The Incidental Economist

The following has been cross-posted at The New Republic’s Citizen Cohn.

During debate over and since passage of the Affordable Care Act (ACA), there has been some concern over whether the individual and employer mandate provisions will work.  Will employers drop coverage in large numbers once their workers can purchase insurance through exchanges? Will enough individuals game the system–purchasing insurance only when sick–to destabilize those exchanges? If the Massachusetts experience is any guide, the answer to both questions is “no.”

At first glance one might think the ACA’s and Massachusetts’ mandates wouldn’t work because the penalties for noncompliance are low. For example, the employer mandate in Massachusetts has a very weak penalty, just $295 per employee per year, far below health insurance premiums and the ACA’s penalty. But employers have not been dropping coverage in Massachusetts. In their recent NBER paper, Colla, Dow, and Dube summarize the relevant empirical findings:

Based on a pre-post comparison from a Massachusetts household survey, Long and Masi (2008) found no evidence of dropped coverage or restricted eligibility, and no major changes in the scope of benefits, network of providers, cost to employees or quality of available care under health plans. They also found that employer sponsored coverage had expanded due to increased take up among employees. Gabel and colleagues surveyed Massachusetts employers, finding that the percentage of firms with 3 or more employees offering health benefits increased from 73 to 79 percent, that there was an increase in firms offering Section 125 plans, and that Massachusetts employers were less likely than other US firms to terminate coverage or restrict eligibility (Gabel et al. 2008, Gabel, Whitmore, Pickreign 2007). Furthermore, evidence from Massachusetts indicates that despite concerns about potential crowd out from new public options (Cutler and Gruber 1996, Gruber and Simon 2008), there was actually an expansion in private coverage. (© 2010 by Carrie Hoverman Colla, William H. Dow, and Arindrajit Dube.)

Despite apparent incentives to the contrary, employer-based coverage is alive and well in the Bay State.

Turns out the individual mandate is working fine too. Although there are individuals gaming the system in Massachusetts—by waiting to purchase insurance until they need it–the overall coverage rate is high (about 96% insured) and the associated degree of adverse selection is very low (meaning insurers are able to cover medical costs with premium dollars, a necessary condition for a stable market).

In a recent report released by the Massachusetts Division of Insurance, actuaries estimated that part-year insurance purchasing in Massachusetts’ combined individual and small group market increased premiums by 0.5 percent to 1.5 percent. Based on an average individual premium in Massachusetts of about $5,000 per year, that translates into an annual premium increase of $25 to $75, far too low to have a major impact on the market. Insurance companies can pass that level of premium increase on to consumers without many of them dropping coverage.

Thus, there is reason to think gaming won’t be an issue with the national individual mandate. First, the ACA’s penalties for lack of compliance with the mandate are actually higher than Massachusetts‘. Second, exchanges will have open enrollment periods, which don’t exist for the Massachusetts version of an exchange right now. Restricting the enrollment decision to a once-per-year event reduces the ability for individuals to time coverage to coincide with illness. There are, of course, differences between Massachusetts and other states that may cause results to vary.

Note that I am not saying that everything about the health care system in Massachusetts is wonderful. The Bay State still has a health care cost problem and no agreed upon solution to it, for example. Nevertheless, the individual and employer mandates are functioning as designed in Massachusetts, even with lower penalties than will exist under the ACA. That should give us hope that they can work well elsewhere, though it doesn’t guarantee that they will.

The following is a re-post of my most recent Kaiser Health News column. It has been cited in the 4 August 2010 edition of Health Wonk Review.

In Massachusetts, the individual mandate requiring state residents to buy health insurance is working. Yet, a similar requirement remains among the more controversial elements of the new national health reform law. Opponents of the mandate resent being required to purchase a product they may not want. Proponents claim that the mandate is necessary to prevent an unraveling of the broader set of reforms in the law. But will it work? It is in Massachusetts, and that should give reform advocates some confidence.

