rickety.”  Indeed.

For two other reasons the ACA, as construed by the Supreme Court, is destined to fail, see my recent Regulation article, How the Supreme Court Doomed the ACA to Failure.

In economics, health care, health care reform debate, law and economics, markets, regulation
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Regulation Magazine Cover Article: “How the Supreme Court Doomed the ACA to Failure”

Thom Lambert —  11 January 2013

My recent essay, How the Supreme Court Doomed the ACA to Failure, is the cover article of the current issue of Regulation Magazine.  I’ve been over the essay’s basic points several times (e.g., here, here, and here), so I won’t belabor them now.  My basic assertions are:

  • The Affordable Care Act (ACA) provisions mandating both ”guaranteed issue” (insurers must sell to everyone) and “community rating” (insurers can’t charge higher rates to high-risk insureds) create a perverse incentive for young, healthy people to forego purchasing costly health insurance until they need medical treatment, at which point they will be assured coverage (because of guaranteed issue) at rates not reflecting their infirmities (because of community rating).
  • When young, healthy people drop out of the insurance pool, premiums — reflective of the average health care expenditures of the covered population — will rise, driving even more young, healthy people from the pool.  To prevent such “adverse selection,” the ACA needs to encourage the young and healthy into the insurance pool, and ensure that they remain covered.
  • SCOTUS’s opinion upholding the ACA, however, rejected (quite properly) the Act’s mandate to carry insurance and instead read the ACA to impose a ”tax” on those who freely opt not to buy insurance.  That tax, though, is far too small to induce a great many young, healthy people to stay in the insurance pool — even after the ACA’s generous (i.e., expensive) subsidies are accounted for.  And the reasoning of SCOTUS’s majority opinion limits Congress’s ability to raise the no-insurance penalties to an effective level.  Thus, adverse selection is inevitable and will tend to drive up the cost of health insurance by “sickening” the pool of insureds and increasing the average number of claims per insured.
  • Now, an increase in claims per insured would not necessarily raise health insurance premiums if the ACA actually reduced the underlying cost of medical services, the primary driver of health insurance premiums.  Sadly, though, it does no such thing.  The handful of provisions in the 1,000-page statute that are aimed at underlying medical costs, rather than health insurance, range from anemic to silly.  Some, such as the requirement that all preventive services be provided with no out-of-pocket expenditure (the requirement underlying the controversial “contraception mandate”), are sure to increase underlying medical costs.  After all, what incentive do providers have to compete on the price of preventive services if the individuals making the decision to purchase those services face no marginal cost when deciding whom to patronize?
  • The fundamental problem with the ACA’s purported cost-saving provisions is that they ignore the primary driver of underlying medical costs: the near complete absence of price competition among health care providers, who know that most individuals making consumption decisions (those with a standard or better health insurance policy) have no “skin in the game,” get no benefit from selecting a cheaper provider, and thus will not tend to award business to providers who are less expensive.  This unfortunate result stems largely from the federal tax code, which perversely encourages employees to demand (and employers to provide) such generous health insurance benefits that insurance has now effectively become “pre-paid health care.”  The tax code achieves this result by making employer contributions to health plans tax free, while fully taxing any dollars paid instead as salary.  As that bastion of free-market ideology, NPR, has reported, economists across the ideological spectrum agree that tax subsidies for employer-provided health insurance drives up the underlying cost of health care.  So did President Obama and his team, as evidenced by this op-ed in which Council of Economic Advisers Chair Christina Romer explains how “[e]mployers['] … strong incentives to pay workers with more generous insurance policies” tends to “lead families to be less vigilant consumers of health care.”  Sadly, President Obama’s shamefully disingeuous 2008 attacks on John McCain’s proposed health care reforms took off the table any treatment of the perverse tax code provisions that largely underlie medical inflation.  Ah, the Price of Politics.
  • So the ACA will drive up the costs of health insurance and underlying medical costs.  But isn’t its redeeming virtue the fact that it will drastically expand health insurance coverage?  Hardly.  First, SCOTUS’s opinion prevents the Feds from forcing states to expand their Medicaid rolls, one of the primary means by which the ACA was to increase health insurance coverage.  At this point, ten states (including biggies like Texas and Georgia) are not participating in the Medicaid expansion, five others (including New Jersey and Virginia) are leaning against participation, and fourteen others (including Florida, Michigan, Ohio, and Pennsylvania) are undecided.  The upshot is that in a great many populous states, individuals and families that are not Medicaid eligible but earn incomes less than 133% of federal poverty level will receive no subsidy to buy health insurance on an individual basis.  Moreover, the plain language of the ACA denies individual purchase subsidies to citizens of states that decline to set up a state insurance exchange.  As of January 4, 2013, 25 states had firmly decided not to set up their own exchanges, and several others were in limbo.
  • The primary reason that the ACA will fail to expand insurance coverage, though, is that it encourages employers of low- to moderate-wage employees to drop health insurance benefits.  The media have largely lambasted employers for this move, but it’s actually in the interest of their employees.  The ACA, you see, provides generous subsidies to employees who cannot obtain qualifying health insurance from their employers at an affordable price.  Those subsidies are far, far larger than the implicit tax subsidy an employee receives for employer-provided health care (by virtue of the fact that compensation paid as health benefits is not taxed).  Employees thus have a strong incentive to demand — and employers to provide — a compensation package that consists of higher salary in exchange for no health insurance coverage.  In the Regulation article, I run the numbers to show how the ACA creates an incentive for employers to drop coverage and pay a higher salary but fails to incentivize moderately compensated employees to turn around and purchase health insurance.  The upshot is that coverage levels are likely to fall.

