President Trump and Obamacare
Healthcare reformers, like the wives of King Henry the 8th, have a thankless job. In a curious inversion of the Tudors, President Trump, who has promised to make healthcare great again, finds himself in the same predicament as the King’s sixth wife who knew what she had to do, just didn’t know how she could do it any differently. Dr. Mark V. Pauly (MVP), Professor of Economics at the University of Pennsylvania, believes President Trump’s options are neither exhaustive, nor exhausted.
SJ: I’m quoting from your book Healthcare Reform without side effects “with community rating…doors are open for political and special interests to lobby…Imagination will be stifled…political rent seeking will be rampant.” When I read this paragraph I checked the publication date of your book. It was not 2016. It was 2008 – before the passage of the ACA.
MVP: Unfortunately, the book wasn’t published soon enough before the ACA.
SJ: What, in a nutshell, is the problem with the ACA?
MVP: The nucleus of the problem, from which all other problems arises, is community rating. This is why the premiums have risen so much. This is what is hurting the middle class. We’re hurting many more people financially to help a few. Insurance has been politicized. Furthermore, to control the premiums insurers have limited the network. This means that the healthy are paying higher premiums, with more restrictions, than they might have if there was no interference in the market.
SJ: So, what happened is that the government which robbed (low-risk) Peter to help (high-risk) Paul lost the support of Peter.
MVP: The problem is beyond that. While the ACA has a provision where insurers enrolling higher risk get money from insurers enrolling the lower risk, the formula is not exact. This, and the fact that insurers are constrained by the amount they can charge, the thing that I feared the most happened.
SJ: Insurers abandoning the exchange?
MVP: That’s right. And this destabilizes the individual market more than anything.
SJ: What are the attributes you like about the ACA?
MVP: I like many things about the ACA. I support the subsidies.
Subsidizing the premiums of the low-income is important because subsidies increase the chances that people buy insurance, lower the administrative costs of the insurer and reduce their motivation to risk rate. Subsidies, by lowering the premiums, increase the expected value of insurance for a given level of risk aversion, increasing the quantity of insurance purchased. When the insurer sells more insurance, the selling costs of insurance decrease. Lowering the premium lowers the cost of persuading people to buy insurance. The best way to persuade people to buy insurance is to make the premiums cheaper.
Now, given that the insurer is selling more insurance, the insurer is less motivated to risk rate – part of the motivation for risk rating is that the insurer does not have enough people buying insurance. When the quantity of insurance sold increases, the added value of risk rating diminishes.
Also, and this seems counterintuitive at first, subsidies can, after a while, negate the need for subsidies by reducing the administrative costs which reduce the premiums further, which reduces the very need for subsidies. I once calculated that a 5 % subsidy, which increases the percentage buying insurance from 20 % to 80 % can reduce the administrative loading (as a percentage of premiums) from 30 % to 10 %.
SJ: That’s a beautiful example how a government intervention can drive the market and the intervention need only be temporary. In a sense, this is the opposite of a death spiral – subsidies are an immortality spiral for insurance.
Do you favor the individual mandate?
MVP: I do favor a mandate, which SCOTUS calls a “tax”, on the moderate-income low-risk. While lower premiums will entice more people to buy insurance, there will always be people, the young invincibles, or free riders, who will be disinclined to buy insurance at any price. Sufficiently large penalties targeted at the right income group can be valuable.
In summary, subsidies for the low-income average risk; penalties for the high-income average-risk; and subsidies for the high-risk, and guaranteed renewability to prevent reclassification risk, would be my prescription.
SJ: People like low premium insurance, such as high deductible insurance with catastrophic coverage, until they have to pay the deductible. What role does a high deductible have in reducing premiums?
MVP: People will never be happy with insurance all the time. As Kenneth Arrow explained, high deductibles reduce the administrative loading of insurance. It is easy to see why. High deductibles reduce the administrative time and cost processing small claims, reducing the administrative loading and reducing the premiums.
Sure, the person who pays the deductible will be unhappy. But this is balanced by several others whose premiums are lowered and who have more money in their pockets. As with much of healthcare, deductibles are a tradeoff. We hear about the unhappy Paul who is paying the deductible. We don’t hear about the happy Peters who have more money in their pockets to spend on a vacation, or whatever else takes their fancy.
SJ: What does “competing between insurers” even mean? What can they compete about?
MVP: That’s a good question. There is certainly some, though not much, fat to trim. The profit margins aren’t as much as people think. For-profit health insurers earned a pretax return on equity in 2008 of 8 % – 11 % – not a lot by the standards of other industries. Cutting profits in half, though politically popular, would barely touch premiums.
Healthcare can be made a little cheaper if people are willing to sacrifice some care, but the costs in the long run can’t be reduced much. Solutions such as squeezing the wages of doctors and nurses only redistribute welfare, and do not lower real resource cost, and are frustratingly temporary.
