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Health Insurance Prices

Two events occurred this week which got me to thinking about health insurance prices.  One was that, by chance, I saw a film clip of Barack Obama campaigning for election, promising that if his health insurance ideas were implemented, health insurance for families would decline by $2500 per year (here is a link to a Youtube video of these claims). Second, the November 2012 issue of Consumer Reports arrived and, in this issue, there is an article about the changes to health insurance that will be brought about by Obamacare. This article lays out the changes to health insurance that have already occurred and those that will occur in the future as a result of Obamacare. Both of these events suggest the need to use economic theory to decide if health insurance will get cheaper or more expensive and they suggest the need to get some empirical evidence on health insurance policy prices.

First to the empirical evidence. The Kaiser Family Foundation regularly conducts surveys of the cost of health insurance. A summary of their most recent findings is that in 2012, insurance for a single individual averages $5429 and family coverage averages $15073. These figures reflect increases of 3% and 4% respectively over their levels in 2011. But the more remarkable finding is that family coverage has increased by 97% since 2002. There is no evidence that I can find in the latest survey indicating a decline in health insurance prices. Since 2002, the price of health insurance has risen faster than wages and prices measured over the same time period.

One might respond to this evidence by saying that most of the changes to health insurance have not yet been implemented so that this empirical evidence is misleading. That is not an unfair point so we might ask what changes have yet to occur and what will these future changes do to the price of health insurance? The Consumer Reports issue lists the changes that will occur in 2014. They include: guaranteed issue, and an inability to price health insurance on the basis of health.

I have written previously that guaranteed issue will raise the price of health insurance because of the possibility of adverse selection (see An Analysis of Obamacare Part I: Guaranteed Issue). But the inability to price health risk will also raise the price of health insurance as a simple example will illustrate.

The crucial feature of insurance markets is what economists call asymmetric information. When someone applies for health insurance, the buyer knows his or her health condition but the insurance company does not. This explains why insurance companies would require health examinations, a form of screening designed to establish the health condition of the buyer. There is no point to screening applicants if you can’t price the risks inherent in the buyer. If you were running an insurance company, what would you do?

You could price insurance as though all buyers were good risks but what if the buyers are bad risks? You risk bankruptcy if you do this. Thus the safe strategy is to price all health insurance policies as though the buyers are bad risks. That is the safest strategy that the insurance company can pursue. Thus by preventing health risk screening, good risks will pay prices as though they are bad risks. Thus averaging across individuals, health insurance prices will be higher than otherwise.

Overall, one would need to conclude that the promises of Barack Obama will not materialize. Health insurance has not declined in price and there is no reason to think that it will in the future.

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Economics One

A blog by John B. Taylor

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