First of all, what does it mean for the mandate to “work?” The purpose of the mandate is to counter a potential threat to health insurers’ stability when they are required to accept all comers, even those with preexisting conditions. If individuals have access to insurance coverage whenever they please but are not required to have it all year, some will choose to enroll only when sick and then drop coverage when healthy. If too many people were to do just that, then insurers would be on the hook for more health care expenses than they could cover with collected premiums.

No insurer could survive a sufficiently severe level of such “adverse selection” (policyholders’ health care costing much more than their collective premiums can cover), and the individual mandate is designed to ensure that they won’t face one. Requiring individuals to purchase coverage–and pay premiums–even when they’re healthy guarantees that insurers have sufficient funds to cover the claims of the sick.

The individual mandate is working in Massachusetts because it is preventing a destabilizing level of adverse selection. Although there are individuals gaming the system in the state—by waiting to purchase insurance until they need it–the overall coverage rate is high (about 96% insured) and the associated degree of adverse selection is very low.

In a recent report released by the Massachusetts Division of Insurance, actuaries estimated that part-year insurance purchasing in Massachusetts’ combined individual and small group market increased premiums by 0.5 percent to 1.5 percent. Based on an average individual premium in Massachusetts of about $5,000 per year, that translates into an annual premium increase of $25 to $75, far too low to have a major impact on the market. Insurance companies can pass that level of premium increase on to consumers without many of them dropping coverage.

This is good news for Massachusetts and for the country. The penalty for lack of compliance with the state’s mandate is slightly lower on average than what the fully phased-in penalties will be (in 2016) under the new national health reform law. (I’ve estimated them to be about $674 per person per year under the national law and $537 under Massachusetts law.) Thus, all else being equal, individual mandate compliance ought to be at least as high under the new law as it is in Massachusetts. The results seen in the state imply that little gaming should be expected nationally.

Still, one should not be too complacent. Not every state is like Massachusetts (as some might rejoice). It is possible that individuals in conservative states where the mandate is not popular would be more likely to make short-term insurance purchases. However, the new health reform law has one thing that the Massachusetts reforms lack, the ability for insurance exchanges to impose open enrollment periods, something Massachusetts Gov. Deval Patrick (D) and Massachusetts Senate President Therese Murray (D) both advocate for their state’s version of the exchange.

Year-round access to insurance facilitates gaming the system, so limiting access to certain months should reduce it. It may also reduce levels of coverage overall, so there is a catch. Another perfectly reasonable reform that avoids this trade-off would be to increase the penalties for non-compliance.

No doubt tweaks to the Massachusetts and the national law such as these will be made. But it is reassuring that they’re just that: tweaks. The fundamental structure of both laws and the role of the individual mandate they include appear to be sound. It’s working in Massachusetts. That’s good news for all of us.

The employer mandate in Massachusetts has a very weak penalty, just $295 per employee per year. That’s far below health insurance premiums and the ACA’s penalty. One might think that employers in Massachusetts would drop insurance coverage and pay the tiny penalty instead. Nope.

In their recent NBER paper, Colla, Dow, and Dube wrote a useful paragraph about employer responses to the Massachusetts employer mandate:

Based on a pre-post comparison from a Massachusetts household survey, Long and Masi (2008) found no evidence of dropped coverage or restricted eligibility, and no major changes in the scope of benefits, network of providers, cost to employees or quality of available care under health plans. They also found that employer sponsored coverage had expanded due to increased take up among employees. Gabel and colleagues surveyed Massachusetts employers, finding that the percentage of firms with 3 or more employees offering health benefits increased from 73 to 79 percent, that there was an increase in firms offering Section 125 plans, and that Massachusetts employers were less likely than other US firms to terminate coverage or restrict eligibility (Gabel et al. 2008, Gabel, Whitmore, Pickreign 2007). Furthermore, evidence from Massachusetts indicates that despite concerns about potential crowd out from new public options (Cutler and Gruber 1996, Gruber and Simon 2008), there was actually an expansion in private coverage. (© 2010 by Carrie Hoverman Colla, William H. Dow, and Arindrajit Dube.)