So this is where we are.  The grand promises of reduced health care costs and expanded coverage look ever less credible.  As the ACA implodes, watch for calls for a single-payer system.  We may start with a Public Option, but I’d be surprised if single-payer’s not where we end up at the end of the day.  On the bright side, maybe we can see something groovy like this at the next American Olympics!

In health care, health care reform debate, markets, politics, regulation
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Do Your Low-Wage Employees a Favor: Drop Their Health Care Coverage

Thom Lambert —  12 November 2012

Another day, another (presumably) unintended consequence of the Affordable Care Act.  (I say presumably because there’s a plausible theory out there that the Act was engineered to fail and thereby pave the way for a single-payer health care system. I’m not cynical enough to embrace that view, though a close look at the Act reveals design flaws so fundamental that one wonders who ever could have expected the thing to succeed.)

The latest unintended development is the move by employers to cut workers’ hours so as to avoid having to provide ACA-compliant (generous) health insurance policies. Under the Act, an employer with 50 or more employees faces an annual fine of $2,000 per worker if it fails to offer high-benefit insurance at an affordable rate and a full-time employee therefore purchases subsidized insurance on a state exchange.  One way to avoid this liability is to hold employees’ hours below thirty per week so that they are not deemed full-time.  The CEO of Papa John’s Pizza recently announced that his franchisees are likely to take that tack.  Darden Restaurants, which operates 2,000 restaurants under Olive Garden, Red Lobster, and Longhorn Steakhouse labels, is currently experimenting with a 29.5 hour work week aimed at evading the ACA’s so-called employer mandate. Applebee’s and Jimmy John’s are making similar plans, as are, according to the Wall Street Journal, Pillar Hotels and Resorts (owner of 210 franchise hotels), CKE Restaurants (parent of Carl’s Jr. and Hardee’s restaurants), and Anna’s Linens.

ACA proponents are incensed.  Referencing an interview in which Jimmy John thanked his parents for the start-up money they provided him and stated “I hope that I can give back to society the way they have,” one blogger wrote:  “Maybe Jimmy John can start ‘giving back to society’ by giving his employees health care? What a loser.”

In actuality, the kindest thing employers can do for their low-wage employees is to drop their health insurance coverage.  Here’s why:

  • It is well understood in labor economics, and a vast body of empirical research demonstrates, that employee benefits are a one-for-one substitute for salary. When an employer purchases benefits for an employee, she normally reduces the employee’s take-home pay by an amount equal to the amount she spends on the benefit. The employer thus faces a “wage or benefits” decision whenever she sets up a employee’s compensation package, and she should settle on the combination that provides the most total benefit to the employee.
  • When the employer buys health insurance for her employees, they receive an effective subsidy from the federal government because compensation paid in the form of health insurance benefits, rather than salary, is not taxed. The amount of the effective subsidy is the sum of the payroll tax rate and the employee’s marginal income tax rate times the policy price paid by the employer. Because marginal tax rates increase with income, the effective subsidy for high-wage earners is much greater than for low-wage employees. (For most lower-income workers, the effective subsidy will be 22.65% * the policy price. That assumes a 7.65% payroll tax (1.45% Medicare + 6.2% Social Security) and a marginal income tax rate of 15%.)
  • If, but only if, an employer declines to purchase ACA-compliant insurance for her lower-wage employees (those earning up to 400% of the Federal Poverty Level), they may purchase federally subsidized insurance on a state exchange. The amount of the subsidy available on an exchange is greater at lower-income levels. It generally swamps the effective subsidy for employer-provided health insurance, especially at lower wage levels.
  • Because higher-wage employees (1) receive relatively higher effective subsidies for employer-provided health benefits, and (2) are not eligible for ACA subsidies on state exchanges, it makes sense for their employers to continue providing them with health insurance benefits. Lower-wage workers, by contrast, are better off if their employers stop compensating them with health insurance, for which only relatively small subsidies are available, and thereby enable them to take advantage of the large subsidies available to employees without employer-provided health care coverage.

An example may help here. Suppose an employer wishes to provide $40,000 in total compensation to a 40 year-old employee who is the head of a four-person household. If the employer purchases a family policy for the employee (approximate cost $12,000/year), it will pay the employee $28,0000/year.  The employee will pay no payroll or income tax on the component of her compensation provided as health insurance, so she receives an effective federal subsidy of $2,718 (22.65% * $12,000).  If the employer were to drop health care coverage, the employee would receive all her compensation — all $40,000 — as take-home pay.  On the incremental $12,000 paid as cash rather than benefits, she’d have to pay $2,718 in tax, but she would now be eligible to purchase her own insurance at a subsidized rate. The ACA would limit her out-of-pocket insurance expense to 4.95% of annual income ($1,980), which means she would receive a whopping $10,020 subsidy on the $12,000 family policy. This employee is $7,302 better off if her employer drops coverage (costing her $2,718 in foregone tax subsidy) and allows her to access the more generous subsidies available on state exchanges (benefiting her by $10,020).

In a competitive labor market, we can expect all sorts of employers seeking to attract lower-wage workers to follow this ”pro-employee” practice. We can also expect ACA-proponents and a compliant press to pillory such employers. The real culprit, though, is the group of policymakers who forced upon us the perverse set of incentives known as the Affordable Care Act.  Sadly, it seems it’s here to stay.

In health care, health care reform debate, markets, regulation, taxes
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Why the Affordable Care Act, as Construed by the Supreme Court, Will Fail

Thom Lambert —  8 October 2012

I’ve recently posted to SSRN a new paper with the same name as this post.  The paper asserts, in greater detail, a number of points I’ve previously made on TOTM:

  • Health insurance premiums will rise under the (SCOTUS-modified) ACA, because the Act’s “guaranteed issue” and “community rating” mandates will generate widespread adverse selection that cannot be corrected through the (now constitutionally constrained) penalty system the Act imposes.
  • Underlying medical costs will continue to outpace inflation because the ACA does nothing to alleviate the primary driver of health inflation: the lack of price competition among providers, an artifact of the federal tax code’s encouragement of overly generous health insurance policies that ultimately amount to “pre-paid health care.”
  • Insurance coverage will expand far less than ACA proponents promisedbecause (1) the Act encourages employers to drop insurance coverage for lower-income workers, and (2) SCOTUS has largely disabled the Act’s Medicaid expansion.

I’ve been talking about these matters quite a bit lately.  On Constitution Day, I participated in this discussion of the ACA with my Missouri colleagues Phil Peters (a health law expert), Josh Hawley (a constitutional scholar and former Roberts clerk), and Stan Hudson (associate director of MU’s Center for Health Policy).  (My remarks begin at 23:45.)  On September 25, I presented a lecture on the ACA at my undergraduate Alma Mater, Wheaton College.  My PowerPoint presentation is not visible in the Wheaton video, but I’m happy to share it with anyone who’s interested.  Just email me at lambertt at missouri dot edu.

In constitutional law, health care, health care reform debate, markets, regulation, Supreme Court
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From July 30 WSJ

Paul H. Rubin —  8 August 2012

Wall Street Journal

‘A Climate That Helps Us Grow’

By PAUL H. RUBIN

President Obama’s riff on small business—”If you’ve got a business, you didn’t build that, somebody else made that happen”—has become a major controversy. The Romney campaign has made this quote the subject of several speeches and ads, and there have been rallies all over the country of business people with signs saying that “I did build this business.”

