eco question

Health Economics Econ 5860 Prof. Kurt Lavetti

Leg 3: Subsidies and Affordability

 Affordability achieved through combination of:  Expansion of Medicaid eligibility for adults up to 138% of federal

poverty line

 Income-based insurance premium credits and subsidies for insurance purchased on the exchanges, up to 400% of federal poverty line

 Tax credits for small businesses that provide insurance for employees

2

Medicaid Expansion

 Prior to ACA, state Medicaid programs could choose whether to offer Medicaid for adults (other than pregnant women)  Some states voluntarily chose to offer limited coverage, but most

(44/51) didn’t

 Under the ACA as originally written, every person in the country would be eligible for Medicaid if their income is below 138% of FPL (Federal Poverty Line)

 To finance expansion of the program, federal government pays for 90% of costs of newly eligible enrollees, states pay remaining 10%  New expansion imposes much lower costs on states (per Medicaid

enrollee) compared to before the ACA

3

4 Percent of Medicaid Costs Paid by Federal Government

4

Medicaid Expansion

 In 2012 the US Supreme Court in National Federation of Independent Business v. Sebilius ruled that the mandatory Medicaid expansion part of the ACA was unconstitutionally coercive to states, since the penalty for noncompliance was very large  As a result, states were given a choice whether to implement

Medicaid expansion component of the ACA

 Ohio passed a law stating that they will accept Medicaid expansion as long as the Federal Govt continues paying 90% of the cost

 Congressional Budget Office initially estimated that ACA would reduce number of uninsured from 56 million to 31 million  About 12 million of the 25 million newly insured come from Medicaid

expansion

 Would have been 6 million higher (18 instead of 12) if not for ruling

5

Source: http://www.cbo.gov/sites/default/files/cbofiles/attachments/43472-07-24-2012- CoverageEstimates.pdf

Medicaid Expansion  36 states have now chosen to expand Medicaid under the ACA, 14 declined  In 2014 28 states initially chose to expand

6

Medicaid Expansion

 Current Medicaid eligibility varies hugely by state

7

Childless Adults

Medicaid Expansion

 Smaller disparities for parents of dependent children

8

Insurance Exchanges and Medicaid

 Only families earning between 100%-400% of the poverty line can get subsidies to purchase insurance on the exchanges

 Law was written so that Medicaid would cover lowest income group, and exchanges would cover people with slightly higher incomes

9

Insurance Exchanges and Medicaid

 Due to unexpected change in law from Supreme Court decision, in states that opt out of Medicaid expansion there will now be a gap between Medicaid and exchange subsidies

 Many families earning below 100% of the poverty line but above the Medicaid threshold in their state will remain uninsured, and will fall into a coverage gap

 Even larger gap for non-parent adults in poverty in opt-out states

10

Insurance Premium Credits

 Federal credits to purchase insurance through exchanges

 After credits, price of insurance faced by consumer is capped at:

 2% of income if income between 100-133% of FPL  3-4% of income if income between 133-150% of FPL  4-6.3% of income if income between 150-200% of FPL  6.3-8.05% of income if income between 200-250% of FPL  8.05-9.5% of income if income between 250-300% of FPL  9.5% of income if income between 300-400% of FPL

 Credit amount is based on the price of the second cheapest “silver” plan in the area  Amount of credit equals price of 2nd cheapest silver plan minus price

cap based on income rules above

11

Insurance Premium Credits 12

Source: Wall Street Journal

Cost-Sharing Subsidies

 In addition to subsidizing the premium, there are also subsidies for copayments, coinsurance, and deductibles for plans purchased through exchanges

 For low income households, government subsidizes part of the deductible and coinsurance to make the plan more generous  Income between 100-150% of FPL:

 Only pay 6% of medical spending on average, instead of 30%

 Income between 150-200% of FPL: pay 13% of medical spending

 Income between 200-250% of FPL: pay 27% of medical spending

13

How Will Consumers Figure All of This Out?

 Healthcare.gov website automatically adjusts the prices and generosity shown on the website to that individual’s situation https://www.healthcare.gov/see-plans/

 Makes it easy to compare plans without needing to know all the complicated rules

 However, has drawbacks:  If you earn more money than expected may have to pay back

some of premium subsidy (but not cost-sharing subsidy).

