The Individual Mandate: Another Look at the Penalty Trade-Off

Most of the recent attention on the 2010 health care reform legislation has focused on the individual mandate. After two federal court rulings upholding the mandate, a third federal judge—in Virginia—ruled that the Constitution does not allow the government to require the purchase of insurance as part of regulating an interstate commerce market. Simultaneously, Congressional Republicans have reiterated their intention of preventing the individual mandate from being implemented, regardless of the constitutionality of the provision.

One interesting response to the resulting media coverage came in the form of a Kaiser Health News article [http://www.kaiserhealthnews.org/Columns/2010/December/121410laszewski.aspx] suggesting that the issue might be overblown since, even if the mandate were implemented, it would be relatively unsuccessful in leading the uninsured to purchase coverage. Unfortunately, the article misinterprets some of the legislative language, not entirely surprisingly given the complexity of the mandate provision. Following are clarifications of the mandate and associated requirements, and a somewhat more careful look at the mandate’s possible impact.

A Brief Summary of the Mandate

The individual mandate requires almost all legal residents of the United States to have at least a defined level of health care coverage. Those lacking such coverage will be subject to a penalty to be paid as part of tax filing. Exclusions are made for members of certain religious groups, Indian tribes, incarcerated individuals, and those whose income is below the tax filing threshold or inadequate to pay for coverage. To assist those with lower incomes but not eligible for Medicaid or SCHIP, the legislation provides for both premium credits and cost-sharing subsidies.

Definition of “Income”

The penalty and premium credit (and cost-sharing subsidy) provisions are each tied to “income.” The legislative language defines household income (which may be that of an individual or several family members) to be “modified adjusted gross income.” Adjusted gross income is that normally reported at the foot of the first page of a Form 1040, before subtraction of personal exemptions; the modifications add non-taxable interest and excluded foreign income to this number. Thus, “income” may be more or less than paycheck earnings.

Taxpayer versus Individual versus Family versus Household

Although income is derived from tax return data and therefore may relate to multiple household members, the penalty for non-compliance is applied per individual. The reform legislation uses all of the following terms: taxpayer, household, family, and individual, creating potential problems of interpretation, for example, where multiple returns are filed within a single household. Although penalties apply to individuals, they must be paid as part of a tax return, raising questions of taxpayer responsibility for other household members.

Percentage versus Fixed dollar Penalty

The penalty is the greater of a fixed dollar amount or a percentage of income above the filing threshold. An individual’s taxable income is the household income divided by the number of household members, as reported on the tax return. The fixed dollar penalty is set at $95 in 2014, $325 in 2015, $695 in 2016, and indexed to inflation thereafter (but with the amount halved for under-18-year-olds, and capped for a family at 300 percent of the individual amount). The percentage of income penalty goes up less rapidly than the fixed dollar amount, from 1 percent in 2014, to 2 percent in 2015, and to 2.5 percent in 2016 and after, and is capped at the national average premium for Bronze coverage.

Low Income Exclusions

Individuals in households with income below the tax filing threshold are excluded from the minimum essential coverage requirement.

Also excluded are individuals whose “required contribution” exceeds 8 percent of the individual’s household income. Where employer-sponsored coverage is available, the required contribution is the amount the employee would have to contribute. Otherwise, the required contribution is the premium for the lowest cost Bronze plan available, less the premium credit that would have been available had coverage been purchased. However, the premium credit effect means there are likely to be few, if any, families for whom their required contribution would exceed 8 percent of income.

Premium Credit Calculation

Premium credits, paid directly to insurers by the Treasury, are offered to those with incomes below 400 percent of Federal Poverty Level and without other coverage options, and also to individuals eligible for employer-sponsored coverage where the coverage is below 60 percent actuarial value or the employee premium share exceeds 9.5 percent of income. The credit is the lesser of the actual premium and the amount by which the second lowest exchange Silver plan premium exceeds a defined percentage of family income. The percentage is tied to the ratio between family income premium and applicable FPL.

