I want to show how Obamacare includes a hidden subsidy for the middle class.
It’s a feature of any insurance system with an individual mandate and government subsidies. The government pays full freight for the poor person’s insurance, but some of that subsidy ends up lowering costs for wealthier people.
Here’s an example of how it works. I’ve taken an extreme case and not tried to tailor it to all the complexities of Obamacare, which would make the matter too hard to follow.
We have two people, identical in all but two aspects. One is the Healthy Guy, but he can’t afford insurance. This person’s expected health costs are $1,600 for the year, as you can see in column A. The other person is the Wealthy Guy. He can afford insurance but is not in such good physical shape. His expected health costs are $5,000 per year.
Column B shows what the two parties should pay in an unregulated world, assuming an 80% loss ratio and perfect underwriting. Healthy Guy would pay $2,000, reflecting his fine physical condition. Wealthy Guy would pay $6,250. The total of the two is how much the insurance industry would have to charge to insure both – $8,250.
Wealthy buys the insurance. Healthy doesn’t have the $2,000, so he goes bare.
But Obamacare has two features – the individual mandate and community rating. The mandate says Healthy has to buy insurance. Community rating says, in essence, you can’t discriminate because of pre-existing conditions.
Column C shows how much these two would be charged – the same amount. And that amount would have to be enough to cover the total expected cost, $8,250. So each would be charged $4,125.
Well, if Healthy didn’t have $2,000, he sure won’t have $4,125. He’d rather not buy insurance. But that’s where the mandate comes in. He has to buy it. If he doesn’t buy it, the insurance company has been roped into covering $5,000 of losses for $4,125.
But if he doesn’t have the money, how can he buy it? Well, the government pays for it. That’s what Column D shows. The insurer gets a check from the U.S. government for $4,125 to pay for the Healthy Guy’s insurance.
Meanwhile, the Wealthy Guy pays $4,125 for his insurance, and he has gotten a good deal indeed. He paid $4,125 for $6,250 worth of insurance.
The government subsidy of $4,125 went entirely to the impoverished Healthy person, but the benefit of that subsidy was split between Healthy and Wealthy. Column E shows how the benefit was split. The Healthy Guy got $2,000 of insurance, for which the government paid $4,125. The difference, $2,125, is how much the Wealthy Guy’s rate fell because the Healthy Guy was in the individual market.
Column F sums things up on a percentage basis. The government paid 100% of Healthy’s insurance, but the Wealthy Guy got a break, too – a 34% discount. In fact, in this example, the Wealthy Guy got a bigger subsidy in dollar terms ($2,125) than the Healthy Guy ($2,000).
And Wealthy doesn’t even know it. He probably doesn’t know his own expected costs, and he certainly doesn’t know the expected cost of the Healthy Guy. If he thinks about the Healthy Guy at all, it’s probably to grumble about the good fortune of a Guy who gets a free ride from the government. But both parties benefited, even though it doesn’t seem that way at a glance.
Notice that this system works only because you have:
- An individual mandate.
- Government subsidies.
- Community rating.
Were there no mandate, Healthy Guy would remain out of the market, and Wealthy Guy’s premium would jump back to $6,250.
Were there no government subsidy, the mandate would be a joke for Healthy Guy. He’d simply stay out of the market. Wealthy Guy would still pay $4,125 for insurance, but the insurer would incur $5,000 of losses – clearly an unsustainable situation.
Were there no community rating, the government would simply pay Healthy Guy’s $2,000 premium, and Wealthy Guy’s premium would be $6,250.
Now I’ve created a simplified example here to make the point. The difference in expected costs between the insured and uninsured isn’t this generally this great. And the subsidy is not 100% – it’s a sliding scale going up to 400% of the poverty level. I’m not pretending that Obamacare will bring anyone’s premium down 34%.
However, the general analysis holds as long as the uninsured have lower expected losses than the insured. And adverse selection practically guarantees that to be the case.
Now obviously the government’s contribution doesn’t come from the Money Tree in Dad’s Backyard. In this two-person universe, wealthy probably pays most, if not all of the $4,125 in taxes that the government pays out.
Let’s assume all the money comes from the Wealthy Guy. First, in our example, he gets more than half of it back. With the remainder, he has purchased a moral good for $2,000.
He has also stabilized the health insurance market, which was until recently an important bipartisan goal in the health care debate. Recall the number of uninsured rose 20% in the past decade, and every year another million Americans lose their insurance. Nothing in our old system addressed that problem well.