Posted: 8th July 2017


In the generous hands of Medicare in Australia, the thought of health care insurance rarely crosses our minds unless we’re rich or tune into US politics regularly. Should our universal health care system be stripped away, health care insurance would look a little like pre-Obamacare – expensive, exclusive and inaccessible. Whilst Obamacare did not eradicate these problems, it has not only allowed over 20m more people to gain coverage by some sort of health care insurance, it has also been great for business. The US Health Care Index (IXHC) has almost doubled since the enactment of Obamacare in 2010 (Figure 1). How did Obamacare bring about these results and even more intriguingly, why is it so detested?

What’s inside Obamacare?

The price of health care insurance is driven primarily by two factors – risk premiums and market forces – which the mechanisms of Obamacare seek to manipulate. Its key components include an individual mandate, prohibition of price discrimination, an online marketplace and income-based tax credits.

Individual mandate: When Obama expressed he wanted everyone to have health care insurance, he didn’t mean it lightly. The highly controversial individual mandate imposed hefty tax penalties on ordinary individuals without insurance. “Socialist” and “freedom depriving” were commonly used to describe the mandate by its critics. However, the individual mandate can lower risk premiums.

To understand why, we must first consider the theory behind diversification. An individual stock carries idiosyncratic risk which can be diversified away. If an investor holds a well-diversified or the market portfolio, they are only exposed to systematic risk (Figure 2). The same logic can be applied if we substitute an individual stock for an individual and the investor for the health insurance provider. Insurers will be able to lower premiums as they insure more people and diversify away idiosyncratic risks.

Figure 2: https://en.wikibooks.org/wiki/Principles_of_Finance/Section_1/Chapter_5/Risk/Risk

Secondly, we must appreciate that insurance policy holders typically believe they lead higher risk lifestyles. This is known as adverse selection and insurers will raise their premiums in response. If low risk individuals are forced into the system, it is analogous to adding low beta stocks into a portfolio and thus should also lower premiums. Thus, Obamacare favours insurers and those who believe they need insurance over those who believe they do not – the fairness of which is debated.

Price discrimination prohibition: Previously, insurers could deny coverage or charge further premiums merely on the basis of gender and pre-existing conditions. Obamacare now prohibits this. Unfortunately, the rational response for the good guy insurer is not to lower premiums for women and those with pre-existing conditions, it is to raise premiums for everyone else. Once again, a well-intended policy could be deemed unfair by critics. Nonetheless, if we consider the price discrimination prohibition in conjunction with the individual mandate, the net effect would be wider insurance coverage with a nominal impact on premiums.

If we consider the forces of demand and supply, another layer of complexity is added. Universal insurance coverage means higher demand and thus higher prices. The intuitive response would be to lower prices through increasing supply or competition. However, more competitors will make it more difficult for insurers to be well diversified as it is nonsensical to hold the same insurance policy with different insurers. We are led back to higher premiums and Obamacare seems counterintuitive without considering its other mechanisms.

Online marketplace: The establishment of an online marketplace for health-care insurance is Obamacare’s supply side answer. Searching costs for consumers are reduced as policies can be more easily compared. This has the effect of providing the illusion of greater competition and possibly its benefits (i.e. better quality, lower prices) without needing to actually increase the number of competitors.

Income-based tax credits: This is a standard progressive redistribution policy to assist individuals who have been locked out of insurance coverage due to a lack of income. Without these tax credits, it would be counterintuitive to have a universal health care seeking plan with policies that may drive up premiums.

Health insurance costs rose sharply after the enactment of Obamacare in 2010, but eased thereafter (Figure 3). In the short term, Obamacare unsurprisingly failed to lower the cost of health insurance.

Figure 3: https://data.bls.gov/timeseries/CUUR0000SEME

The Future of Obamacare?

As the mechanisms of Obamacare to complement one another, to sever any controversial parts without an adequate replacement is implausible. However, its most controversial aspect may merely be its nickname “Obamacare” which the media arbitrarily coined and legislatures have no control over. Admirers of Obama may irrationally overvalue Obamacare whilst his critics may irrationally undervalue it. The Trump Administration is eager to repeal it but have yet to come up with an adequate replacement.

Whilst Obamacare’s theoretical basis is sound, strong results are yet to be seen for the consumer – leaving the policy open to debate. Nonetheless, it is a cost-effective plan that is favourable for the budget bottom line and even better for business. If President Trump has gotten one thing right, it is that health care is truly complicated.