Cost-Sharing Subsidy

In addition to premium credits, the legislation provides for subsidies of cost-sharing. However, unlike the premium credits, the cost-sharing subsidy is available only to those actually enrolled in Silver plans. The subsidy is calculated on a sliding scale from one-third to two-thirds of the out-of-pocket limit, depending on income relative to FPL.

Effect of Non-Payment of Penalty

The legislation requires that the penalty, if any, be reported on federal income tax returns, and paid at tax filing time. However, individuals who fail to pay the penalty will not be subject to criminal penalties, liens, or levies.

Premium Payment versus Penalty Trade-offs: Revising the Conclusions of the Kaiser Health News Article

Based on the preceding discussion, it is apparent that the KHN piece overstates the percentage-of-income penalties; these are applied to income in excess of the filing threshold, not just to income. More significantly, the KHN piece fails to recognize that although the premium credit calculation is based on the cost of Silver coverage, people will be able to purchase Bronze coverage (or even, if eligible, catastrophic coverage) and receive the same credit.

Three examples, reflecting the distribution of the currently uninsured (assumed to be those most likely to choose to pay a penalty rather than purchase coverage) show the combined effects. The premiums and credits shown are based on Kaiser Family Foundation’s Health Reform Subsidy Calculator, with premium estimates reduced to reflect lower actuarial values of Bronze and catastrophic coverage. The penalties are calculated at the 2016 rate, and the mainland FPL schedule is assumed.

Example 1: A young adult with $25,000 income could have “catastophic” coverage for an estimated premium of $2,500, offset by a $1,664 credit for a net premium of $836–compared with a potential penalty of $695.

Example 2: A family of four with two children under 18 and $55,000 income could have Bronze coverage for an estimated premium of $9,500, offset by a $6,969 credit for a net premium of $2,531–compared with a potential penalty of $2,085.

Example 3: A family of four with two children under 18 but with $85,000 income could have Bronze coverage for an estimated premium of $9,500, offset by a $3,029 credit for a net premium of $6,471–compared with a potential penalty of $2,085.

Of the approximately half of the currently uninsured who will not be eligible for Medicaid or CHIP under reform, some 20 percent are young adults who will be able to choose catastrophic coverage for little more than the potential penalty cost. Approximately 50 percent are in the 133-250 percent of FPL range, where a family earning $55,000 would be typical and could purchase Bronze coverage for a few hundred dollars above the penalty rate. Approximately 25 percent are in the 250-400 percent of FPL range, and would face premiums several thousand dollars more than the non-compliance penalties. The 20-25 percent above 400 percent of FPL will face even larger premiums or penalties. (Percentages do not total to 100 because the young adults are also counted in the other groups.)

Based on these estimates, it appears that a substantial majority of the non-Medicaid-eligible uninsured should find subsidized coverage attractive, especially as the penalties increase from 2014’s minimal levels. Only for incomes above 250 percent of FPL does the penalty begin to be significantly less costly than buying Bronze coverage, and at these levels families may have rather more disposable income.

The conclusion? Although there will undoubtedly be those who choose the risk of penalties over the cost of coverage, and while there will certainly be regional variations in premium costs relative to penalties, it seems inappropriate to conclude that the individual mandate will be ineffective if it is found to be constitutional.

Roger Collier was formerly CEO of a national health care consulting firm. His experience includes the design and implementation of innovative health care programs for HMOs, health insurers, and state and federal agencies.  He is editor of Health Care REFORM UPDATE.

2 replies »

  1. I see the idea behind having everyone pay for some kind of health insurance. It is a great idea, but I think it will be as effective as requiring everyone to have car insurance. Many will go without it and it will go unnoticed for a while until an accident happens or in this case a medical emergency happens. Unless there are extra funds focused on enforcing this, I just don’t see this going far. Especially since there are no consequences for not paying the penalty. Those struggling with funds will most likely choose to go without insurance and will also choose not to pay the expensive penalty.