Mr. Obama is now claiming that his words, delivered at a campaign stop in Roanoke, Va., on July 13, were taken out of context. “Of course Americans build their own businesses,” he said in a campaign ad last week. What he meant was simply that government sets the stage for business creation. In his speech, and again in his campaign ad, the example Mr. Obama pointed to was “roads and bridges.”

The context of the speech indicates the president really did mean that “you didn’t build that.” But let’s give him the benefit of the doubt; let’s assume he merely meant that business is impossible without government institutions that create the infrastructure for the economy to operate. As Mr. Obama’s deputy campaign chief Stephanie Cutter said, in clarifying his original remarks on July 24, “We build our businesses through hard work and initiative, with the public and private sectors working together to create a climate that helps us grow. President Obama knows that.”

But business is certainly not getting “a climate that helps us grow” from the current administration. That administration has instead created a hostile climate through its regulatory policies.

The news media report almost daily about new regulatory burdens. More generally, according to an analysis in March by the Heritage Foundation, “Red Tape Rising,” the Obama administration in its first three years adopted 106 major regulations (those with costs over $100 million), compared with 28 such regulations in the George W. Bush administration. Heritage notes that there are 144 more such major regulations in the pipeline.

Consider a major example of government investment—roads and bridges. A transportation system needs roads, but it also needs gasoline. This administration’s policies—its refusal to allow a private company to build the Keystone XL pipeline, its reduction in permits for offshore drilling and increased EPA regulation of pollutants—retard the production of gasoline. If transportation is an important input from government to creating a favorable climate for business, shouldn’t we be encouraging, not discouraging, gasoline production?

Other inputs needed by business are capital and labor. The Dodd–Frank Wall Street Reform and Consumer Protection Act, signed by Mr. Obama and enforced by his appointees, makes raising capital and investing more difficult. Since many regulations needed to implement this law have not even been written, business cannot know how to adapt to them. This increases uncertainty and so reduces incentives for investment.

The increased minimum wage, passed and signed in the early days of the administration, discourages hiring of entry-level workers. ObamaCare has increased uncertainty regarding future labor costs and so hindered business in hiring and expanding. The pro-union decisions by Obama appointees at the National Labor Relations Board do not create a climate to help the economy grow.

There are many other burdens placed on business. Example: The Americans With Disabilities Act is being interpreted by the Justice Department to require all hotel-based swimming pools to provide increased access to disabled persons. This will come at a high cost per pool. Many hotels and motels are small, family-run enterprises. This requirement will either lead to an increase in prices or to a decision not to have pools at all.

Either policy will induce patrons to shift to larger chain motels. Interestingly, the application of this rule has been delayed for existing pools until Jan. 31, 2013, after the election. Families vacationing this summer will not notice the new requirement.

If we accept the plain meaning of Mr. Obama’s speech, it indicates that he does not believe in the importance of entrepreneurs in creating businesses. But if we accept the reinterpretation of his speech in light of his administration’s deeds, it indicates a belief that a hostile regulatory climate poses no danger to economic growth. Either interpretation means that this administration is not good for business.

Mr. Rubin is professor of economics at Emory University and president-elect of the Southern Economic Association.

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In consumer protection, doj, health care, health care reform debate, regulation
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Why Premium Subsidies and the “Employer Mandate” Won’t Solve the ACA’s Adverse Selection Problem

Thom Lambert —  3 August 2012

A couple of weeks ago, I argued that the Supreme Court’s decision upholding the constitutionality of the Affordable Care Act will ultimately doom the Act to failure. The problem, I argued, is that the ACA’s guaranteed issue and community rating provisions create a perverse incentive for young, healthy people not to buy insurance until they need it, and the Supreme Court’s reasoning that the penalty for failure to carry insurance is a “tax” because it is small relative to the price of insurance precludes Congress from increasing the no-insurance penalty to the point at which it prevents young, healthy people from dropping coverage. As those folks remove themselves from the pool of insureds, insurance premiums (reflective of the per capita expected health care costs of the covered population) will rise, leading even more relatively healthy people to exit the pool and thereby exacerbating the “healthy flight” problem. In short, guaranteed issue (i.e., insurers have to insure you regardless of your health) + community rating (i.e., insurers can’t charge you more if you’re sick) + constitutionally limited low penalties for failure to carry insurance (a result of the Supreme Court’s reasoning in NFIB v. Sebelius) = adverse selection that will drive insurance premiums through the roof.

