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Under the new law, which will be phased in over the next four years or so, insurance companies are not allowed to deny coverage of pre-existing conditions. For the parents of autistic children, individuals with diabetes, chronic heart disease patients, etc., this is great news. For everyone else, this is, quite frankly, not so great news. But this isn’t a post about how unfair it is that I will soon be forced to purchase insurance, which I may or may not want, that will cover the costs of others at added cost to myself. It’s unfair; that’s a fact, and that’s okay. First of all, “fairness” is a question of morality, and I’m a positive economist, so I don’t concern myself with the moral implications of policies, just the economic implications. Secondly, it’s not as unfair as many people may think: good health has positive externalities, and I benefit (directly or indirectly) from the fact that the parents of an autistic child no longer have to spend copious amounts on behavioral therapy. They’re happier and more productive and the child is guaranteed treatment and will likely develop better and has a better shot at becoming a productive member of society; both of these things benefit me, so I’m okay shelling out a few extra bucks because I know the economy as a whole (including me) will be better off in the long run. Even still, that’s not the point. The point is that, in a round-about sort of way, this is one of the dumbest things I’ve ever heard of.
But before you write me off as some bitter tea-partier, hear me out.

The Oxford English Dictionary (OED) on my computer defines insurance generally as, “a thing providing protection against a possible eventuality.” There’s one key word there: possible. The purpose of insurance is to distribute the risk of some cost being incurred. We purchase home-owner’s insurance and pay a premium so that if we should be robbed, we will be compensated for our losses. In the meantime, the premiums we pay go to compensate others for their losses. In their simplest form, insurance pools are a group of people who all pay into a pot with the expectation that if some event happens to someone, that person will be allowed to take some money from the pot; everyone hopes that they never have to take from the pot, but know that’s an unrealistic expectation, so they distribute the risk of some bad event happening amongst everyone. Barring some catastrophic event, people should pay less in premiums over the course of their lifetimes than they would expect to pay if that bad event happened.

In the ideal case of health insurance, I know that I have probability p of getting some disease that costs $x to treat, so I pay a premium of p*x (plus some percent for administration costs) so that if and when I get that disease I’ll have already paid for the treatment and not get hit with an unpayable sum all at one time. If I get enough people together, we can further spread the risk (not only risk for each year, but risk for each person) and lower overall costs for everyone and life is happy.

This is not the case with pre-existing conditions. In this case, p=1, you have the condition. So buying insurance to cover the costs of diabetes is non-sensical because you’re no longer spreading out the “risk of incurring costs from diabetes”; there is no risk, just certainty, that you will need insulin. So forcing insurance companies to cover pre-existing conditions goes completely contrary to the purpose of insurance.

Once again, I’m not a crazy tea-partier, I’m just looking at definitions and fundamentals. All this being said, it is not the law that is broken: they did (roughly) what they needed to right now given the system. Instead, the system is broken (and the law does nothing to change it, that’s the job of future laws). Health insurance, due to the astronomically high prices of getting sick (x in our previous model), has ceased to spread out risk, and has begun to spread out costs. Once again, this a moral issue that I would rather not discuss; I’m just saying how things are, not how they ought to be. If we want a system that spreads costs rather than risks, okay, but calling it insurance is a misnomer.

The purpose of risk distribution is so you will end up paying less for treatment overall than you would if purchased that treatment without insurance. If you end up not needing treatment, then you’ve still paid into the system, subsidizing the cost for those who do need it, and getting peace of mind that “if I need it, I can get it.” Overall, costs are reduced, and people are happy.
The problem with cost distribution is that it doesn’t do this. Everyone will still pay the same amount overall. It will be spread out over time, but in that case insurance becomes nothing more than a piggy bank that you put your premiums in while you’re healthy and bust open when you get sick, the overall cost is still the same. If people are worried about excessively high costs (which I’m not denying), then this isn’t going to solve the problem.

Granted, there still is an element of risk distribution in addition to cost distribution, but that doesn’t change the fact that distributing costs is not going to drive down costs over the course of one’s lifetime.

Notwithstanding the historical significance of this law, to say this law is going to change anything 10 years down the road is, quite frankly, naive. All it does is change the operational definition of “insurance.” Absolutely, it will help people in the short run. But at best it will get things under control just long enough to do an actual overhaul of the system. If this law is not followed up with a more comprehensive overhaul, the system will go bankrupt. To use a medical analogy, it’s a tourniquet that will stem the bleeding, but if we don’t do something to fix the wound, the the limb is going to fall off.

The tattooed economist sends his love

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