Despite incentives to the contrary, employer-based coverage is alive and well in the Bay State. Go figure.

References

Cutler, D. and J. Gruber (1996). “Does public health insurance crowd-out private insurance?” Quarterly Journal of Economics 111: 391–430.

Gabel, J.R. et al. (2008). “After The Mandates: Massachusetts Employers Continue To Support Health Reform As More Firms Offer Coverage.” Health Affairs 27 (6).

Gabel, J.R., H. Whitmore, J. Pickreign (2007). “Report From Massachusetts: Employers Largely Support Health Care Reform, And Few Signs Of Crowd-Out Appear.” Health Affairs 27(1).

Gruber, J. and K. Simon (2008). “Crowd-out 10 years later: Have recent public insurance expansions crowded out private health insurance?” Journal of Health Economics 27(2):201-217.

Long, S.K. and P.B. Masi (2008). “On the Road to Universal Coverage: Impacts of Reform in Massachusetts at One Year,” Health Affairs 27 (4).

On The Health Care Blog, Roger Collier speculates about what might happen if the ACA’s individual mandate is struck down as unconstitutional.

The reactions of individual states to an unconstitutionality finding would presumably reflect their politics, with states to the right of center being able to claim a fundamental failure of reform, especially as premiums increase in the absence of new healthier enrollees. Left-leaning states might take the option, however, of imposing their own individual mandates consistent with their state constitutions—much as Massachusetts did in 2006, although possibly with a different, more effective structure that would further lower the number of uninsured. And that might make for some interesting comparisons.

Legal thinkers I trust think the mandate won’t be struck down so I don’t spend much time thinking about what might occur if it is. There are also alternative ways to compel folks to purchase insurance so I’m not terribly worried in any case.

However, I expect that even with a national mandate in place there will be considerable state variation in compliance. With the penalty for noncompliance relatively low, states with populations culturally/ideologically opposed to the mandate will tend to have higher uninsurance rates (controlling for all other relevant factors). Those more likely to need and use insurance will buy it, forcing premiums higher–the adverse selection problem. (There is also likely to be variation in compliance with payment of the tax penalty.)

What will policymakers in states with high uninsurance rates and, perhaps, high premiums due to the expected adverse selection do or say about the individual mandate then? When premiums are increasing disproportionately across states due to disproportionate compliance with the mandate won’t mandate enforcement begin to look like a good idea? Don’t most voters actually want (and have) insurance coverage and pay premiums? Won’t they demand that something be done about the free riders?

The long-term outlook for an anti-mandate position doesn’t seem good.

The notion that employers might stop offering health insurance coverage once decent policies are more readily available on exchanges warrants some concern. It would actually be a good thing if we transition away from an employer-based system, but it would be preferable that the transition occurs gradually. If employers abandon coverage en masse, it could lead to discontent and a dramatic increase in government subsidy costs.

Shawn Tully’s recent story in Fortune on this subject is getting some attention. In it he writes that

Internal documents recently reviewed by Fortune, originally requested by Congress, show what the bill’s critics predicted, and what its champions dreaded: many large companies [including AT&T and Deere] are examining a course that was heretofore unthinkable, dumping the health care coverage they provide to their workers in exchange for paying penalty fees to the government.

For large firms that do not offer coverage, those penalty fees would be $2,000 for every employee over 30 that the firm employs.

Are those fees too low? Perhaps. But it is worth noting that they’re far higher than those of the Massachusetts’ employer mandate, described in a recent Millbank Quarterly paper by Michael Doonan and Katherine Tull of Brandeis University. “Employers who do not provide health insurance to their employees must pay a ‘fair share’ assessment to the state of up to $295 per employee per year.”

What’s the experience in Massachusetts under the mandate with this penalty level? Doonan and Tull write,

The first year of health reform showed no evidence of crowd-out, either from a decrease in the number of employers offering health insurance coverage or in the number of workers taking up coverage (Long 2008). The number of employers offering health insurance also rose between 2005 and 2007 from 70 to 72 percent. … Health reform facilitated the uptake in employer sponsored plans without the feared crowd-out.