14

Small Business Tax Credits

 For small businesses with 10 or fewer workers and average annual earnings of $25,000 or less, business can purchase insurance for workers through the exchange and get a tax credit of 50% of the employer’s contribution to the premium

 Tax credit phases out from 50% to 0% as size of firm increases from 10 to 25 workers, and as average annual income increases from $25,000 to $50,000

 Tax-exempt small businesses can get credits too, but credits are 30% smaller

15

Outline of ACA Topics

1. Big picture overview on the 3 legs of the ACA  What changed, how does the ACA work, and how does it

fit together

2. Effects of the ACA on adverse selection in individual health insurance markets

3. The economics of individual health insurance mandates

4. Employer mandates: the pros and cons of reinforcing the system of employer provided insurance

5. Overall effects of the ACA so far

16

ACA Conceptual Framework: Impacts on Adverse Selection

 Financing  Subsidize insurance for low-income

 Mandates  Tax individuals without insurance and large employers that don’t offer

insurance

 Insurance reform  Insurers selling plans on the exchange cannot charge different prices

based on health status or pre-existing conditions

 Insurers cannot deny coverage to anyone

 Questions:  How do each of these components affect adverse selection in health

insurance markets?

 What would happen if we keep some components but remove others?

17

Effect of Insurance Subsidies on Adverse Selection (Akerlof Model) 18

Price

Percentage of Population with Insurance

Demand

Average Cost

0 100%

Marginal Cost

P*

Q*

Effect of Insurance Subsidies on Adverse Selection (Akerlof Model) 19

Price

Percentage of Population with Insurance

Demand

Average Cost

0 100%

Marginal Cost

P*

Q*

• Question: what is the deadweight loss from adverse selection in this health insurance market?

Effect of Insurance Subsidies on Adverse Selection (Akerlof Model) 20

Price

Percentage of Population with Insurance

Demand

Average Cost

0 100%

Marginal Cost

P*

Q*

• Answer: the shaded area.

• This area is the total difference between WTP and MC added up over everyone who is priced out of the market because of adverse selection

Effect of Insurance Subsidies on Adverse Selection (Akerlof Model) 21

Price

Percentage of Population with Insurance

Demand

Average Cost

0 100%

Marginal Cost

P*

Q*

• If there were no adverse selection, this area could have been included in consumer surplus and/or producer surplus

Effect of Insurance Subsidies on Adverse Selection (Akerlof Model) 22

Price

Percentage of Population with Insurance

Demand

Average Cost

0 100%

Marginal Cost

P*

Q*

• Question: what happens to the deadweight loss if health insurance is subsidized?

Effect of Insurance Subsidies on Adverse Selection (Akerlof Model) 23

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

• Question: what happens to the deadweight loss if health insurance is subsidized?

Demand Plus Subsidy

PNew

QNew Percentage of Population with Insurance

100%

Effect of Insurance Subsidies on Adverse Selection (Akerlof Model) 24

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

• As the subsidy increases, demand shifts further upward

• This reduces prices for everyone, increases Q, and decreases deadweight loss

Demand Plus Subsidy

PNew

QNew Percentage of Population with Insurance

100%

Effect of Insurance Subsidies on Adverse Selection (Akerlof Model) 25

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

• A large enough subsidy can induce everyone to buy insurance, and eliminate all of the deadweight loss

Demand Plus Subsidy

PNew

QNew

Percentage of Population with Insurance

100%

Effect of Insurance Subsidies on Welfare 26

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

Demand Plus Subsidy

PNew

QNew

Percentage of Population with Insurance

100%

• Eliminating deadweight loss increases welfare by

• What are the other welfare effects?

Effect of Insurance Subsidies on Welfare 27

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

Demand Plus Subsidy

PNew

QNew

Percentage of Population with Insurance

100%

• Effect 2: equilibrium price falls, increasing CS by

Effect of Insurance Subsidies on Welfare 28

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

Demand Plus Subsidy

PNew

QNew

Percentage of Population with Insurance

100%

• Effect 3: requires raising tax revenue. Total cost of subsidy is

• Raising this tax revenue may cause deadweight loss in market being taxed

• Welfare effect = marginal cost of public funds *

Pros and Cons of Subsidizing Insurance

 Welfare Gains:  Reduction in deadweight loss from adverse selection

 Subsidy counteracts the negative externality imposed by sick people on healthy people

 Because information is asymmetric, insurers cannot charge higher prices to sicker people

 Sick people drive up average costs in the insurance pool

 This causes healthy people to be priced out of the market

 Welfare Losses:  Money required to pay for the subsidy must come from somewhere

 Taxation generally imposes some deadweight loss in whatever market is taxed

 Empirical Question: are the welfare gains from reducing adverse selection large enough to justify imposing taxes and using them to subsidize insurance?

