Code Red: Two Economists Examine the U.S. Healthcare System

November 23, 2009

Individual Insurance Mandates

Filed under: Health insurance,Health Reform,Uninsured — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 2:21 pm

In a letter appearing in today’s Wall Street Journal, Dr. Charles Jackson criticizes Democratic proposals to mandate individual insurance purchases.  An obviously ardent opponent of regulation, Dr. Jackson states, “I thought insurance was a voluntary exchange in which I and an insurance provider estimate my risk” and goes on to state that mandates are not insurance but “a tax and a transfer.”

Mandates are indeed a transfer.  So too is insurance.  And both transfers serve the same purpose, to help individuals cover the cost of illness.  They are two very different sides of the same stone.  The key to understanding their similarities and differences is to consider timing.

Dr. Jackson takes a remarkably short term perspective.  It is true that in any given year, individuals can contract with insurers and if they fall ill in that year, their insurer will cover the cost.  This would represent a transfer from healthy enrollees to sick enrollees.  So far, so good.  Now consider what happens at the end of the year.  In an unfettered market, the insurer would raise the premium.   If the illness is serious and chronic, the individual may face a lifetime of higher premiums.  But these high premiums are just as much a cost of illness as the expenses born during the first year.  If free market insurance is supposed to limit individual exposure to financial risk, then free market insurance has surely failed.

Lifetime insurance contracts would solve this problem by essentially creating an intergenerational transfer between our young and old selves. Mark Pauly and others have shown, however, that adverse selection might make impossible for an insurer to turn a profit, which may explain why private lifetime health insurance does not exist.  Government lifetime insurance does exist, on the other hand – just ask any Canadian.  The purchase mandate (combined with other insurance market reforms) offers an alternative way to obtain lifetime insurance.  Just like lifetime insurance, the mandate would be an intergenerational transfer.  Much like Social Security, today’s young and healthy lose money but make it back as they age.  As long as the system endures, everyone ultimately benefits.  No one is penalized for getting diabetes or cancer or just growing old.

Without some insurance regulations, those who are ill through no fault of their own will continue to pay higher insurance premiums, thereby making a mockery of the notion of insurance.  Or they will go without insurance altogether and, once ill, throw themselves on the mercy of providers (and, eventually all of us.)   Of course, regulation is no panacea.  We will have to raise taxes to subsidize purchases by low income individuals and we may have to impose steep penalties to insure that everyone participates.  Will we actually enforce them?

No one knows if a regulated insurance markets will prove worse than the status quo.   But there is no use pretending that free market health insurance achieves some sort of textbook ideal.    That position and does an injustice to the serious issues in hand.  (Though it is no worse than some of the rhetoric spewed forth by single payer supporters.)  The fact is that the market screws things up and the government screws things up.  Let’s try to understand exactly what gets screwed up and find realistic ways to make things less screwed up.  Let the ideologues fight it out on cable and the op-ed pages of the Journal and the Times.  Maybe that will keep them out of the way while deeper thinkers find real answers to our problems.  There is too much important work still left to be done.


  1. A few questions for Prof. Dranove:

    First, what is the argument for transferring wealth from younger people to older people? Younger people are healthier than older ones, but they are also poorer, not having had their lifetimes to earn income and save. Younger people are also presumably higher on the marginal utility curve than older people. Why transfer wealth from poorer to richer or from people who are more capable of deriving enjoyment from the marginal dollar to people who are less capable?

    Second, the argument that in Period 2 the insurer could raise premiums for a person who gets sick in Period 1 just suggests that we need a second type of insurance to cover this risk. Do you know why such a form of insurance is not available? Are there inherent obstacles to providing it?

    Third, you use Social Security as a positive example (young people lose money upfront but gain money back as they age), yet in many ways Social Security cuts the other way. My understanding is that returns on “investments” in Social Security have historically lagged returns on private retirement funds. Social Security is also badly underfunded–a private insurer that ran its business the way Congress runs Social Security would be placed into insolvency immediately. Finally, insofar as the elderly are concerned, many wealth elderly persons receive transfers from much poorer young people because Social Security isn’t means tested. What is the reason for that?

    Comment by Charlie — November 25, 2009 @ 11:18 am

    • Charlie,

      The argument is pretty simple — we are all going to be old one day. The key to making it work is a commitment from the government to keep the program intact, and not just for a few years or a few decades. I can’t argue with your skepticism about the latter point.


      Comment by dranove — November 25, 2009 @ 1:26 pm

  2. From your mouth to god’s ears!–as the religionists say.

    I believe that any program Congress enacts today will endure for many years, so early termination won’t be the problem. Programs develop constituencies that profit from politically-directed cash flows. These constituencies spend money to keep the flows flowing. So, the flows flow. My friends in CA tell me that the prison guards’ lobby is one of the most powerful in the state. Who’d have guessed.

    But the point that we’ll all be old some day isn’t much of a reason for a forced wealth transfer. One might observe, with greater accuracy, that we were all young once too. Perhaps the social compact should move money in the opposite direction.

    In your opinion, which ways of spending money on health-related matters (broadly construed to include things like sanitation, electrical power, and automobile safety as well as direct health care) generate the greatest bang for the buck? If not intensive medical care for the elderly, why encourage more spending there?

    Comment by Charlie — November 25, 2009 @ 2:12 pm

  3. A follow up to my prior comment. David’s observation that we’ll all be old one day can be used to justify all manner of wealth transfers from young to old. An article in today’s NYT reports that Pittsburgh is adopting a tax on college tuition to fund benefits for retired city workers. Here’s the link. This is a pure intergenerational transfer which few college students can have any hope of recovering. To me, the Pittsburgh proposal is a completely bogus attempt to make up for the city’s failure to set aside sufficient funds for pension benefits on current basis. The same failing afflicts publicly funded pensions nationwide. It also afflicts Social Security and Medicare. I recall once reading that Medicare is underfunded to the tune of $70 trillion (might have been Medicare and Social Security together.) It seems ludicrous to talk about intergenerational contracts when what really is going on is convenient politics: spend now and defer the taxes onto later generations.

    Comment by Charlie — December 16, 2009 @ 12:35 pm

  4. Another follow up. In today’s NYT, David Brooks writes that the elderly are draining the young dry. “According to Julia Isaacs of the Brookings Institution, the federal government now spends $7 on the elderly for each $1 it spends on children.” Here’s the link. He urges the elderly to stop being selfish and start helping the young. Hear, hear.

    Comment by Charlie — February 2, 2010 @ 9:44 am

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