Health Insurance and Markets for Lemons
http://www.nytimes.com/2016/11/15/upshot/why-keeping-only-the-popular-parts-of-obamacare-wont-work.html?rref=collection%2Fsectioncollection%2Fupshot&action=click&contentCollection=upshot®ion=stream&module=stream_unit&version=latest&contentPlacement=38&pgtype=sectionfront
President-elect, Donald Trump has not had kind words for the Obama Administration’s signature legislation, the Affordable Care Act. He has vowed to repeal it and replace it, but he also said he would like to save one of the most popular parts of the law, the part that forbids insurers from declining to sell you insurance because of a pre-existing health condition. However, according to this New York Times article, it may be very hard to keep that provision and hold down costs without also keeping the individual mandate to buy insurance, one of the law’s least popular provisions and something many republicans consider an overreach of government power. The reason for this can be explained with concepts from class related to the Markets for Lemons where one party has more information than the other.
Let’s assume that the Affordable Health Care Act worked perfectly and every one, sick and healthy, bought health insurance. In this model we can assume sick people make up 25% of the population and healthy people make up 75% of the population and that the relative values of insurance for both types of peoples are shown below.
| Value to Buyer | Cost to Insurer | |
| Healthy | 7 | 5 |
| Sick | 15 | 12 |
Because insurers are not allowed to exclude sick people, they don’t know where a person seeking insurance is sick or healthy so there expected cost is .75(5) + .25(12)= 6.75.
If the insurer offers insurance at price 6.75 it will still be affordable enough for healthy people to buy(6.75<7) and it will obviously be affordable for sick people. Thus, everyone will buy insurance, which is the goal of the law.
On the other hand, let’s do another model of a possible Trump Health Care plan, which we assume for simplicity is identical to the current ACA, except there is no individual mandate. Without a mandate, a certain segment of healthy people simply don’t buy insurance, even though it is priced affordably, because these people know that under the law, they will still be able to buy insurance if they ever become sick. Now the market of people looking to buy insurance is 50% healthy and 50% sick, because so many of the healthy people will not buy insurance no matter the price. Assuming the costs of insurance remain the same, an insurer will now have an expected cost of .5(5) + .5(12)= 8.5. If they offer insurance at this price, no healthy people will sign up because it is too expensive (8.5>7). This means that insurers will quickly have to raise their price up to 12, because they will only be insuring sick people.
This scenario, where insurance is so expensive only sick people buy it, is what the article found happened in New York State when they outlawed denying insurance to those with a pre-existing condition without also implementing an individual mandate. Although the situation in the second model is a stable Nash Equilibrium, it does not accomplish the basic goal of health care reform: increasing the number of insured Americans.
The differences between the first model (NE: everyone buys insurance) and the second model (NE: only sick people buy insurance) demonstrate why the individual mandate is necessary, despite its unpopularity, if the president elect wants to save the most popular part of health care reform and keep costs affordable.