SJ: Will competition across state lines reduce premiums?
MVP: I doubt it. But I don’t think it’ll be a race to the bottom as some of my colleagues on the left fear. There is no harm in trying. It may make a difference in a heavily regulated state such as California. I doubt it’ll make much difference in Pennsylvania.
SJ: So, intrastate competition ought to be sufficient and interstate competition will add little. Do you think health savings accounts (HSAs) will make a difference and should be encouraged?
MVP: My view of HSAs is the same as my view of tattoos. Some people like them. Those who like them should get them.
SJ: As insurance works by the law of large numbers is it not inevitable that only large insurers will survive in either the individual market or ESI, and that healthcare will be an oligopoly of either large insurers or self-insuring healthcare systems such as Kaiser?
MVP: No, it’s not inevitable at all. The law of large numbers does apply but the optimal large number to pool risk is around 50, 000.
SJ: So, we will not necessarily be Kaisered?
MVP: No, there’s no reason we will be Kaisered, Blued or Aetnaed. A local mutual is good enough to provide insurance. A related point is the barrier for new entrants in the insurance market. It is not the market power and concentration of a dominant insurer, such as the Blues, per se. Rather, it comes from a dominant insurer’s provider network and/ or management tools, which new entrants find hard to duplicate.
SJ: Do you favor a single payer?
MVP: The U.S. is not Sweden. Americans are different. Americans have choices and preferences about their health insurance and healthcare and these preferences are not the same. If everyone had the same preference even an incompetent government would solve our problems. The reason markets exist is because preferences are heterogeneous.
SJ: Who has influenced you the most?
MVP: My PhD thesis adviser, and Nobel prize winner, James Buchannan. Also, Victor Fuchs, who was the first real health economist.
SJ: Do you believe medical care is a right?
MVP: People talk about the right to medical care, but they do not say how much is rightful or how it should be produced and paid for. Let me answer the question differently. Watching your neighbor suffer is a negative externality, and we want to avoid negative externalities and encourage positive externalities. Access to medical care in a country as affluent as the U.S. is neither a right nor a privilege but a moral obligation. Even President Trump recognizes that. The question is what is the optimum combination of government and market which gives most access to medical care to most people most equitably.
SJ: In the raging debate between Keynes and Hayek, who do you side with?
MVP: Neither. That (macroeconomics) is all black magic.
SJ: William Baumol in the Cost Disease believes that medical care can occupy even larger chunk of the GDP without any real problems. Do you agree?
MVP: It’s an interesting question. Some economists say that medical care can consume 30-40 % of the GDP. The point here is not how much of the GDP medical care can or should consume. The point, from welfare economics, is how it reaches that level of spending. If it is by the voluntary preferences of the people, who consume more medical care because of affluence or risk-aversion, and prefer spending on medical care than other goods and services, I support it. If that level of spending is imposed by fiat, rather than preferences, then it’s not fine. The market is amoral but crucially the market must decide.
SJ: What would you advise President Trump?
MVP: The president should not make promises he can’t keep. He has promised cheap insurance and complete access – you can have one, not both. I’d advise him to stick to the Ryan plan. I’d advise that he minimizes rent-seeking and keeps the hand of regulation light and graceful.
I’d advise that he improves the ACA by making the individual market more robust. He should allow risk rating and think very carefully how to help the high-risk. I’d favor a value-added tax, but general taxation will do. He should maintain guaranteed renewability in the individual market and extend the renewability to the people with employer-sponsored insurance, so that they can be covered if they lose their jobs, or move to new jobs. This will deal with job-lock.
There is no getting around the subsidizing of the high-risk. There is a more efficient way of subsidizing their premiums without discouraging the participation of insurers in the individual market. Strengthening the individual market and undoing the problems created by employer sponsored insurance, will take a long time, but I believe this is the most optimal strategy for health insurance in this country.
SJ: Will the sky fall if Obamacare is replaced?
MVP: The sky can fall if the ACA is repealed without an alternative and replaced without a grace period to a new system. I’d allow at least two years where the provisions of the ACA are kept intact. The sky need not fall.
Speaking to Pauly is not like speaking to an astrologer or a healthcare leader. He does not inspire people to cross the Red Sea. I don’t think Pauly would be good at Tweeting, so thoroughly devoid is he of rhetoric. All one gets with Pauly is reality and more reality, and if he’s pushed, even more reality. It’s hard to pin Pauly to a specific ideology. But healthcare makes graveyards out of ideologies. It is just as well that the economist who thoroughly understands the healthcare system is ideologically-neutral. President Trump would do well to have coffee with Mark Pauly.
About the Author
Saurabh Jha is a radiologist and contributing editor to THCB. He knows far less about economics than he thinks he knows, and he thinks he knows far too little. He can be reached on Twitter @RogueRad