Perhaps there are other features of the Massachusetts law or its employers that invalidate a national extrapolation. Or perhaps Massachusetts employers hung in for the first year but began dumping or will dump later. I’ll be on the lookout for other explanations and evidence along these lines (leads appreciated). However, based on what I know now, I’m not too concerned about widespread employer dumping.

This is a re-post of my Kaiser Health News column of Monday, 26 April 2010.

The Patient Protection and Affordable Care Act continues the American tradition of privately provided, publicly subsidized health insurance. It’s how most Americans’ health insurance is financed today. But despite its advantages, there is a hidden cost to this arrangement: insurers have more information about health care coverage, spending and utilization than the taxpayers that help fund them. The system’s opacity gives insurers the upper hand in debates over government payment rates.

Public funding of private health insurance is ubiquitous. Employer-sponsored coverage is provided by private insurance companies and is publicly subsidized through the exemption of premiums from payroll and income taxes. Recently, private insurers announced their interest in increasing their participation in state Medicaid programs. Private plans participating in Medicare Advantage or Medicare’s prescription drug program are taxpayer-subsidized, as are those offered through Massachusetts’ Health Connector–the precursor to state exchanges that will be established in 2014 under the new health law.

Recent events in Massachusetts and years of experience in Medicare reveal that the opacity associated with public financing of private coverage is a set-up for conflict. A few weeks ago, Massachusetts insurance companies filed suit after the state’s Division of Insurance rejected proposed rate increases of hundreds of insurers.

In justifying their proposed rate increases, one of the claims made by Massachusetts health insurers is that they’re experiencing adverse selection (enrollees are sicker than expected). They claim that individuals are taking advantage of the state’s ban on preexisting exclusions and low penalties for violation of the state’s individual mandate. The way the game works, insurance firms say, is that an individual signs up for insurance in advance of an expensive procedure, paying the premium for just a few months. After the procedure the individual drops coverage and pays the lower penalty.

Unfortunately, no publicly available data are sufficient to test Massachusetts insurers’ claims or those of the Division of Insurance. The data exist of course. Insurers have it; the public does not. Survey data sources are a second best, but no surveys with a sufficient sample ask the right questions to measure the degree of adverse selection experienced by Massachusetts plans.

With no way to validate the assertions of insurers or regulators, the public–those that actually fund the low-income insurance subsidies–can’t know the extent to which insurers are exaggerating the level of adverse selection or if regulators are unfairly dismissing it. Since Massachusetts’ health reform is so similar to that which will be implemented nationally under the new health reform law, it is a tremendous loss that we don’t know more about precisely how it is working (or not).

A similar lack of data prevents researchers from fully analyzing the risk selection experience of private Medicare plans. There is indirect and self-reported evidence that Medicare Advantage plans experience favorable selection (enrollees healthier than expected). Because plans are not required to release all utilization data the issue cannot be analyzed head-on. As a consequence, the perennial clashes over payment between the industry and budget-conscious politicians and watchdog groups occur in a climate of incomplete information. Medicare Advantage plans are overpaid, but by how much? Taxpayers can’t fully know.

At the heart of these conflicts are empirical questions: Are payments sufficient to cover costs? Are taxpayers getting a fair deal, a bad deal or a bargain? Not surprisingly, insurers and regulators generally provide opposing answers.

How can we tell who is right? With the necessary data so closely guarded by insurers and not available to the public, academics and consumer and taxpayer advocacy groups, who might provide valuable checks of claims made by insurers and regulators, are locked out of the debate.

The hidden data imposes a hidden cost on taxpayers. Though it can’t be fully quantified, there is a likely cost in the form of inflated payments. Insurance companies know far more about their costs and enrollee characteristics than regulators or academics. The information asymmetry plays to their advantage and can only drive up taxpayer costs. Unless plans are compelled to provide data, their advantage is likely to continue as the public begins paying a substantial sum to subsidize exchange-based coverage in every state.