Some readers noted flaws in my analysis. One correctly observed that I had ignored the premium support subsidies the ACA provides for lower- and middle-income people (those earning from 1.33 to four times the Federal Poverty Level). Those subsidies may prevent many younger, healthier people from failing to buy or dropping coverage because the no-insurance penalty will exceed the out-of-pocket cost of insurance (i.e., the policy price minus the amount of the federal subsidy). Someone else observed that I had ignored the ACA’s employer mandate, which requires employers with more than 50 employees to provide insurance coverage or else pay a penalty for each employee that buys her own subsidized insurance on a state exchange. Since most people get their insurance coverage through their employers—an unfortunate result of the federal tax code—perverse incentives in the individual insurance market might not be that significant.

Unfortunately, neither the ACA’s premium support subsidies nor its employer mandate will save the Act from failure. Here’s why:

Premium Support Subsidies

The ACA’s premium support subsidies are unlikely to prevent substantial “healthy flight” for two reasons. First, they’re too small. When a young, healthy person is deciding whether to buy insurance now or to hold off, pay the penalty, and sign up for coverage when her family needs it, she will compare the no-insurance penalty with her out-of-pocket expense for a subsidized policy. If the penalty exceeds out-of-pocket expenses (policy price minus available subsidies), then it makes sense to purchase insurance. Otherwise, it makes sense to pay the “tax” until insurance coverage is needed, at which point it will be available (guaranteed issue) at rates not reflecting the family’s particular health care needs (community rating). To assess the risk of adverse selection, then, we must consider the magnitude of penalties, expected insurance premiums, and available subsidies.

The ACA provides that the penalty for failure to purchase insurance shall be the greater of:

  • A flat dollar amount per person (for adults, $95 in 2014, $325 in 2015, $695 in 2016 and beyond, adjusted for inflation; for children, half the adult penalty), with the flat amount per family never exceeding three times the adult amount; or
  • A percentage of income (1% in 2014, 2% in 2015, and 2.5% in 2016 and beyond) above the tax-filing threshold (estimated to be around $10,250 for single filers and $20,500 for joint filers in 2016).

For four-person families eligible for premium support subsidies (those earning from 133% to 400% FPL), the flat rate will always exceed the income percentage, so the maximum penalty will be $2,085 (adjusted for inflation from 2016 dollars). Insurance premiums will be substantially higher than that amount. According to Kaiser Family Foundation estimates, the 2014 price of “silver level” (70% actuarial value) insurance coverage for a family of four living in a moderate cost region will range from $10,108 for a family headed by a 30 year-old to $19,750 for a family headed by a 55 year-old. Since the ACA mandates only “bronze level” (60% actuarial value) coverage, so we can estimate prices of qualifying policies to be about 86% (60/70) of those levels, or from $8,693 for the 30 year-old’s family to $16,985 for the family of the 55 year-old.

The important comparison, however, is between the penalty amount ($2,085) and the subsidized price of qualifying insurance. For qualifying individuals and families, the ACA lavishes generous subsidies that are inversely related to income. Even after accounting for available subsidies, though, most families will find it more advantageous to pay the penalty than to purchase insurance.

The following table, based on Kaiser’s Health Reform Subsidy Calculator, shows for different family income levels the maximum income percentage and out-of-pocket dollars the family would have to pay for subsidized insurance, the percentage difference in outlays for the family’s two options (buy insurance or pay penalty), and the family’s likely decision (buy or don’t buy):

 Family   income

Maximum % of income to be spent on insurance

Maximum dollar amount to be spent on insurance

Comparison of insurance expenses
vs. penalty

Likely decision

$35,000

3.97%

$1,388

  Penalty is 50% more than ins.

Buy

$40,000

4.96%

$1,982

  Penalty is 5.2% more than ins.

Buy

$45,000

5.94%

$2,672

  Ins outlays are 1.28 times penalty amount.

Don’t buy

$50,000

6.77%

$3,385

  Ins outlays are 1.62 times penalty amount.

