Defining an effective individual mandate

What follows is excerpted from the recent healthcare reform briefing paper, “Adverse selection and the individual mandate”:

Proposals for individual mandates usually incorporate an incentive (a carrot) to purchase coverage and a penalty (a stick) for not purchasing coverage.

  • The carrot is a subsidy, voucher, or other financial mechanism to help make insurance more affordable and put uninsured people of limited means in a position where the cost/benefit decision bears a more realistic relationship to their respective income levels. This would reduce the cost component of the cost/benefit decision described above, and thereby encourage more people to purchase health insurance.
  • The stick is a financial penalty of some sort on individuals who fail to purchase coverage. This changes the cost/benefit decision in that it makes the alternative to purchasing health insurance more expensive and therefore less attractive financially.

The strength or weakness in any mandate lies in the level at which these incentives and penalties are set. For example, an insufficient subsidy for healthy but lower-income individuals, even if paired with a tax penalty, may not be enough of an incentive, especially if the tax penalty doesn’t create an imperative to purchase insurance.

This delicate balance is overlaid with pricing considerations. If the pricing of the insurance, even after a subsidy and considering the consequences of any penalty, remains too expensive relative to an individual’s perception of its value, then he or she is unlikely to buy it. For example, if too much of the cost under a legislatively restricted rating structure is shifted off of higher-risk individuals (who presumably would place great value on it) onto younger/lower-risk people (who may not), then those healthier people may be willing to suffer the consequences of a penalty rather than paying the price to buy insurance. This may be a sound, rational decision for the individuals involved, but the absence of such individuals from the insurance pool will push the pool’s costs upward for others who do purchase coverage. A delicate balance must be struck.

A weak coverage mandate that does little to incentivize healthy lives to buy insurance will result in adverse selection, leading to a market environment that has the same fundamental problem that exists currently. Except that, in the post-reform world, carriers will not have the tools available to them to manage this risk—and so sicker, more costly individuals will be entering the insurance pool, while the healthier and less costly people are more likely to remain uninsured. The end result if this occurs: higher health insurance costs. 

Click here to see the full paper.

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