The American tradition of public financing of private coverage is alive and well, and so is the practice of hiding the facts about what taxpayers are getting for their money. Wouldn’t you like to know what you’re paying for? Me too.

My attention to Massachusetts’ individual mandate and the extent of “gaming”* thereof raises another issue, one on which I haven’t yet explicitly focused. The reason we do not know how much gaming of the Massachusetts mandate occurs or the implications of it for premiums is that the relevant data aren’t available to researchers. I know this from two e-mails from academics who study Massachusetts health reform (one of which I quoted earlier).

The paucity of data from private health insurance plans participating in public programs is not new. The Medicare Advantage program also obscures a substantial amount of health care utilization data for private plan enrollees that is otherwise available for traditional Medicare users. I know well the limitations this imposes on research, including my own.

There is a consequence to proprietary barriers to data access. We don’t learn as much and, thus, we don’t know as well what works or doesn’t. What we end up knowing is driven to a larger extent by industry statements and reports than it is by less biased scholarly analysis. This is a real loss and has implications for policy and government budgets.

As just one example, the one I’ve been writing about, will the Affordable Care Act’s individual mandate penalties be sufficient to discourage gaming and limit the adverse selection associated with it? Much of the evidence from Massachusetts and my own analysis suggests they will be. But recent industry reports of gaming give us pause. If only we researchers had the data to judge for ourselves we might be able to draw more solid conclusions.

In a few years, when national health reform is implemented questions such as this will be raised on a national scale. Will we have the data to answer them? Or will we be at the mercy of the industry (again)? This is a tree-falls-in-the-woods question. If we can’t measure the effect of health reform, what happened? Anything good? Well, it is a large tree and we will have paid for it! Wouldn’t you like to know what you’re getting for the money? Me too.

* Some object to the use of this term. I use it here as a convenient shorthand for short-term insurance purchase timed to coincide with increased risk of high health expenses and the payment of the low penalty otherwise.

Today Kay Lazar reported in the Boston Globe that thousands of Massachusetts residents are purchasing health insurance only when it is needed and dropping it and paying the relatively low penalty when it is not.

In 2009 alone, 936 people signed up for coverage with Blue Cross and Blue Shield of Massachusetts for three months or less and … [paid a monthly premium of] $400, but [had] average claims [that] exceeded $2,200 per month. …

Governor Deval Patrick recently filed legislation that state regulators believe will help fix the problem, by restricting insurance enrollment to twice a year for people who buy on the open market and allowing waiting periods before coverage kicks in. …

It would also bring back the rule allowing insurers to exclude coverage for preexisting conditions for six months, or impose a similar waiting period under certain conditions for people buying coverage on their own. …

Consumer advocates said they aren’t convinced that a lot of people are gaming the system, and they said that many of the individuals buying on the open market are likely those who are between jobs, new to the state, or have some other legitimate reason to buy coverage for a short period.

Implications for the nation’s individual mandate are obvious. But there is plenty of time to learn from Massachusetts’ experience and tweak the federal law, as there is to do more thorough analysis of the issue.

I have no doubt there is some gaming going on, as there would be with any mandate. What has not yet been shown by anybody is the total size and significance of it. That is, how much higher are premiums due to the selection experienced by insurers? Is this a mountain or a mole hill? Some of the reporting is based on sources that have a reason to inflate the significance of this problem. And it can’t be all that big when about 97% of the state’s population is covered (though it depends how that figure is measured).

All in all, I haven’t seen enough work on this that suggests there is a sound basis for policy. I hope somebody, somewhere can get their hands on some solid data and do some credible analysis.

Later: I have many other posts on this topic.

Sometimes readers get confused by the title of a post (or newspaper article, book, etc.). How accurate and complete can a brief statement be? Not very. Sometimes one has to read the content of the piece and apply a little thinking to assess the title’s scope. We know this, right?

