An Optimal Health Insurance System

It is now nine years after the passage of the Affordable Care Act (ACA) and there are still 28 million Americans without any form of health insurance. Despite its current strong financial health, the long-term continuation of the ACA exchange market is in doubt. The individual mandate is no longer being enforced by the Trump administration and there continue to be challenges to the ACA in federal courts.

There are several legislative proposals to either create a public health insurance option or do away with private insurance altogether (aka Medicare-For-All (MFA)). In a series of posts, I will analyze these various proposals by estimating their costs to society as well as their effects on healthcare access and quality. My aim is to be as thorough and balanced as I can.

Before diving into specific proposals, I want to first explore something I call “optimal” public health insurance. Any public provision of health insurance will necessarily call for costs borne by taxpayers and consumers. If the main objective is to provide health insurance to those who do not already have it, then an interesting starting place for that discussion would be to see how that can be done at a minimum cost to society. Only once we have established how an optimal system is designed and how much it costs can we intelligently assess the relative costs and benefits of specific legislative proposals.

Using the concept of constrained optimization, we should first identify the objective to be optimized (i.e. minimum costs) and then the constraint (i.e. everyone has access to a minimally-acceptable level of healthcare). Without this constraint the solution might seem simple – leave the provision of health insurance entirely to private insurers. The direct costs to taxpayers would be zero in that case, similar to what the U.S. had prior to the start of Medicare and Medicaid in the 1960’s. But notice that I did not restrict costs only to those borne by taxpayers. The costs of public health insurance can be borne by many different entities and are not restricted to the amount of money paid in taxes or premiums.

There are three main types of costs associated with the public provision of health insurance:  taxation, adverse selection, and moral hazard. Taxation is usually the focus of the current policy debate: the Public Option vs. MFA. Yet the other two types of costs are even more germane to that debate. These two costs are inextricably linked and explain why health insurance has been such an intractable public policy problem for so long.

What would an optimal public health insurance system look like? The details are for future posts, but here are a few broad strokes. First, it would completely achieve the main objective of providing insurance to all those who don’t already have it. It is worth noting that although the number of uninsured has declined significantly, the ACA has failed to completely achieve this objective. So, an optimal system would look a lot different than our current taxpayer-subsidized exchange markets.

To minimize the cost to taxpayers, it would rely on our current public insurance infrastructure so that the cost of creating a new one is avoided. This is something that an optimal health insurance system would have in common with MFA. Medicare has well-established payment structures based on data it collects annually from providers.

To avoid adverse selection — the incentive for healthy people not to pay an actuarially fair premium — the optimal system would not charge a premium for coverage. This provision is key because adverse selection is a main reason why so many people lack health insurance. Many of the uninsured are relatively young and healthy individuals who believe the actuarially fair premium for health insurance is too high. In this regard, the optimal system is much closer to MFA than to the ACA.

So far, our optimal plan sounds a lot like MFA: health insurance that is provided at a zero premium to everyone that doesn’t already have it and that relies on the current Medicare system. But here is where the similarities to MFA stop. MFA would replace our current patchwork system of private and public health insurance with a single-payer approach. Although private health insurance would not be banned outright, MFA would leave little room for its continued existence. Taxpayers would bear the full cost of our healthcare system.

Moral hazard, the tendency for people to over-utilize the healthcare system when they bear no costs for using it, would be a significant problem that MFA would likely exacerbate. By subsidizing private health plans that impose out-of-pocket costs to the insured, the ACA does a relatively good job in this regard.

And lastly, a plan that minimized taxation, would be very different from both the ACA and MFA. The ACA mandates that everyone purchase insurance. This form of taxation is necessary with a system that relies on revenues from premiums, but since this mandate is no longer being enforced, the exchange markets will likely fail during our next economic recession. Even when the mandate was being enforced many people chose to pay the penalty rather than purchase health insurance. The penalty is a percentage of taxable income and is therefore not collectible for the unemployed. During the next recession, healthy people who are out of work will tend to stop paying their premiums while people with pre-existing health problems will maintain their coverage. This is a textbook example of adverse selection. Even if it was still being enforced, it is doubtful the mandate was ever large enough or reliable enough to create a stable health insurance exchange market.

The ACA’s taxation, however, pales in comparison to that of the MFA. Without a price mechanism for limiting the demands on healthcare resources, the moral hazard inherent in an MFA plan would result in an enormous increase in taxes or require restrictions on certain procedures, limited allocations of medications and long wait times.

In summary, the optimal system would bear some similarities with MFA (i.e. everyone is insured, uses the Medicare system, and charges no premiums therefore no adverse selection and no individual mandate) and some with the ACA (i.e. allows private insurance and imposes out-of-pocket costs therefore controlling moral hazard). That’s a tall order, but one that I believe is doable. The next posts will describe the optimal public health insurance system in more detail.

Published by TheLoneEconomist

I am a PhD economist who studies just about anything and proudly specializes in nothing.

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