29

Outline of ACA Topics

1. Big picture overview on the 3 legs of the ACA  What changed, how does the ACA work, and how does it

fit together

2. Effects of the ACA on adverse selection in individual health insurance markets

3. The economics of individual health insurance mandates

4. Employer mandates: the pros and cons of reinforcing the system of employer provided insurance

5. Overall effects of the ACA so far

30

Effect of Individual Mandate on Adverse Selection (Akerlof Model) 31

Price

Percentage of Population with Insurance

Demand

Average Cost

0 100%

Marginal Cost

P*

Q*

• Question: what does the individual mandate do to the deadweight loss from adverse selection?

32

Price Demand

Average Cost

0

Marginal Cost

• Answer: The same thing as a subsidy!

• The benefit of buying insurance is that you get insurance, plus you avoid paying a tax

• A large enough mandate tax penalty can eliminate the deadweight loss from adverse selection

Demand Plus Mandate Tax

PNew

QNew

Percentage of Population with Insurance

100%

Effect of Individual Mandate on Adverse Selection (Akerlof Model)

33

Price Demand

Average Cost

0

Marginal Cost

• Eliminating deadweight loss increases welfare by

• However, mandate does not benefit everyone

• What are the other welfare effects of mandate?

Demand Plus Mandate Tax

PNew

QNew

Percentage of Population with Insurance

100%

Effect of Individual Mandate on Adverse Selection (Akerlof Model)

Effect of Individual Mandate on Welfare 34

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

• Effect 2: equilibrium price falls, increasing CS by

Demand Plus Mandate Tax

PNew

QNew

Percentage of Population with Insurance

100%

Effect of Individual Mandate on Welfare 35

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

• Effect 3: some consumers are compelled to pay a price that exceeds their WTP without the mandate

• This reduces CS by

Demand Plus Mandate Tax

PNew

QNew

Percentage of Population with Insurance

100%

Effect of Individual Mandate on Welfare 36

Price Demand

Average Cost

0

Marginal Cost

POld

QOld

• Net effect on welfare is:

+

-

Demand Plus Mandate Tax

PNew

QNew

Percentage of Population with Insurance

100%

Pros and Cons of Individual Mandate

 Welfare Gains:  Reduction in deadweight loss from adverse selection

 Consumers that would buy insurance anyway benefit from lower prices

 There is always zero producer surplus in this competitive insurance market, so lower prices increase total welfare

 Welfare Losses:  Healthy people lose consumer surplus by being compelled to buy

something they weren’t willing to pay for

37

Mandate versus Subsidies  Suppose you are a policymaker and your objective is to maximize

total social welfare

 What economic factors would you consider in choosing between a subsidy or a mandate?

38

Mandate versus Subsidies  Suppose you are a policymaker and your objective is to maximize

total social welfare

 What economic factors would you consider in choosing between a subsidy or a mandate?

 Both can achieve reductions in deadweight loss caused by adverse selection

 Both benefit sicker individuals by reducing market price of insurance

 Economic cost of subsidy is deadweight loss of raising tax revenue

 Individual mandate doesn’t require any tax revenue  Welfare cost is that healthier people lose some consumer surplus

39

Mandate versus Subsidies  A mandate has a similar effect as taking welfare away from

healthy people and creating (potentially even more) welfare for sick people  If everyone has some risk of getting sick, a mandate is a form of partial

health insurance  Give up some utility when you’re healthy, but you’re better off in case you

get sick

 The ACA includes both subsidies and mandates, rather than choosing one  Some partial subsidies, plus a smaller mandate tax penalty

 However, individual mandate was removed in 2018

40

Removing the Individual Mandate

 What do you expect would happen if the individual mandate is eliminated, while subsidies remain the same?

41

Removing the Individual Mandate 42

Price Demand without Mandate

Average Cost

0

Marginal Cost

Pwithout

Qwithout

• Removing the mandate shifts the demand curve down

• This increases prices, reduces quantity

• Healthy people exit the market

Demand with Mandate

Pwith

Qwith Percentage of Population with Insurance

100%

Source: https://www.cbo.gov/publication/53300

43

ACA Conceptual Framework: Impacts on Adverse Selection

 Financing  Subsidize insurance for low-income

 Mandates  Tax individuals without insurance and large employers that don’t offer

insurance

 Insurance reform  Insurers selling plans on the exchange cannot charge different prices

based on health status or pre-existing conditions

 Insurers cannot deny coverage to anyone

 Questions:  How do each of these components affect adverse selection in health

insurance markets?