Case in point: I titled a prior post “Individual Mandate Penalties Are Adequate.” Adequate for what? And in what sense? Adequate to rid the world of disease and famine? Adequate to confuse or annoy people? Of course the body of the post is crystal clear of the scope of adequacy, the means by which the assessment was made, and the limitations of analysis applied. As Reihan Salam quoted my conclusion,

Since there is little evidence of substantial gaming in Massachusetts, based on an analysis of penalty size alone there would seem to be little cause for concern over gaming under ACA, particularly for higher income individuals. This analysis ignores other differences between Massachusetts and its health reform law and the national population and ACA, respectively. Results are sensitive to assumptions, but I deliberately selected those conservatively as indicated above.

Salam also correctly points out that Massachusetts permits insurers to apply a six month pre-existing condition exclusion period. That is, they must guarantee issue of a policy but do not have to cover a pre-existing condition in the first six months. As far as I know, no such exclusion period is permitted under ACA rules. So, this is a difference between the Massachusetts individual mandate and the ACA’s mandate. I pointed out this difference in a prior post to which I linked in the “Individual Mandate Penalties Are Adequate” post.

For all that, Salam concludes, “Frakt titles his post, ‘Individual Mandate Penalties Are Adequate.’ I’m struck by his confidence, and impressed by it.” I’m delighted to be viewed as impressively confident, but what’s so impressive really? Does Salam think I meant that the penalties are adequate to overcome all the other differences of relevance between the Massachusetts and ACA laws? That would be an impressive assertion. Impressively dumb. If I meant that would I have pointed out that other important differences may exist and linked to a post that described one (the exclusion period)? No. Nor would I have written the conclusion Salam quoted, emphasizing that my analysis was based on “penalty size alone.” And I wouldn’t have started the piece with “Some have asserted that the individual mandate penalties under the Affordable Care Act (ACA) are lower than those imposed in Massachusetts.”

Thus, it should be clear to that I was documenting that there is no basis for an argument that the ACA penalties are lower than Massachusetts’ penalties. That’s not how one goes about supporting a claim that there will be gaming under ACA. Yet that’s the argument Salam had made in an earlier post in which he wrote, “My reading is that the penalties are considerably more onerous in Massachusetts than under the new federal legislation.” Since that is false, one has to base the argument on something else. That is, ACA penalties are adequate as far as penalties go, but other provisions of ACA may not be sufficient to prevent gaming.

I’m not saying there is no cause for concern about gaming. On that Salam and I may agree. I’m saying that penalty size differences aren’t the place to look for support of such a concern. Clear?

This post has been cited in the 1 April 2010 edition of Health Wonk Review. See also my follow-up post on this topic.

Some have asserted that the individual mandate penalties under the Affordable Care Act (ACA) are lower than those imposed in Massachusetts. If that were the case then it would be one reason why one couldn’t generalize the experience in Massachusetts where guaranteed issue exists and near-universal coverage has been achieved with low penalties. If ACA penalties are lower than Massachusetts’ penalties then there is reason for concern that individuals might game the system–buying coverage only when sick, paying the low penalty when coverage isn’t needed–more than they appear to in Massachusetts.

So, are ACA penalties lower than those in Massachusetts? This is an empirical question, and I can answer it. The details are below, but to cut to the chase, the ACA penalty will be $674 for an average U.S. resident while the Massachusetts penalty would be $537 on average. That doesn’t mean the ACA penalty is higher for everyone. About 40% of the population would have a higher penalty under Massachusetts rules than under ACA rules. However, nearly half of those who would have a higher Massachusetts than ACA penalty are exempt from ACA penalties due to low income. Many such individuals are eligible for premium and cost sharing subsidies under ACA. Thus, the incentive for gaming is lower for this subset.

So, I don’t think it is fair to say the ACA penalties are lower than Massachusetts’ penalties. On average they’re higher, and they’re higher for 60% of of the population. If gaming is low in Massachusetts we cannot expect it to be higher under ACA based on a penalty-size argument. Hence, ACA penalties are not too low. However, the U.S. population may differ from the Massachusetts population, and other details of ACA differ from health reform in Massachusetts. For these reasons, gaming may still be an issue despite the evidence on penalty size.  Keep reading if you want the details.

