facts are stubborn things

The one great thing about Obamacare is that it is a beautiful illustration of economics in action. With most things in this world, it is very hard to discern cause and effect from just what is visible. I am reminded of William Easterly’s The Elusive Quest for Growth in which he recounts an instance in which he correctly predicted a decrease in growth of “the Gang of Four”, not based on policies, but because that was where growth was highest and was thus bound to decrease.

But Obamacare is a different animal. It is a wide-sweeping piece of legislation that affects all health care in an economy of 300 million people. It institutes a host of policies that economists have claimed as being harmful: mandatory coverage, limits on deducible, no limits on preexisting conditions. In fact, Obamacare takes the “insurance” out of “health insurance”. The effects of Obamacare were predictable and widely predicted.

Regular insurance works by people who are subject to risk paying a fraction of the price of covering loses incurred during an unpredictable event. I will use “flooding” as an example. Not everyone will have their houses flooded. But although the risk is small, the damages can be massive. People might be willing to pay a sum of money per month (the premium) to cover their house. This premium will be priced based on risk. Their house may or may not flood, but their premium is pooled and will cover any house that does flood in the same insurance pool. Insurance only works if enough people are willing to pay a slight cost to cover the risk of an event, the total sum of which covers the people that actually have to pay the full cost of that event when it occurs. The premium must also cover administrative costs.

There is no such thing as insurance for a predictable event. If a house flooded every year, either no insurance would be offered or the cost to the individual over the course of a year would necessarily be greater than the yearly cost of the damage. When Obamacare mandates age triggered screenings, birth control, or regular check-ups, this cost must necessarily be born directly by the contributors. They are no longer paying for risk, but paying for certainty. In other words, they are handing their money to a third party to hand to a doctor. They are procuring a paying agent, not insurance.

If insurance prices are not allowed to be priced based on risk, all incentives to minimize costs fly directly out the window. No one would have incentives to use their own time and money to prevent flooding. They would also issue claims over the most minor water damage because there would be no individual repercussions for issuing such claims. In other words, without price signaling, no one is incentivized to economize and everyone is incentivized to consume. Naturally, as the costs rise due to overconsumption, people with low risk will begin to see that the costs of insurance do not cover the risk of the event. They will drop out of the market.

Politicians have invented a mechanism to force consumers to still buy insurance and cover exuberant consumption. In Obamacare, this is called the individual mandate. People who drop out of the insurance pool are fined. But if the fine is too low comparative to the premium cost, people will opt for the fine over insurance.

Obamacare incentivizes taking this fine because Obamacare mandates that coverage must cover pre-existing conditions. This means that the yearly pool not only has to cover the chance that individuals in the pool have a disaster, it also has to cover people who have not even contributed. These people have paid nothing but show up only after their house floods. This cost must be priced into the premiums paid by the prior insurance contributors. This cost will not be negligible, because all these new entrants will be entering the insurance pool with guaranteed and massive costs. There is no good way for an insurance company to predict what costs they have to price in existing insurance in order to cover these unexpected guaranteed costs. Expect health care firms to compete over how unappealing they can be to new entrants, as every company will want another company to take the new guaranteed costs.

The only real way that Obamacare could reduce premiums is if it coerced enough people to pay more into insurance plans than they ever expect to use. This would be like people who live in Death Valley, California being forced to pay for flood insurance. They will pay into the system, but never withdraw. But with Obamacare there are subsidies for low income individuals (who tend to be healthier). Those meant to support the system become a drain.

The entire Obamacare system is an economics nightmare designed to skyrocket costs. Economics predicts the already apparent effects of Obamacare. Health care plans are being cancelled en masse, premiums are skyrocketing, and health insurers are scaling back coverage. Obamacare is teaching America basic economics. This will also serve as an enduring example of free market predictions being undeniably true, contrasted to the hubris of the statists. Facts are stubborn things.

About christopher fisher

The blog is meant for educational/entertainment purposes. All material can be used and reproduced in any length for any purpose as long as I am cited as the source.
This entry was posted in Econ 101, Economics, Goverment, Price Controls, prices. Bookmark the permalink.

3 Responses to facts are stubborn things

  1. Good post. If Democrats understood basic economics, they wouldn’t be Democrats.

  2. Enlightening post! :-)

  3. Can you explain this part please?: “low income individuals (who tend to be healthier)”

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