As I noted in my earlier post today, the big news is that people are fretting about the Obama administration abandoning its commitment to the public option — a government-run health insurance company that would compete with private insurance companies. I’m a supporter of the public option, and I really hope that it makes it into the final bill. But it’s not the prize. The prize is the individual mandate. The individual mandate says that everyone must have health insurance. It’s the only non-negotiable piece of health insurance reform.
Why’s it so important? Because of adverse selection. Whenever anyone talks about a plan to reform health insurance (or talks about insurance, period), adverse selection is the issue that must be addressed. Conceptually, it’s simple. Adverse selection describes the condition where insurance is usually purchased by the people most likely to file claims.
Let’s say I want to start an insurance company — the way to make money is to take in more money in premiums than I pay out in claims. That’s the bottom line for car insurance, flood insurance, health insurance, or credit default swaps.
Premiums must go up to account for the amount I’m paying out in claims, plus the overhead of the business. One thing I can do to make my business more profitable or lower my prices is get rid of the people who file too many claims. This is why insurance companies charge people with preexisting conditions more money, refuse to cover sick people, and so on. It’s also why they try to dump expensive customers by any means necessary rather than paying all their claims.
This is where adverse selection comes into play. Only people who think they will need insurance are liable to buy it. People who don’t live in areas that don’t flood rarely buy flood insurance. Young healthy people often choose not to buy health insurance. People who drive old clunkers only buy the auto insurance that’s mandated by law.
If I offer health insurance, this is a problem. Without healthy people who probably aren’t going to need to use their health insurance in my plan, I’m going to have to charge a lot of money to cover the claims from the sick people who I am insuring. Those healthy people do still need health insurance, though. Any of them could get sick — really sick — any time. Sure, they are healthy and probably aren’t going to have a stroke, but there are diseases who strike the young and healthy as well. Hospitals in America cannot turn away patients, so they wind up getting treated anyway, not paying their hospital bills, and either filing for bankruptcy or dying because they can’t afford proper followup care.
This is where the individual mandate comes in. It simply requires everyone to have health insurance. That maximizes the size of the risk pool and eliminates adverse selection as a problem for health insurance companies. As long as everybody is buying in, they can sell insurance to people with preexisting conditions at the same rate as everyone else without worrying about it. (This is how insurance through employers works. If a company has enough employees, then the differing health of the employees doesn’t matter much.)
And once there’s an individual mandate, lots of good things follow from it. First of all, everybody is insured. Secondly, the government has a stronger incentive than ever to control health care costs, because it would be subsidizing the premiums for the poor. Perhaps that would even lead to the creation of a public option that seems so elusive right now. Finally, it is a huge leap for America. Imagine a real commitment, written into the law, that every American will have health insurance. That’s a big deal — the biggest deal. Everything else is an implementation detail. Does anyone really think that five or ten or twenty years from now, anyone will vote to take away their own health insurance? The individual mandate is the ballgame.