Let’s first look at the Massachusetts penalty schedule for 2010:

FPL = Federal Poverty Level. This table is copied from the Massachusetts Department of Revenue website. I believe the 18-26 age specification in the 250.1-300% band is in error, that the dollar figures in that band apply to all ages. The penalty figures shown are per adult (i.e., married couples pay double, kids are exempt).

When fully phased in (2016), the penalty under ACA will be $695 per person per year up to a maximum of three times that amount ($2,085) per family or 2.5% of household income, whichever is greater. For the penalty calculation, children under 18 count as half a person (i.e. lead to a penalty of $374.50–h/t reader Jacob Shmukler). Individuals with out-of-pocket (OOP) premium-to-income ratio above 8% are exempt from the penalty. Here, OOP premium is net of employer contribution or exchange subsidies (source for premiums: 2009 Kaiser/HRET Employer Health Benefits Survey; premiums for employer-sponsored plans not reduced by the tax subsidy, which is conservative).

With a nationally representative source of income data we can calculate what proportion of individuals would face lower penalties under ACA than in Massachusetts. To answer these questions I turned to the Medical Expenditure Panel Survey (MEPS) because I have it handy and am very familiar with it. One could also use the Current Population Survey or any number of other nationally representative surveys with income data. Because it is the latest available, I used the 2007 version of MEPS. I didn’t trend incomes forward to 2010, which is conservative to the extent incomes went up (but given the economy they likely have not).

I computed the penalty paid by each family in the MEPS sample under each set of rules, ACA and Massachusetts. I then assigned to each individual in each family an equal share of each penalty and averaged the penalties over the population, weighted appropriately to compute national means. I also computed the number of individuals for whom the ACA penalty would be greater than the Massachusetts penalty. Results:

• Mean ACA penalty: $674
• Mean Massachusetts penalty: $537
• Percent of population for whom ACA penalty > Massachusetts penalty: 60%

These results are qualitatively robust after stratifying according to exchange subsidy eligibility. Since there is little evidence of substantial gaming in Massachusetts, based on an analysis of penalty size alone there would seem to be little cause for concern over gaming under ACA, particularly for higher income individuals. This analysis ignores other differences between Massachusetts and its health reform law and the national population and ACA, respectively. Results are sensitive to assumptions, but I deliberately selected those conservatively as indicated above.

Bloggers over on EconLog are anticipating some gaming of the individual mandate (Arnold Kling, Bryan Caplan). I agree with them that the individual mandate is sufficiently low that it could make financial sense for some folks to wait until they are sick to enroll. I don’t agree that there is enough incentive for employers to drop coverage, or certainly not in large numbers. Here’s why.

Kling and Caplan are ignoring the reason why employers offer coverage, to compete in the labor market. They compensate with health insurance at the expense of wage due to the employer tax subsidy. That subsidy is huge and will not be available for exchange-based plans for large firms (at least not initially, and ultimately at the discretion of states; the distant future is uncertain in this regard).

Workers in the labor market, and especially the older, experienced, and highly valued ones with families, want health insurance and, moreover, want it through their employer. Thus, if a firm doesn’t offer insurance it will lose access to the class of workers who value it. For larger firms that’s going to be a lot of people, some they can’t afford to lose. Doing so will put them at a competitive disadvantage in the labor market and the quality of their products will suffer. That doesn’t sound like a good business plan.

Smaller firms might rationally decide not to offer insurance. But many already make that choice. Health reform law now includes tax credits for those businesses to offer insurance. On net I think we’ll see an increase in small businesses that do so.

And finally, nobody has explained why we should ignore the experience in Massachusetts where guaranteed issue exists and near-universal coverage has been achieved even with low penalties.  Maybe the six month exclusion of coverage for pre-existing conditions in Massachusetts is enough. That could be replicated nationally, though simply raising the penalty would eliminate the adverse selection problem Kling and Caplan point to. Either way, it is conceptually a small tweak to the system. Such a tweak may not be necessary, but if it is at least the structure is in place that can accommodate it. None of this is good reason to condemn that structure.