 What would happen if we keep some components but remove others?

44

Outline of ACA Topics

1. Big picture overview on the 3 legs of the ACA  What changed, how does the ACA work, and how does it

fit together

2. Effects of the ACA on adverse selection in individual health insurance markets

3. The economics of individual health insurance mandates

4. Employer mandates: the pros and cons of reinforcing the system of employer provided insurance

5. Overall effects of the ACA so far

45

Explaining the Dominance of Employer-Provided Insurance

 The US is the only high income country in the world in which the primary source of insurance coverage comes from employers  88 % of private health insurance is obtained through

employers (this number is decreasing post-ACA)

 Why does this happen? Is it a good idea?

 Does this link between insurance and jobs distort labor markets, employment rates, or wages?

46

Explaining the Dominance of Employer-Provided Insurance

 Potential explanations for this unique coverage system a) Historic determinism

b) Economies of scale (loads and administrative costs)

c) Avoids adverse selection

d) Tax subsidy

e) All of the above

47

48a) Historical “Accident” • About 170 million people in the US get health insurance from

an employer (through individual or family coverage) • Why do we rely upon labor markets for providing health

insurance, unlike almost every other country? • Federal wage and price controls imposed during WWII

• Firms couldn’t increase wages to attract good workers, instead shifted towards attractive nonwage benefits to increase compensation

• Health insurance was the main way of increasing fringe benefits

• Historical system has been too difficult to change since it grew to be the primary source of coverage

b) Economies of Scale

• Cost of insurance for large groups is lower than for small groups due to economies of scale

• Potentially caused by: • Costs of selling, negotiating contract • More efficient billing and processing medical claims

• Large employers pay premiums on average about 5% markups above medical costs

• Small groups (1-5) pay about 25-30% markups • By comparison, cost of running all of Medicare equals

about 2% of medical costs

49

c) Adverse Selection in Insurance Markets

 Most people seek jobs for reasons other than their health status  That is, firms aren’t organized based on sorting

workers with similar health risks together

 Employer based coverage provides a mechanism to group uncorrelated risk and negotiate benefits that does not suffer from adverse selection

50

Why Does Pooling Work for Employer Provided Insurance?

51

Wealth if Sick

Wealth if Healthy

Full Insurance Line

• Recall that no pooling equilibrium can exist in basic R- S model

• Reason is because healthy people will leave plan F if there is a slightly better option G

• Suppose people get insurance from their jobs, and the employer only offers plan F

• Now leaving plan F to get plan G requires changing jobs, which may be very costly

• This could allow healthy people to stay in F, making pooling possible for firms, and reducing the adverse selection problem

Zero Average Profit Line

E

UL

UH

F G

d) The Tax Exclusion for Employer Insurance

• If your employer buys health insurance for you, the cost of the insurance benefit isn’t taxed as income

• However, if the employer gives you money that you use to buy insurance, the cost of the insurance is not deductible, and you have to pay income taxes on the money

• Tax benefit creates a large incentive for employers to purchase insurance for their workers

52

Explaining the Dominance of Employer-Provided Insurance

 Hypotheses: a) Historic determinism

b) Economies of scale (loads and administrative costs)

c) Avoids adverse selection

d) Tax subsidy

e) All of the above

 ACA further reinforces employer-provided insurance system in the US by imposing employer mandates

53

Who really pays for employer- provided insurance?

• Recall from intermediate microeconomics the profit maximizing choice of inputs requires: P*MPL=wage • In a competitive labor market the wage a worker receives is equal

to the value of the marginal product produced by the worker

• Now consider, instead of paying a worker wages, firms pay them with health insurance

• P*MPL is fixed, so if the firm spends more on health insurance, it must spend less on wages

• Therefore a firm offering health insurance will pay workers lower wages, so that the total cost of (Health Insurance + Wage) is fixed

54

S

D0 L*L2

W

W0 P

55 Labor Market Effects of Employer Provided Health Insurance

Labor Market Effects of Employer Provided Health Insurance

S

D0 L*L2

W

W0

D'

56

S''

• D0 is demand curve for labor at firm that does NOT offer health insurance • If the firm provides insurance, it pays lower wages, shifting the demand curve

down to D’ • Vertical distance between D0 and D’ equals the marginal cost of insurance

