Legislating Price Ignorance

As another year under the Affordable Care Act comes to an end, it's once again time to take stock of what both our country and we as individuals spend for the health care we rely on. Prices are a critical part of any market, and the health insurance market, despite special challenges, is no exception. Real prices don't set values; by telling us how individuals and suppliers value goods, they reveal them.

So what happens when national reform changes health care "prices," but not necessarily costs? The first years of the health care law hold an important lesson: Legislating price ignorance does not make the cost consequences go away, as evidenced by a shrinking number of insurers and rate increases of over 20 percent in the government exchanges.

To see why, compare the individual health insurance market, where prices are becoming less of decision-making factor, with the employer-based market.

Health insurance has always posed an information problem. Patients are largely unaware of true pricing because of third-party payment arrangements. People with insurance have an incentive to use as many covered services as possible, at a fraction of the full cost of care. And with employers or government programs paying the largest share of premium costs, people are even further removed from price signals.

Previously, one exception could be found in the individual market in which consumers shopped and paid for their own policies. The result was leaner policies with benefit designs that were more sensitive to total cost.

After the health care law passed, a new group entered this individual market, but they were shielded from price information because insurers were required to charge prices based on other factors.

People will purchase a plan if its subsidized price makes sense for them, even if the overall cost does not. Post-health care law, that price is based on their income, and not on the actual value of the insurance. If their income stays constant and they see no price increase, then they are insensitive to the signals high prices send (namely that there isn't enough of a limited resource to go around at that price).

Likewise, the law doesn't allow insurers to vary their price for heavy insurance users versus modest users. So instead, they price plans to cover higher expected costs, since heavy users value the coverage most. Prices rise as a result, and people who use their insurance less are the first to drop their coverage. In the end, only the people who are subsidized continued to value the product.

People with incomes above four times the federal poverty level who purchase insurance in the individual market faced all the consequence of these inflamed market problems, without any of the social assistance that others received. It is little wonder that very few high-income individuals have chosen to purchase within this market. Those who do are typically heavy insurance users, including people previously characterized as uninsurable. Most non-subsidized insurance customers have sought exemptions, retained grandfathered plans, or simply paid the fine for non-compliance.

Exemptions have become particularly common, thanks to prices rising much faster than income. Premiums above 8.16 percent of income are considered unaffordable and consumers facing them are exempt from the mandate. In many markets, the high costs of policies exempt most of the unsubsidized. In Fairfax, Virginia, for example, a couple in their 40s making $100,000 cannot receive subsidies even as a silver plan is priced in excess of $10,000.

So today, the expanded ranks of the insured are made up almost entirely of individuals and families whose incomes justify subsidies or whose health makes high-priced policies a bargain relative to the costs of care. The result is a market characterized by consumers who either don't know the real price of their coverage, or would be priced out under competitive conditions.

Contrast this market with what has happened in the broader employer-based health insurance market. Here, the pace of insurance price increases has slowed in recent years. Several factors account for this (the recession, for example), but one is the increased level of premium contributions, co-pays and deductibles employers are passing on to employees. Employees who face more up-front or out-of-pocket costs make decisions based on price. This helps keep costs down in the long run.

Thus, we have two different trends. In the individual health insurance market, price signals are being dampened and price continues to rise quickly. In the employment-based market, patients are incorporating prices into more of their decision making, reducing some of the demand pressures of the past.

Once again, we are reminded that ignoring price signals to serve other social goals risks serious consequences.