Tuesday, March 27, 2012

In Defense of Obamacare

This week, the U.S. Supreme Court is hearing arguments for and against the Patient Protection and Affordable Care Act, more commonly known as "Obamacare".  The primary issue at stake is whether or not the Government has the right to require that people buy health insurance or else face a fine, otherwise known as the "individual mandate".  Since legal terms such as "interstate commerce clause" and the like tend to make my eyes roll back in my head, I am far from qualified to offer a legal opinion on whether or not Obamacare is constitutional.  However, from a purely economic point of view, requiring people to buy health insurance is one of the only ways to keep health care affordable.  Therefore, if it is declared unconstitutional, it will be a big loss not just for the Democrats, but for the millions who cannot afford health insurance.

In its most basic form, insurance is a way to spread the risk of a catastrophic event among a large group of people.  Everybody pays a little bit into a pool of money and then if something "bad" happens to one of those people, that one person gets the money from the pool.  If you find out that you have cancer, you might be forced to pay for extended hospital stays, surgeries, chemotherapy, and so forth.  The bills would be so big that it would bankrupt most people.  Yes, the odds of being diagnosed with cancer are relatively small, but if the unthinkable happens, it is pretty catastrophic financially (among other things).

To protect against this loss, most people buy health insurance.  You, along with thousands of other people, might pay $5,000 a year towards this insurance.  The insurance company collects money from you and thousands of other people and sets the money aside.  Then, if one person's gets ill, the insurance company takes some of the money they collected and uses it pay for the medical care that you need to get better.

The benefit of this type of arrangement is enormous.  While $5,000 a year is not chump change by any stretch of the imagination, writing that check gives you the peace of mind to know that you'll be able to afford to get the medical treatments that you need.  That, certainly, is worth $5,000 a year.

One of the potential pitfalls of this arrangement is known as "Adverse Selection".  Adverse selection is when a person buys insurance only when they know that they'll need it.

Let's say that you don't have any health insurance whatsoever.  You experience sharp pains in your side so you go to the doctor.  The doctor examines you and says that your appendix is about to burst and that you need to go to the hospital immediately to have it removed.  Faced with a $25,000 medical bill, you immediately dial up your local insurance agent (preferably while you are en route to the hospital) and purchase health insurance so that you can cover your impending five figure bill.

If you could actually do that, one of two things would happen.  Either the insurance companies would go bankrupt, or premiums would be so high that it would be just as expensive to just pay the medical bill out of pocket.  Why is that?  The whole premise of insurance is that you collect premiums from the many and pay claims to the few.  That way, the relatively smaller premiums from the larger group are able to pay for the relatively larger medical bills of the smaller group.  However, if only the sick buy insurance, then this math doesn't work anymore.

To combat this phenomenon, insurance companies do a number of things.  One thing they do is that they don't pay for medical bills on so called "pre-existing conditions".  This prevents you from buying insurance when you need it.  You can't just pick up the phone and buy a policy when you are faced with $25,000 worth of medical bills.  You have to buy it when you are healthy.

Of course, this pre-existing condition clause casts a wide net.  While it does prevent somebody from buying insurance only when they need to make a claim, it also prevents people who might lose their job or who retire early or who are too old to be covered under their parents' health insurance.  In this case what happens is that these people avoid going to the doctor altogether.  In the long run, this might make their medical condition even worse.  Eventually, they might end up in the hospital in a life-or-death situation.  In this case, the hospital ends up footing the bill, since they are obligated to save the patient's life.  The cost of this care isn't free, since it gets added to the hospital bill of each and every one of the paying customers.  Additionally, this care costs more than it would have cost if the person had just been able to go to the doctor for routine checkups. 

To prevent this from happening, one could do away with this pre-existing condition clause.  Now if you did that, then premiums would go up from everybody since now you'd have people only buying insurance when they absolutely needed it.  We have a dilemma here.  There are two options:

  1. Either we have to keep the pre-existing clause clause and let people go uninsured which makes things more expensive for everybody in the long run, or
  2. We get rid of the pre-existing conditions clause which drives up insurance premiums which makes things more expensive for everybody in the long run.
Of course, Obamacare goes off the board and chooses option 3:

Get rid of the pre-existing condition clause so that everybody can access insurance, but require everybody to buy insurance so that people can't buy it when they need it.

It is an elegant solution to a tough problem.  Not only does it extend coverage to more people, but it keeps the insurance premiums lower.  From an economic standpoint, this aspect of Obamacare makes perfect sense.

Now I understand and acknowledge that there is something inherently fishy about the Government requiring people to buy a product from a private company.  However, health insurance is something that is unique among most commercial products.  Unless buying a TV or something, there is a public policy component to health care, as its rising cost impacts society as a whole.  If somebody can't afford a TV, well then tough luck.  Not being able to watch the latest reality show really doesn't cause society as a whole any harm.  However, when people cannot afford health care, that's a different story.  People will get health care with or without insurance.  If they don't have insurance and they cannot afford to pay, we all pay for it.  We pay for it through higher premiums.  We pay for it through higher taxes.  Therefore, rather than burying our heads in the sand and not deal it because of some dogmatic belief, we need to somehow figure out a way to solve this issue.