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PHILIP KLEIN
Obamacare
ignores the elasticity of demand for health insurance

by Philip Klein, Executive Editor & Commentary Editor | 
June 24, 2013 12:00 AM
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“Health insurance is subject to elasticity of demand,” actuarial firm Milliman
explained in a 2011 report. “Individuals and groups will make purchasing
decisions based on the cost of insurance, insurance options in other markets,
and consideration of the consequences of being uninsured.”
Economists use the term “elasticity of demand” to describe how responsive
consumers are to changes in the price of certain goods or services. Because
the “consequences of being uninsured” are much less significant for
younger and healthier people, they are much more sensitive to variations in
the price of insurance than older and sicker people with less avoidable
medical costs. This isn’t to say that recent college grads don’t want or
wouldn’t take health insurance at the right price, but merely that they’re less
likely to stretch their budget to purchase health insurance than people in
their 50s with diabetes and heart disease who have far higher routine
medical expenses and are at a much greater risk of suffering medical
emergencies. Yet the design of President Obama’s health care law ignores
this very basic reality.
As conceived, Obamacare promises to extend coverage to older and sicker
individuals and those with pre-existing conditions by pulling more young
and healthy people into the risk pool to offset costs. Given that a)
Young/healthy people are much more responsive to variations in the price of
insurance, and b) attracting more young/healthy people is essential to the
functioning of the insurance market under Obamacare, it would make sense
for Obamacare to lower insurance rates for younger and healthier people as
much as possible so that insurance is a more attractive option to them. In
reality, it does the exact opposite.
Obamacare limits the amount that insurers can vary premiums by age,
meaning that making insurance more affordable for older and sicker
Americans will translate into significantly higher rates for young and healthy
individuals. Even if this doesn’t prompt the younger Americans who are
currently insured to drop coverage, as I’ve noted previously, Obamacare can’t
get by merely by retaining the same level of young and healthy individuals
as the current system. Instead, it must bring millions of new young and
healthy people into the Obamacare-controlled insurance market. Thus, the
relevant comparison to use when considering whether Obamacare will
function properly is not the difference between what insurance costs in the
current market and what it will cost under Obamacare, but rather, the
difference between purchasing insurance and going without insurance.
Under the current system, the cost of going without insurance is $0. Once
Obamacare passes, there will be a penalty attached to going without
insurance. It will grow over time, but in 2014, the penalty will be $95 or 1
percent of a person’s taxable income.
Defenders of the law argue that calculations regarding the cost of insurance
should also take into account the subsidies the federal government will be
providing to individuals to purchase insurance on government-run
exchanges. But those subsidies are significantly lower for younger
Americans.
In California, which has been touted as a model for implementation of the
law by Obama and his supporters, a 26 year-old making $32,000 per year or
more would not qualify for any subsidies and the cheapest plan available
would be $1,944 per year. The cost of this Californian going without
insurance would be a mandate penalty of around $200, based on taxable
income. This means that the relevant cost differential (i.e. the difference
between obtaining insurance and going without it) would be just over
$1,700.
In contrast, a 59-year-old with the same income level would be eligible for
$4,344 in subsidies. The thinking here is that because an older person would
have to purchase more expensive insurance, they should receive more
subsidies so that they don’t pay more than a certain percentage of their
income on health insurance. But what if the formula used to allocate these
subsidies were adjusted to reflect the elasticity of demand for health
insurance? What if, instead of giving the 59 year old $4,344 in subsidies and
the 26 year old $0 in subsidies, the federal government offered the older
Californian $3,000 toward the purchase of insurance and the younger one
$1,344?
Under such a design, Americans with pre-existing conditions could still get
covered and older Americans would still receive substantially more subsidies
than younger Americans with a comparable income. And suddenly, the
younger Californian would be able to purchase coverage for $600 per year, or
roughly $400 more than the cost of going without insurance. That price
would be much more likely to entice the younger person to purchase
coverage.
True, this would mean that older individuals would have to stretch their
budgets more than under Obamacare as currently envisioned. But that’s an
argument about fairness and the intention here is to make an argument
about functionality. And functionality is pretty important. If there aren’t
enough young people in the system, then Obamacare will structurally
collapse, and insurance rates will soar for everybody.
To be clear, I do not think it’s the role of the federal government to interfere
in the health insurance market in this manner. I would much rather reforms
that broke down government barriers to the creation of a true free market
for health insurance than a law that creates new barriers. But if the
government is going to interfere, enacting a policy that raises insurance
costs the most on those who need insurance the least when the
functionality of the entire scheme hinges on convincing them to purchase
insurance, doesn’t strike me as a very effective way to go about it.
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