Don’t buy

$55,000

7.52%

$4,135

  Ins outlays are 1.98 times penalty amount.

Don’t buy

$60,000

8.23%

$4,937

  Ins outlays are 2.36 times penalty amount.

Don’t buy

$65,000

8.85%

$5,751

  Ins outlays are 2.76 times penalty amount.

Don’t buy

$70,000

9.47%

$6,626

  Ins outlays are 3.18 times penalty amount.

Don’t buy

$75,000

9.50%

$7,125

  Ins outlays are 3.42 times penalty amount.

Don’t buy

$80,000

9.50%

$7,600

  Ins outlays are 3.65 times penalty amount.

Don’t buy

$85,000

9.50%

$8,075

  Ins outlays are 3.87 times penalty amount.

Don’t buy

$90,000

9.50%

$8,550

  Ins outlays are 4.1 times penalty amount.

Don’t buy

$95,000

No maximum.

Policy cost

  Ins outlays (dependent on ages) significantly exceed penalty amount.

Don’t buy

$100,000

No maximum.

Policy cost

  Ins outlays (dependent on ages) significantly exceed penalty amount.

Don’t buy

 

As the table reveals, at all but the lowest income levels it makes more sense for healthy families to refrain from purchasing insurance and pay the penalty until insurance coverage is needed. In fact, until 2016, even families with the lowest two income levels on the table would be better off foregoing insurance purchases. Because the no-insurance penalties are phased in between 2014 and 2016 (they’re only $285 in 2014 and $975 in 2015), they are initially less than the out-of-pocket cost of a qualifying insurance policy. It is likely, then, that even low-income healthy families will drop out of the insurance pool in 2014 and 2015, driving up insurance premiums for those remaining in the pool.

In addition to being too small, the ACA’s premium subsidies may not be available in many states. As Jonathan Adler and Michael Cannon have demonstrated, the text of the ACA provides for premium support subsidies only on purchases made through exchanges that the states establish.  While proponents of the ACA presumably assumed that all states would voluntarily establish such exchanges so as to make subsidies available to their citizens, a great many states (36 at this point) either have declared an intention not to set up a state exchange or have made little movement in the direction of doing so. The IRS has taken the position that the subsidies should also be available through federal exchanges set up as a “fallback” in states that do not establish their own. It insists that expanding the subsidies is consistent with the purpose of the statute. But that’s far from clear. As Adler and Cannon show, the ACA’s legislative history suggests that Congress deliberately provided subsidies only through state-established exchanges in order to encourage states to set up and manage such exchanges.  In any event, the statutory language limits subsidies to state exchanges, and courts are generally loathe to exalt a statute’s purported purpose over its clear text, particularly when congressional intent is ambiguous.

Because the premium support subsidies (1) are too small and (2) may not be available in many states, they’re unlikely to correct the adverse selection problem resulting from the toxic combination of guaranteed issue, community rating, and constitutionally constrained low penalties for failure to purchase health insurance.

The Employer Mandate

But what about the fact that the ACA penalizes employers who fail to provide insurance coverage for their workers? Won’t that be enough to prevent large numbers of young, healthy people from failing to purchase or dropping health insurance? No, because the ACA’s subsidy provisions actually encourage employers to drop health plans for lower-income employees, many of whom will not be motivated to purchase insurance on their own.

As we’ve frequently discussed, the federal tax code currently exempts employer-provided health insurance benefits from taxation.  That exemption, which does not apply to individually purchased health insurance, amounts to an implicit subsidy percentage equal to the payroll tax rate plus the recipient employee’s marginal income tax rate. Because high-income workers are subject to higher marginal tax rates than are lower-income workers, the subsidy is greatest for them. Moreover, workers earning more than 400% of FPL will get no subsidy to buy insurance if their employer stops providing it.  Lower-income workers, by contrast, get less of an implicit subsidy for employer-provided health insurance, are eligible for more generous subsidies on state exchanges if their employer does not provide health insurance benefits, and would therefore prefer to work for employers that do not offer such benefits. Employers competing for workers will respond to these preferences.

