David R. Henderson  

Can Higher Limits of Out-of-Pocket Costs Help Consumers?

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UPDATE BELOW: Avik Roy replies.

I got back from my vacation early Monday morning, a vacation on which I had limited Internet access. That's why I didn't respond to this Avik Roy article earlier. Still, I thought that by the time I got back, someone would have responded to the particular point below. But no one did. Thus this post.

In an article titled "Yet Another White House Obamacare Delay: Out-Of-Pocket Caps Waived Until 2015," Avik Roy writes:

Obamacare contains a blizzard of mandates and regulations that will make health insurance more costly. One of the most significant is its caps on out-of-pocket insurance costs, such as co-pays and deductibles. Section 2707(b) of the Public Health Service Act, as added by Obamacare, requires that "a group health plan and a health insurance issuer offering group or individual health insurance coverage may not establish lifetime limits on the dollar value of benefits for the any participant or beneficiary." Annual limits on cost-sharing are specified by Section 1302(c) of the Affordable Care Act; in addition, starting in 2014, deductibles are limited to $2,000 per year for individual plans, and $4,000 per year for family plans.

There's no such thing as a free lunch. If you ban lifetime limits, and mandate lower deductibles, and cap out-of-pocket costs, premiums have to go up to reflect these changes. And unlike a lot of the "rate shock" problems we've been discussing, these limits apply not only to individually-purchased health insurance, but also to employer-sponsored coverage. (Self-insured employers are exempted.)

These mandates have already had drastic effects on a number of colleges and universities, which offer inexpensive, defined-cap plans to their healthy, youthful students. Premiums at Lenoir-Rhyne University in Hickory, N.C., for example, rose from $245 per student in 2011-2012 to between $2,507 in 2012-2013, forcing the school to drop its coverage requirements. The University of Puget Sound paid $165 per student in 2011-2012; their rates rose to between $1,500 and $2,000 for 2012-2013.

According to the law, the limits on out-of-pocket costs for 2014 were $6,350 for individual policies and $12,700 for family ones. But in February, the Department of Labor published a little-noticed rule delaying the cap until 2015. The delay was described yesterday by Robert Pear in the New York Times.

Notes Pear, "Under the [one-year delay], many group health plans will be able to maintain separate out-of-pocket limits for benefits in 2014. As a result, a consumer may be required to pay $6,350 for doctors' services and hospital care, and an additional $6,350 for prescription drugs under a plan administered by a pharmacy benefit manager."

The reason for the delay? "Federal officials said that many insurers and employers needed more time to comply because they used separate companies to help administer major medical coverage and drug benefits, with separate limits on out-of-pocket costs. In many cases, the companies have separate computer systems that cannot communicate with one another."

The best part in Pear's story is when a "senior administration official" said that "we had to balance the interests of consumers with the concerns of health plan sponsors and carriers...They asked for more time to comply." Exactly how is it in consumers' interests to pay far more for health insurance than they do already?

It's not. Unless you have a serious, chronic condition, in which case you may benefit from the fact that law forces healthy people to subsidize your care. To progressives, this is the holy grail. But for economically rational individuals, it's yet another reason to drop out of the insurance market altogether. For economically rational businesses, it's a reason to self-insure, in order to get out from under these costly mandates.


See the problem? Roy says, correctly, that if you ban lifetime limits and limit out-of-pocket costs, then, all else equal, premiums must rise. But then later in the piece he asks, almost as a rhetorical question, "Exactly how is it in consumers' interests to pay far more for health insurance than they do already?" But consumers wouldn't pay more for health insurance. They would pay less. That's the symmetry implicit in his earlier point. There's a tradeoff between size of out-of-pocket costs and level of premium. Allow those out-of-pocket costs to be higher and the premiums will be lower. And that's why allowing higher out-of-pocket costs is in the interest of at least some consumers.

I'm not defending Obama's legal recklessness here. I am separating the economics from the legal issues. If the out-of-pocket costs are allowed to be higher than the law says, insurance premiums will be lower.

Avik Roy is generally very good on these issues. So it's quite conceivable that I've missed something in his reasoning. I'm ready to learn.

UPDATE: Avik Roy replies as follows:

Thanks for writing about my work and for reaching out.

What your reasoning misses is that the costs to the individual in each scenario depends on the individual's health consumption.

If I'm perfectly healthy, and I only go to the doctor once this year for my annual checkup, I benefit from a low premium and a high deductible (that protects me against getting hit by a bus).

If I have a chronic condition, say multiple sclerosis, and my annual consumption is high, then I benefit from a low deductible and higher premiums.

The problem is that individual #1 is likely to drop out of the market if he's forced to pay far more for insurance than he expects to consume in health care (ie, if he's forced to subsidize individual #2). If he does drop out, you incur an adverse selection death spiral.


I replied:
Thanks. So now I get it. There's a hidden assumption that you didn't make explicit: The people who could gain from higher deductibles are no longer in the market.