Or the answer could simply be that that nearly every healthy individual in Massachusetts is irrational. In that case, maybe you can’t believe anything I say.

Later: See my follow-up post that shows that the individual mandate penalties are not low, at least by Massachusetts standards.

Mark Pauly has published two interesting pieces relevant to health reform in the New England Journal of Medicine in the last month or so. Both are short and eminently accessible to a non-economist (or so I think).

One, co-authored by Bradley Herring, describes the differential impact and incentives of a play-or-pay style employer mandate on low- and high-wage workers and on low- and high-wage firms. The source of the heterogeneous effects is the fact that high-wage individuals benefit more from employer-based insurance, which is shielded from (progressive) income tax and low-wage individuals benefit more from exchange-based insurance, which is paid with after-tax dollars but for which low-income subsidies are available.

Short of eliminating the preferential tax treatment of employer-based coverage, Herring and Pauly suggest two other half-measures that are consistent with current proposals.

[W]e could widen the scope of subsidies for low-income Americans in order to improve horizontal equity, making more low-wage workers eligible for the same subsidy regardless of where they work; and we could cap the tax exclusion for employment-based insurance, perhaps for policies with high actuarial value, for higher-income workers, or both. The resulting tax revenue could be used to help fund the more equitable low-income subsidies. These steps would at least begin to move us in the direction of improved equity.

Pauly’s and Herring’s analysis is sound and worth reading for those wishing to more fully understand employer mandates. The recommendation to cap or eliminate the preferential tax treatment of employer based insurance is the main stream economists’ view. Using the recovered revenue to assist low-income individuals purchase insurance is a far more equitable redistribution.

In an earlier article, Pauly warns of side-effects of community rating and guaranteed issue: adverse selection and cream skimming. He doesn’t believe the individual mandate penalties currently proposed are high enough to avoid the former (healthy people would disproportionately delay coverage, seeking it when they become sick). Maybe so, but it would be counter to the Massachusetts experience in which near-universal coverage has been achieved even with low penalties. I do agree that cream skimming may be a problem, particularly if risk adjustment is inadequate.

Pauly offers some alternatives to current proposals.

The objective should be to get people to obtain coverage with guaranteed renewability before they become high risk. One step in this direction would be to add guaranteed renewability for coverage of a worker’s family to small-group insurance. Another would be to implement strong incentives for obtaining coverage before one gets sick. Some of these could be carrots, such as larger subsidies for low-risk people to get them to buy in. Others could be sticks, such as increased premiums for people who decline coverage until they become high risk. The establishment of high-risk pools, adequately subsidized by general taxes but with higher-than-standard premiums and moderately limited coverage, may be all that is needed to get nearly everyone to do the right thing.

These are interesting ideas. Of course greater subsidization would encourage enrollment, though it would increase cost to taxpayers, as mentioned. I’m skeptical that individuals inclined to forgo coverage due to a low penalty would necessarily be more inclined to enroll if future premiums may be higher. It’s possible, but I’m just not sure the “young invincibles” think that far in advance. To help them do so we could simply compute some type of expected present discounted value of the future penalty. But that’s the same thing as a current penalty. In theory there shouldn’t be much difference between a current penalty and a future one if discounted properly. So, the real difference is due to behavioral factors, which argues for a current one.

Another idea would be to increase the penalty. How about making it the same dollar value as the premium the individual would face anyway? That is, you pay the same amount whether you enroll or not. Might as well enroll, right? In fact, if everyone enrolls nobody pays the penalty, so it might as well be infinity. That is, if one really believes in an individual mandate then one should not feel bashful about backing up that policy goal with a penalty with teeth. Nobody would pay it anyway. If one thinks that a high penalty is a political vulnerability then one is admitting moral defeat on the notion of an individual mandate. Pauly is right to point to an inconsistency here.

Still, if one is really going to worry about the penalty size one has to say why the Massachusetts experience isn’t generalizable. That’s not impossible. But I haven’t seen anyone do it.