Consider, for example, a previously uninsured 45 year-old who earns $35,000 and is required by the ACA to purchase a family insurance policy expected to cost around $15,000 in 2016.  If the employer provides the policy, the cash component of the employee’s compensation will fall to $20,000 (benefits generally being a dollar-for-dollar substitute for wages). The employee, however, will not have to pay the approximately $3,400 in federal income, Social Security, and Medicare taxes that would otherwise be due on the $15,000 received as insurance rather than cash.  On the other hand, if the employer does not provide health insurance and the employee purchases it on a state exchange, the employee will be eligible for a federal subsidy worth around $13,600.  Given the choice between a $3,400 implicit tax subsidy and a $13,600 subsidy on the exchange, the employee would prefer the latter. Now, if the employer employed more than 50 workers and failed to provide coverage, it would be charged a penalty of $2,000 for each worker that purchased subsidized insurance (after the first 30 workers).  It would likely choose to pay that penalty, however. It could finance the payment by reducing the employee’s salary by $2,000, and the employee would gladly agree to that arrangement. Even after having his salary diminished by $2,000, the employee would be better off gaining access to the larger government subsidy available only to individuals without employer-provided coverage.

But this analysis shows merely that the ACA encourages employers to drop coverage for lower-income workers. Won’t those workers turn around and purchase subsidized policies on the state exchanges? Perhaps not. For many of those workers, it will make more sense to pay the penalty and wait until health care is needed before purchasing insurance.  A one-income family of four headed by a 40 year-old earning $50,000, for example, would have to pay $3,385 for qualifying insurance or incur a no-insurance penalty of $2,085,  and it could always purchase insurance on a state exchange—with a $9,900 subsidy—the moment coverage became necessary. Such a family’s income level is low enough that the family is better off without employer coverage yet high enough that the family’s out-of-pocket insurance expenses will exceed the no-insurance penalty. Families in this situation can be expected both to lose employer coverage and to refrain from purchasing insurance on a state exchange.

Of course, all this assumes that premium subsidies are indeed available. For the reasons Adler and Cannon set forth, the ACA seems not to authorize such subsidies in states that fail to establish exchanges and instead rely on the federal government to do so.  Employers in such states would have less incentive to drop coverage for low-income employees, but lower income citizens who do not have employer-provided health insurance would not be likely to purchase insurance in such states, where the difference between the non-coverage penalty and the out-of-pocket cost of insurance (without subsidies) would be quite large.

In the end, then, neither the ACA’s premium support subsidies nor its employer mandate is sufficient to prevent the pernicious adverse selection cycle that results from combining guaranteed issue, community rating, and constitutionally limited deficient penalties for failure to carry insurance.

In constitutional law, economics, health care, health care reform debate, law and economics, markets, regulation, taxes
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Why Roberts’ Tax Reasoning Ultimately Damns the Affordable Care Act (But Not in a Good Way)

Thom Lambert —  11 July 2012

There’s great irony in Chief Justice Roberts’ reasoning in the recent Affordable Care Act ruling.  In reading the ACA to impose a tax for failure to carry health insurance, thereby assuring the Act’s constitutionality, Justice Roberts also doomed the Act to failure.  Let me explain.

As the government repeatedly stressed, the individual mandate (now interpreted as a disjunctive order either to carry health insurance or to pay a ”tax”) is necessary because of two “popular” provisions of the ACA: guaranteed issue (i.e., insurance companies are not allowed to deny or drop coverage because of preexisting conditions) and community rating (i.e., insurance companies must set common rates and can’t charge higher premiums to sick people or those susceptible to sickness). Taken together, those two provisions create a terribly perverse incentive for young, healthy people:  Don’t buy health insurance until you get sick!  After all, you can always sign up immediately upon becoming ill or injured (thanks to guaranteed issue), and (thanks to community rating) the insurer can’t charge you a higher price reflective of the greater likelihood — certainty, really — that you’ll make big claims.  To prevent young, healthy people from dropping their insurance, thereby leaving only the older and infirm in the pool of premium-paying insureds, the law must create incentives for them to buy insurance.  The penalty-backed individual mandate was ostensibly designed to do so.

But there’s a problem: penalties don’t deter if they’re set too low.  If a parking meter costs a dollar, but the penalty for not feeding the meter is only a quarter, who’s going to feed the meter?  Unless the expected penalty for an expired meter (the fine times the likelihood of detection) exceeds a buck, feeding the meter’s irrational.