To which Avik replied:
I didn't make it explicit because I've discussed the concept so often in my blog, and it's well understood among health economists. It's why Obamacare has an individual mandate, to force the cross subsidization.

He's not thinking on the margin. Some will drop out but the very fact that out-of-pocket costs are allowed to be higher is what will cause fewer to drop out than otherwise. So my point remains: some consumers will gain. And in any case, there's no way he can claim that allowing higher out-of-pocket costs will raise premiums.


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COMMENTS (13 to date)
Barry Soetoro writes:

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Norman Pfyster writes:

Isn't that exactly what he says? The "cost" he is referring to are premiums.

A more interesting question is whether the expected cost ex ante is the same under either scenario. Coase would know.

Elendil writes:

I think it's just a semantic difference. "Out of pocket" costs are not technically costs of health insurance; they are costs of health care. So Avik's rhetorical question ("Exactly how is it in consumers' interests to pay far more for health insurance than they do already?") is factually accurate in its assumption as stated.

David R. Henderson writes:

@Elendil,
"Out of pocket" costs are not technically costs of health insurance; they are costs of health care. So Avik's rhetorical question ("Exactly how is it in consumers' interests to pay far more for health insurance than they do already?") is factually accurate in its assumption as stated.
No, it's not. If out-of-pocket costs are allowed to be higher, then premiums will be lower. That could well be in many consumers' interests.

Ted Levy writes:

David H: "No, it's not. If out-of-pocket costs are allowed to be higher, then premiums will be higher. That could well be in many consumers' interests."

???

Did you mean "No, it's not. If out-of-pocket costs are allowed to be higher, then premiums will be LOWER. That could well be in many consumers' interests.

David R. Henderson writes:

@Ted Levy,
Yes. Thanks. Correction made.

MikeP writes:

Maybe he's referring to the observation that, in such a transition, insurance companies may manage to profit on both ends. The delay may be necessary to avoid everyone losing. But there's no guarantee that in the single-shot strategic game called "2014" consumers, who know so much less than insurers about all this, will make out well.

In other words, Coase doesn't get a chance until 2015.

Hazel Meade writes:

You know, if you wanted to modify ObamaCare in just such a way as to undermine the progressives stated goals of cost-shifting, allowing higher deductibles would be the place to start.

I'm just sayin'.

David R. Henderson writes:

@Hazel Meade,
Exactly. That's what I'm getting at, and that's why I'm surprised that Avik Roy didn't see it.

MingoV writes:

The silver lining to the ObamaCare black cloud is that the left-wingers* who pushed for it have driven away many young adults. Young adults already got shafted by the Social Security and Medicare Ponzi schemes, and soon they'll get shafted by the high premiums they'll pay with ObamaCare. Small government proponents (libertarians and some conservatives) could make inroads among this subpopulation.

*I refuse to call them progressives.

Handle writes:

This seems to be a miscommunication.

1. The "senior administration official" said "we had to balance the interests of consumers with the concerns of health plan sponsors and carriers ... They asked for more time to comply."

I read this as being that the interest of health plan carriers was opposed to the interest of consumers.

So, the SAO is saying that the new laws effects which are to be delayed - higher-premiums with lower caps - are in consumers' interest.

2. Avik Roy then says, "Exactly how is it in consumers' interests to pay far more for health insurance than they do already? It's not. Unless you have a serious, chronic condition"

This is perfectly consistent with the implication of 1. Consumers are split into two groups. Those who expect to pay much less than the old caps ("healthy"), and those who expect to pay close or more ("chronic").

Under the new, lower caps, healthy people will pay the same out-of-pocket, but higher premiums. They expect to be worse off.

Chronic people will be better off since their out-of-pocket costs will be reduced individually, but their premium-rise spread among the whole population.

So, except for chronic people, from the point of view of healthy consumers - the new caps aren't in consumers' interest.

Which is exactly what Avik Roy said - no assumptions about adverse-selection are needed or relevant.

The SAO is trying to get away with a cheap and obvious rhetorical gimmick - by mischaracterizing a Socialization as a 'Defense of Consumers Interests", when the effect is not in most consumers' interest. Again, that's exactly what Roy said.

The progressive policy is a collectivization designed to subsidize the medical costs of the chronically ill by taxing the healthy but doing so through 'insurance regulation' and the mechanism of premiums and maximum out-of-pocket caps instead of explicitly through the tax system.

Tony N writes:

What if capping out-of-pocket costs significantly increases healthcare consumption? (I've avoided the doctor because of the co-pay once or twice myself)

Ultimately, premiums may have to increase more than expected in order to compensate, thus undermining the offsetting symmetry David H is referring to.

Seems as though this could harm all consumers in the long run.

R Richard Schweitzer writes:

Why can't this just be stated simply as:

the transfer of costs?

The previous private contracts of insurance (transfers of risks) have been perverted into public (politically determined) contracts of multiple requirements outside the area of risks.

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