Economic Effects of Health Care Reform: Insurance Costs with Pre-existing Conditions

This begins a series of posts about the recently adopted health care reform, a subject I have not discussed on this blog so far.  I will not be ranting about how wise or stupid the bill is.  If you want to hear me rant, buy me a martini.  As long you keep buying, I'll keep ranting.  Instead, I want to cover the effects that businesses will face.

Today's topic is health insurance cost impacts due to the access provisions.  The new bill mandates "immediate access to insurance for uninsured individuals with a pre-existing condition," and eliminates "pre-existing condition exclusions for children."  (I'm working off a summary, being no more inclined to read the entire document than any of our elected officials are.)

Why do insurance companies exclude pre-existing conditions?  We economists call it "moral hazard."  If people have a choice about whether they buy insurance or not, then those most likely to buy it are those who are sick or going to be sick.  This self-selection of the sick is mostly avoided through employer-provided health care.  When everyone who works at the ABC company gets health coverage, then there's less chance that only sick people are buying coverage.  However, notice that I said "mostly avoided," because today people who have pre-existing conditions, or suspect they are likely to get sick, seek out jobs with good health care coverage.

I expect three kinds of behavioral effects.

1. Many people will not change their behavior at all, even if it would be in their self-interest.  They don't know about the law, they don't care about their future, or they intend to get around to it once of these days.
2. Some people who currently have health insurance coverage will drop it immediately.  They save money, and they remain certain they can buy coverage whenever they need it.  Here's their risk: they are in an accident, get taken to the emergency room, get treated (the hospital cannot say no), get their huge bill, and the hospital trashes their credit rating.  That's about it.  If follow up care is needed, they simply buy insurance.  If they get a lump and their doctor says let's get a biopsy, they buy insurance.  Avoiding months, and maybe years, of insurance payments will cover an occasional doctor visit.
3. Some people who currently don't have coverage will buy coverage when they get sick or injured.  Their care may be better (or maybe not), but it's quite likely to be more extensive and expensive.  Hospitals and doctors will be better off--they are more likely to get paid.  Insurers will be much worse off.  Those who didn't have coverage but can come up with a little insurance money can get millions of dollars worth of care for a small premium.  (And there are no longer any lifetime caps on coverage, either.)

The direct impacts:   This feature by itself looks good for health care providers (hospitals, doctors, drug companies) and very bad for insurers.  However, I don't know the magnitude of the impact, because I'm not sure how many people will stay in inertia, and how many will respond to the new incentives.  Certainly some will respond, and some won't.

What is the business impact of limits on pre-existing conditions?  If your company currently pays for health insurance for your employees, expect that cost to rise even faster than it has.  If I were advising an insurance company (I'm not, but give me a call if you run one), I'd err on the side of higher premiums rather than lower, because of the potential of many, many sick people signing up for coverage.  I would never recommend a company provide bad service, but some insurance companies might be better off with really lousy service when new customers apply for coverage.

Comments

[What Healthcare?]

"If I were advising an insurance company (I'm not, but give me a call if you run one), I'd err on the side of higher premiums rather than lower..."

One word...OUCH! I already pay over $300 a month for insurance through my work and that's after I dropped from a PPO to an HMO to save $300 (yes I would have had to pay $600 for health insurance).

So in other words all the bill did was to raise the possibility of me paying more money. And since I make 'too much' to be considered poor enough to get any assistance I'm going to have to shell out more of my money for the same service. So much for the middle class!

[Lawrence Kramer]

Why do insurance companies exclude pre-existing conditions? We economists call it "moral hazard." If people have a choice about whether they buy insurance or not, then those most likely to buy it are those who are sick or going to be sick.

Well, not exactly. Moral hazard refers to the tendency of insured people to behave carelessly. The term applies to pre-existing conditions only in the sense that the right to buy insurance after you get sick is tantamount to having free insurance right now. To the extent that that right causes people to take the risks that insured people take, moral hazard applies.

In contrast, the decision to buy insurance if you think you may become sick is called "adverse selection." That, too, is different from moral hazard, because moral hazard is a phenomenon related to how people who are effectively insured (either by a policy or the right to buy one) behave, whereas adverse selection describes how people who are eligible to buy insurance (but cannot buy it after they get sick, and so are not effectively covered unless they buy it) behave.

The decision not to buy insurance until you are sick is just called "gaming the system." Insurance companies cannot allow that game to be played, or they will go broke. They can price for moral hazard and adverse selection, but there is no way to price for freeloaders. That's why mandatory coverage is necessary if pre-existing conditions are to be covered: mandatory coverage eliminates pre-existing conditions by assuring that no conditions "pre-exist," except those incurred in childhood, a risk for which insurers, again, can price.

[Ron Stone]

Very nice analysis. I think the ripple effect of this "healthcare" bill will be enormous and it's cost for the government and business will be astronomical. Even without all the other out of control spending and power grabbing being done by the government, it could push this country into a serious depression. Another case of the government using a sledgehammer to kill a fly.

[Mike Elman]

"immediate access to insurance for uninsured individuals with a pre-existing condition"

Insurance companies are still going to be making TONS more money off of this bill.

[Health Insurance Quotes]

" The term applies to pre-existing conditions only in the sense that the right to buy insurance after you get sick is tantamount to having free insurance right now."

- Good point Lawrence. I was just thinking it's unfair if sick people couldn't buy insurance or get limited coverage. Nevertheless, I still hope they could, because they're the ones who really will use it.