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Posted by grantcart in General Discussion: Presidential (Through Nov 2009)
Sat Sep 26th 2009, 02:58 PM
1) We all hate mandates. That is not however an excuse not to put in a little effort to understand why mandates have become an inherent part of health care reform.

2) It is possible to be against mandates. It should be done in an informed manner.

3) It is absolutely true that mandates will increase the revenue of the plans that are offered - again this is true regardless of whether the plan was for profit, not for profit, private or public.

4) The reason that mandates are included in the plan is not to increase gross revenue.

5) The reason that mandates are included in the plan is because if you

a)require an insurer to accept all applicants regardless of preexisting conditions and
b) prohibit fee differentiation because of pre-existing condition you will create a condition of 'regulatory adverse selection'. (explained below)


In other words if the insurer (again it doesn't matter if it were a public option plan or a private plan) were forced to accept everyone who needed insurance but the people who didn't need insurance weren't required to get it then many people would simply wait until they have an expensive condition and then join the plan. This would force the plan (again either public or private) to increase their premiums. This would encourage more people to drop the insurance starting a viscous cycle with more and more healthy people dropping out and more and more chronically ill people signing up until you ended up with a very expensive plan that was only serving the most critically ill.

This well accepted economic reality is called the "adverse selection spiral".

If you take away the mandate to buy insurance then you must also take away the condition on the insurer (whether it is a private plan or public plan) that they cannot make an individual assessment on accepting an applicant or charging different fees to an applicant based on their preexisting condition.


People who are arguing against mandates either

1) Don't understand the basic economics of how insurance works (whether it is public or private the actuarial reality is the same).


2) Are happy to accept the current system that allows insurers to pick who they accept and discriminate on the basis of pre-existing conditions.

You simply cannot have both an elimination of discrimination of preexisting conditions (on both acceptance and fee) and at the same time make it voluntary.

Regulatory Adverse Selection

The term adverse selection was originally used in insurance. It describes a situation where an individual's demand for insurance (either the propensity to buy insurance, or the quantity purchased, or both) is positively correlated with the individual's risk of loss (e.g. higher risks buy more insurance), and the insurer is unable to allow for this correlation in the price of insurance<1>. This may be because of private information known only to the individual (information asymmetry), or because of regulations or social norms which prevent the insurer from using certain categories of known information to set prices (e.g. the insurer may be prohibited from using information such as gender or ethnic origin or genetic test results). The latter scenario is sometimes referred to as 'regulatory adverse selection'<2>.

The potentially 'adverse' nature of this phenomenon can be illustrated by the link between smoking status and mortality. Non-smokers, on average, are more likely to live longer, while smokers, on average, are more likely to die younger. If insurers do not vary prices for life insurance according to smoking status, life insurance will be a better buy for smokers than for non-smokers. So smokers may be more likely to buy insurance, or may tend to buy larger amounts, than non-smokers. The average mortality of the combined policyholder group will be higher than the average mortality of the general population. From the insurer's viewpoint, the higher mortality of the group which 'selects' to buy insurance is 'adverse'. The insurer raises the price of insurance accordingly. As a consequence, non-smokers may be less likely to buy insurance (or may buy smaller amounts) than if they could buy at a lower price to reflect their lower risk. The reduction in insurance purchase by non-smokers is also 'adverse' from the insurer's viewpoint, and perhaps also from a public policy viewpoint.

Furthermore, if there is a range of increasing risk categories in the population, the increase in the insurance price due to adverse selection may lead the lowest remaining risks to cancel or not renew their insurance. This leads to a further increase in price, and hence the lowest remaining risks cancel their insurance, leading to a further increase in price, and so on. Eventually this 'adverse selection spiral' might in theory lead to the collapse of the insurance market.

To counter the effects of adverse selection, insurers (to the extent that laws permit) ask a range of questions and may request medical or other reports on individuals who apply to buy insurance, so that the price quoted can be varied accordingly, and any unreasonably high or unpredictable risks rejected. This risk selection process is known as underwriting. In many countries, insurance law incorporates an 'utmost good faith' or uberrima fides doctrine which requires potential customers to answer any underwriting questions asked by the insurer fully and honestly; if they fail to do this, the insurer may later refuse to pay claims.

Accusations that President Obama wants to enforce mandates because he is selling out to commercial interests is based in the kind of ignorance that you would expect to see in freeperville. These slurs are not based on understanding the basic economics of insurance.

Insurance plans must have an actuarial reality to them. If you require an insurer to accept all applicants and not differentiate fees regardless of their pre-existing conditions then you have created an adverse selection that can only be remedied with a mandate.

If you do not want mandates then you must allow the insurers (whether it is a public plan or a private plan) to charge different fees to different risk groups.

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