Health Insurance Without the Individual Mandate: Can a Three-legged Stool Stand on Two Legs?

The Issue:

The designers of the Affordable Care Act (ACA) — also known as Obamacare — argued that its many pieces fit together tightly, and the success of the whole law depends upon the maintenance of the individual parts. One key element, the individual mandate — a requirement that Americans obtain insurance coverage or pay a tax-based penalty — was effectively repealed with the Tax Cuts and Jobs Act of 2017, which set the penalty to zero. This repeal becomes effective in 2019 causing us to ponder to what extent the absence of a tax penalty will lead to higher premiums and to an increase in the uninsured.

New thinking is giving greater importance to the role of premium tax credits in keeping the individual insurance market functioning.

The Facts:

• The Affordable Care Act, one of the most sweeping, and largest, pieces of legislation of the Obama era, and the subject of much political debate, represents an effort to attain universal health insurance coverage for Americans. The share of the nonelderly population who lacked health insurance fell from about 17 percent in 2010 (the year the ACA was signed into law) to about 9 percent in 2016, meaning roughly 20 million fewer Americans were uninsured (see here). The reforms introduced by the ACA touched on many aspects of health care coverage including expansions of Medicaid eligibility, changes to Medicare, and changes to individual insurance markets.
• The individual market is where people seek coverage if they don’t receive an offer of employer-sponsored insurance and are ineligible for government provided insurance such as Medicare or Medicaid. While the individual insurance market offers coverage to a comparatively small share of the population — about 7 percent in 2016 compared with 49 percent for employer-provided health insurance and 35 percent for public sources of coverage — many of the provisions of the ACA focused on this segment. (It’s called the individual insurance market because employer sponsored insurance is purchased for groups of employees.) Prior to the Affordable Care Act, many observers worried that the individual insurance market did not work well. People looking for coverage often had to undergo physical exams so insurers could assess their health status. If they had preexisting conditions (such as asthma, diabetes, or a prior cancer diagnosis), they could be denied coverage or charged very high premiums. A key goal for the ACA was to make health insurance available to all Americans, even if they had pre-existing conditions.
• The ACA included three main sets of provisions to expand access to health insurance coverage through the individual market. They included regulations to make it easier for people with pre-existing conditions to acquire insurance, measures to draw in healthy people to keep rates from skyrocketing, and subsidies to help those for whom coverage was too expensive. Collectively, these provisions became known as a three-legged stool, because people believed the individual market could collapse without any one of them. To make it easier for people to acquire health insurance, regardless of their current health status, the reforms introduced guaranteed issue, which established that insurers must sell insurance to anyone willing to pay — they cannot deny coverage because of health. Additional regulations required that insurers use community rating to determine premiums for all applicants of the same age and location based only on community-level factors. They cannot charge more to people with preexisting conditions (although premiums do vary by age and tobacco use).
• But guaranteed issue and community rating regulations can potentially create as many economic efficiency problems as they solve. If healthy people have to pay the same price as unhealthy people, then healthy people might not want to buy insurance coverage. When a disproportionate share of unhealthy people have insurance, the pool of insured people is said to be “adversely selected.” One consequence of adverse selection is that premiums might increase — if only people with preexisting conditions end up with coverage, then insurers will have to charge high premiums to stay in business. Another consequence is that coverage generosity might decline. Insurers want to enroll healthy people, and one way they can do so is by offering low-premium, low-benefit plans, which would appeal less to unhealthy folks. Indeed, there is evidence of these types of unintended consequences from the 1990s, when many states experimented with guaranteed issue and community rating regulations. These reforms appear to have reduced insurance coverage and insurance generosity.
• To avoid these adverse selection problems, the ACA included a second leg of the stool: the individual mandate, which requires that Americans obtain insurance coverage or pay a tax penalty. The idea behind the mandate is that if healthy people have to pay a penalty for going without coverage, they may be willing to be covered at a higher price than they were initially willing to pay — the same premium as unhealthy people pay, thereby averting adverse selection. (While the intent of the law was to keep healthy people among the insured population, everyone is subject to the tax penalty, so in practice it could also mean that more people with adverse health conditions acquire insurance.) The ACA’s mandate — along with many of its other features — was based closely on the Massachusetts model, which also enacted an individual mandate. Research has found that the individual mandate was effective in Massachusetts: it increased coverage, and the brought in relatively healthy people, with relatively low health care spending. Still, the individual mandate was one of the most contentious elements of the ACA. Supporters argue that it is a critical tool for achieving universal health insurance coverage and reducing adverse selection. Opponents of the individual mandate view it as an unreasonable assault on liberty, an encroachment of government authority, and, potentially, an onerous burden on low-income Americans. For 2018, the ACA mandate penalty was about $58 per uninsured person per month (and larger for higher income households — see here). For 2019, the mandate penalty was set to zero by the 2017 Tax Cuts and Jobs Act, effectively repealing it.
• Finally, a coverage mandate could be unfair to low income Americans, if it is difficult for them to afford insurance coverage. A third provision of the Affordable Care Act addressed this concern: the premium tax credit, which offsets the cost of insurance purchased through the Health Insurance Marketplaces. The premium tax credit is designed to place a cap on the maximum amount an American has to pay for insurance coverage. For example, an American family with income equal to 200 percent of the poverty line faces a cap of about 6.5 percent of their income, or about $125 dollars per month for a single-person family. If the actual premium exceeds this amount, then the premium tax credit covers the difference. Eligibility for the premium tax credits only extends up to 400 percent of the poverty line, about $100,000 for a family of four.
• Importantly, the premium tax credit covers the difference between a family’s expected contribution and its actual premium regardless of how high the actual premium is – if premiums rise, then so does the premium tax credit. For example, a 40 year-old in 2017 faced an average premium of $359. If her income were at 200 percent of the poverty line, she would get a tax credit for $234 per month. In 2018, premiums rose by $132 to $481, so her tax credit would rise by the same amount, to $356. In both years she would have to pay the same $125 per month (see here for average premiums).
• Recent economic research has examined the validity of the three-legged stool metaphor. Is each leg equally important? Or could the stool stand without one? New thinking is giving greater importance to the role of the tax credits in keeping the market functioning. For one thing, the dollar value of the premium tax credit is vastly larger than the mandate penalty. In our example above, the subsidy from the premium tax credit is about 6 times larger than the mandate penalty. Moreover, economists have found that the premium tax credit played a much more important role than the mandate penalty in explaining the declines in the uninsured population following the passage of the Affordable Care Act. (Presumably, this would imply that elimination of the mandate would have a similarly smaller-sized role). And research suggests that, while a greater mandate penalty causes more people to obtain insurance coverage, the effect is not very strong. This evidence suggests that, at current insurance premiums, mandate repeal might not have an enormous effect on coverage in the individual insurance market. But will premiums rise? One might expect that mandate repeal could lead to an adverse selection “death spiral” as healthy people (no longer facing a mandate) drop coverage, leading to higher premiums and further coverage losses.  But this is unlikely, because of the premium tax credit, which rises dollar-for-dollar with premiums. What this means is that even if some people drop coverage and list prices increase, many remaining enrollees won’t actually see a premium increase, because their tax credit will rise to the cover the difference. In 2017, tax credits went to about 62 percent of the 13 million people enrolled in the individual insurance market, according to a 2018 government report. This represented an estimated yearly total cost of $57 billion in national tax expenditures (see here).