• Now consider the worker: • Workers supply labor to firms, and choose the quantity of time to

sell to firms in order to maximize utility • Gaining health insurance increases the utility workers get from

working, all else equal, shifting their labor supply curve up

• If workers value health insurance at the same amount that it costs to buy, then size of the labor supply curve will equal the cost of insurance

• Eg. Workers are indifferent between the lower wage with health insurance or the higher wage without insurance

57 Labor Market Effects of Employer Provided Health Insurance

S

D0 L*

W

W0

W1 P

D'

58

S'

• If workers value insurance at the same amount that it costs firms to buy, wages drop by exactly the price of insurance, and total employment stays the same.

• The full cost of insurance is paid by workers in the form of lower wages, regardless of how elastic the supply and demand curves are!

Labor Market Effects of Employer Provided Health Insurance

• However, if workers value health insurance by more than it costs firms to buy then the labor supply curve shifts by more than the labor demand curve

• This could occur if it is cheaper for firms to buy insurance than it would be for an individual to purchase the same insurance

59 Labor Market Effects of Employer Provided Health Insurance

S

D0 L0 L2

W

W0 W1

D'

60

S' S''

W2

• Workers value insurance more than what it costs firms to buy • Supply curve shifts more than demand curve, wages fall more than cost of

insurance, and employment increases

Labor Market Effects of Employer Provided Health Insurance

Who really pays: Evidence from Mandated Maternity Benefits

 Empirical question: when firms provide health insurance, do wages fall by the cost of insurance (or by more or less)?

 Gruber (1994) looked at the incidence of mandated maternity benefits

 Think about this as a mandatory change in insurance generosity and costs

 Strategy: Some states mandate maternity benefits, while others do not. Compare wages of men (control group) to women of childbearing age  Found that women of childbearing age saw wage decreases in

states with mandates, but not in states without mandates  Evidence that wages respond to nonwage benefits  Wage offset was about 100% of the additional cost of insurance

61

• Lots of discussion in popular media about whether the employer mandate in the ACA would “kill jobs”

• Is there any economic validity to this argument? • If workers don’t value health insurance

• Labor supply curve shifts by a small amount

• If wages cannot adjust to reflect cost of insurance • Workers near the minimum wage, for example

62 Labor Market Effects of Employer Mandates

• No effects on shift towards part time work • Moriya, Selden, and Simon (2016) and Mathur, Slovov, and Strain

(2016)

• No effect on full time employment levels or hours of work

• Kaestner et al. (2015)

• Initial forecasts from CBO predicted 1.5-2% reduction in employment

• This prediction was based on estimates that many people are only in the labor force because they have no other way of getting health insurance

• These people would prefer to exit labor force if they could buy insurance somewhere, and the ACA gives them this option

63 Effects of ACA on Labor Markets

• Not obvious that employer-provided insurance is a desirable system

• ACA largely kept this in place because removing it would have been very disruptive to the status quo

• Drawbacks of employer provided insurance: • Individuals have to choose from a limited menu of plans, may not

be offered the type of insurance they would like to have • Empirical evidence: when consumers purchase their own insurance,

they choose much cheaper (and less generous) plans than most firms offer

• Suggests employees may choose higher wages and cheaper insurance if given the option

• Individual insurance is more portable, doesn’t tie workers to employers, and doesn’t distort labor markets

64 Policy Options Going Forward…

• Drawbacks: • Employers may not be sensitive to their workers preferences for

wages versus more expensive health insurance

• The expectation that all “good firms” must offer health insurance causes employers to have inelastic demand, may give insurers pricing power

65 Policy Options Going Forward…

• Positives: • Employer provided insurance can be a good behavioral commitment

mechanism to force consumers to save/pay for insurance • Similar intuition to taking retirement savings out of a worker’s paycheck

• Individual insurance markets can have more problems with adverse selection unless they are intelligently regulated

• ACA policies largely address issues of adverse selection and economies of scale, reducing these two motivations for employer-based insurance

• IRS tax code currently incentivizes employer provided insurance • Allowing all health insurance purchases to be tax deductible would remove

this justification for employer-based insurance

• Going forward: • Removing tax benefit, while keep regulations in ACA marketplaces

could create benefits by shifting away from employers as a source of insurance

• Further reading: Pauly, Percy, and Herring Health Affairs 1999

66 Policy Options Going Forward…

67 Most large employers chose to offer health insurance before the ACA anyway