Unintended Consequence of the Day

Martin Feldstein in the November 6th Washington Post:

Obamacare could have the unintended consequence of raising health insurance premiums and causing a decline in the number of people with insurance.

Here's why: A key feature of the House and Senate health bills would prevent insurance companies from denying coverage to anyone with preexisting conditions. The new coverage would start immediately, and the premium could not reflect the individual's health condition.

This well-intentioned feature would provide a strong incentive for someone who is healthy to drop his or her health insurance, saving the substantial premium costs. After all, if serious illness hit this person or a family member, he could immediately obtain coverage. As healthy individuals decline coverage in this way, insurance companies would come to have a sicker population. The higher cost of insuring that group would force insurers to raise their premiums. (Separate accident policies might develop to deal with the risk of high-cost care after accidents when there is insufficient time to buy insurance.)

The higher premium level would cause others who are currently insured to drop coverage, pushing premiums even higher. The result would be a spiral of rising premiums and shrinking numbers of insured.

In an attempt to prevent this, the draft legislation provides penalties for individuals who choose not to buy insurance and for employers that do not offer health insurance. But the levels of these fines are generally too low to cause a rational individual to insure. . .

To simplify, let's look at a family in which one adult earns $50,000 and receives the family plan that costs $13,375. Employees typically pay about 25 percent of the premium cost, or $3,340. The $10,035 remaining cost is deductible by the employer and not taxable to the employee. So the total net cost to the employer of this employee's compensation (taking into account the payroll tax and the corporate tax deduction) is $41,509. The employee would receive the $50,000 minus his part of the health insurance premium, or $46,660 as pretax income.

If that employer stopped providing insurance, he could be subject to a fine of 8 percent of payroll, or about $4,000 for this individual. But even with this fine, he could pay a cash wage to the individual of $53,605 and still have the same net cost of $41,509 (because the cash wage would be subject to the 7.65 percent payroll tax and the combined amount would be deductible at the 35 percent corporate tax rate.) The employee's pay would therefore rise from $46,660 to $53,605, an increase of $6,945. That would be subject to income and payroll taxes, leaving a net increase of $4,677. Even after paying the 2.5 percent personal fine on his cash income of $53,605, he would have additional net income of $3,337, a substantial rise for someone who started with pretax income of $46,660.

In short, for those who are now privately insured through employers or by direct purchase, there would be substantial incentives to become uninsured until they become sick. The resulting rise in the cost to insurance companies as the insured population becomes sicker would raise the average premium, strengthening that incentive.

Unintended, yes, but entirely predictable. In fact, it's what happened in New Jersey (page 16), home of the second-highest average health insurance premiums.

See also Greg Mankiw in the November 1st New York Times.

(via Carpe Diem)