What does this have to do with the ACA?  Well, the statutory penalty for not carrying health insurance is really low — way lower than the cost of insurance.  As Justice Roberts observed:

[I]ndividuals making $35,000 a year are expected to owe the IRS about $60 for any month in which they do not have health insurance. Someone with an annual income of $100,000 a year would likely owe about $200. The price of a qualifying insurance policy is projected to be around $400 per month.

So what is the young man or woman, fresh out of college and beginning a career, going to do — pay the $400/month or pay $60/month until he or she gets sick, at which point he/she can call up the insurance company and be assured of coverage (guaranteed issue) at rates not reflecting his/her impaired health (community rating)?  Surely a great many young people will take the latter tack, especially since — as Justice Roberts repeatedly emphasized — they’re not acting “unlawfully” in doing so.

Then we’ve got real problems.  Health insurance premiums are based on the likely health care expenditures of the pool of insureds.  The greater the percentage of young and healthy (low expenditure) folks in the pool, the lower the premiums.  Conversely, when the young and healthy drop out so that the pool of insureds is older and more infirm, premiums will rise.  And, of course, the higher insurance premiums rise, the more sensible it becomes for the relatively healthy to drop their insurance, pay the small “tax” instead, and wait to get sick before signing up for increasingly costly coverage.  It’s a pernicious cycle.

None of this is rocket science, and proponents of the ACA certainly understood these dangers when the statute was enacted.  They likely assumed, though, that the deficient penalties for failure to carry insurance were a “bug” that Congress would eventually fix once the Act was put in place and became operative.  Proponents needed for the penalties to be low so that they could get the statute through the political process; they figured they could fix the deficiencies later.

Justice Roberts’ opinion, though, will make it very hard for Congress to raise the penalty for not carrying health insurance.  The small size of the penalty was one of three factors that, according to the Chief Justice, transformed the penalty into a tax for constitutional purposes.  He explained:

[T]he shared responsibility payment may for constitutional purposes be considered a tax, not a penalty: First, for most Americans the amount due will be far less than the price of insurance, and, by statute, it can never be more.  It may often be a reasonable financial decision to make the payment rather than purchase insurance, unlike the “prohibitory” financial punishment in Drexel Furniture. Second, the individual mandate contains no scienter requirement. Third, the payment is collected solely by the IRS through the normal means of taxation — except that the Service is not allowed to use those means most suggestive of a punitive sanction, such as criminal prosecution.

This reasoning suggests that the penalty for failure to carry health insurance can count as a tax for constitutional purposes only if it is kept so small as to be ineffective.  Justice Roberts has thus transformed what was effectively a “bug” in the ACA into a “feature” of the statute — one that is required for the Act to constitute a valid exercise of congressional power.  He has damned the ACA in the process of saving it.

But market-oriented folks shouldn’t rejoice.  It’s true that Justice Roberts’ reasoning has assured that the ACA, if not repealed, will implode. That will occur because the combination of guaranteed issue, community rating, and constitutionally required low penalties will drive young and healthy folks from the pool of insureds, causing health insurance premiums to spiral upward and inducing even more people to opt for the ”tax” over costly coverage.  Congress will eventually have no choice but to restructure or repeal the Act.  But its replacement won’t be pretty.  Look out for the argument, “We tried a solution involving private insurance.  It failed.  Now our only option is a single-payer system.”

Justice Roberts’ decision may turn out to have been an even bigger gift to the left than anyone initially thought.

In constitutional law, health care, health care reform debate, regulation, Supreme Court
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David Post on Issue Versus Outcome Voting in NFIB v. Sebelius

Josh Wright —  6 July 2012

David Post has a really interesting post this morning on the Volokh Conspiracy about the implications of issue versus outcome voting in NFIB v. Sebelius.  Post and Steve Salop’s 1992 Georgetown Law Journal article sets forth an analysis of issue versus outcome voting.  The blog post works through that analysis in the context of the healthcare decision.  Its too long to excerpt.  But go check it out (the comments, thus far, are also pretty good).

In economics, health care, Supreme Court
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Earl Warren and John Roberts

Paul H. Rubin —  28 June 2012

President Eisenhower appointed Earl Warren to the Supreme Court thinking that Warren was a conservative.  Of course,Warren turned out to be a very liberal Justice.  Eisenhower later said that appointing Warren was the biggest mistake of his presidency.

Is John Roberts the Earl Warren of this century?

In constitutional law, health care, health care reform debate, politics, Supreme Court
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