Thursday, 1 April 2010

Individual Mandate Penalties

Austin Frakt argues that the penalty for not buying health insurance under the Affordable Care Act is not too low, as some, including me, have argued. The problem, of course, is that if we disallow the practice of rejecting or penalizing people with pre-existing conditions the amount these people will pay for their insurance won't actually reflect the risk of payout they present to the insurance company. To compensate, people with less risk will have to overpay given the amount of risk of payout they present to the insurance company. So, being greedy people as we are, why would anyone overpay like this? Well, that's where the penalty comes in. (The other fact, of course, is that those without insurance are getting a free ride insofar as emergency rooms are still obligated to treat them, so it's only fair that they pay some kind of penalty to reflect this free ride.)

But, my concern is that the penalty might not be adequately high. Health insurance in the US is so expensive that a $600 penalty is small beans compared to the cost of a year of coverage. So I worry that low risk people won't buy insurance leaving a smaller pool of people sharing a heavily disproportionate amount of the costs. Nonetheless, based on coverage and penalty rates in Massachusetts, Frakt argues that the penalties under ACA are adequate. He may well be right and if he's right, I wonder why. There are a few possible explanations:

a) The $600 is greater than or equal to the amount that they're, effectively, overpaying. I don't think that's the case, but would need more data. And, of course, the more people that participate in the plan, the closer this comes to the actual overpayment. (And, yes, arguably, insofar as any comparable health care insurance will have to compensate for the effective subsidy for pre-existing conditions, the person is not really overpaying at all, i.e., one is really only overpaying if they could have received the same good or service elsewhere for a lower price. )
b) People actually tend to be slightly irrational consumers. The typical consumer would rather overpay by X and get some real value in return than pay a penalty of Y and get nothing in return even if X is more than Y. In the former case, it feels less like we're just wasting our money.
c) Another explanation, one that I prefer, is that people simply perceive it as a fair obligation despite the fact that they recognize they're overpaying. They willingly take on the overpriced insurance just as many people willingly pay taxes despite realizing that the direct benefit they receive from the tax is less than the amount they pay out. But insofar as this is true, the penalty could work against us. There's a discussion in Freakonomics about a day care that experimented with charging a small penalty to parents who showed up late. The effect of the penalty was to increase tardiness. The reason is that people perceived the penalty as simply a, quite affordable, fee for extra babysitting and no longer felt a moral obligation to show up on time.

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