The Affordable Care Act Affects Moral Hazard in the Health Insurance Industry

The Patient Protection and Affordable Care Act was signed into law by President Barack Obama in 2010. Commonly known as the Affordable Care Act (ACA) or Obamacare, the new law expanded Medicaid, created health insurance exchanges, and included health-related provisions so millions of uninsured Americans could get health insurance. Under the ACA, coverage was designed to be affordable, and helped give those with lower incomes premium tax credits and cost-sharing reductions.

The act inflated existing moral hazards in the health insurance industry by mandating coverage and community ratings, restricting prices, establishing minimum standards requirements, and creating a limited incentive to compel purchases. To see how the act affects moral hazard, it is first important to understand moral hazard and the nature of the health insurance market.

What Is a Moral Hazard?

Moral hazards existed in the U.S. insurance markets before Obamacare, but the act's flaws exacerbate, rather than alleviate, those problems. It's a bit of a misnomer as there are no normative, morality-based elements to the economic sense of moral hazard. So if it has nothing to do with morals, what exactly is moral hazard?

Moral hazard means that a situation exists where one party has an incentive to use more resources than otherwise would have been used because another party bears the costs. Ultimately, one party to a contract assumes the risk to the other party without any consequences. The aggregate effect of moral hazard in any market is to restrict supply, raise prices, and encourage overconsumption.

Moral hazards can be found in employee-employer relationships, in the financial industry with contacts between lenders and borrowers, and in the insurance industry between insurers and their clients. As we note below, moral hazard has a significant role in the health insurance segment of the economy.

Moral Hazard and Health Insurance

Moral hazard is often misunderstood or misrepresented in the health insurance industry. Many argue that health insurance itself is a moral hazard since it reduces the risks of pursuing an unhealthy lifestyle or other risky behavior.

This is only true if the costs to the customer—the insurance premiums and deductibles—are the same for everyone. In a competitive market, however, insurance companies charge higher rates to riskier customers.

Moral hazard is largely removed when prices are allowed to reflect real information. The decisions to smoke cigarettes or go skydiving look different when it means premiums can increase from $50 per month to $500 per month.

Insurance underwriting is crucial for this very reason. Unfortunately, many regulations designed to promote fairness end up clouding this process. To compensate, insurance companies raise all rates.

In the United States, moral hazard in health insurance was already encouraged before Obamacare. Tax incentives encourage employer-based health coverage, placing consumers farther away from medical costs. As economist Milton Friedman once stated: "Third-party payment has required the bureaucratization of medical care...the patient...has little incentive to be concerned about the cost since it's somebody else's money."

Moral Hazard and the Affordable Care Act

The act is 2,500 pages long, so it's really difficult to discuss its impact with any brevity. So, here's a look at some of the basic provisions outlined in the law:

• Insurers can no longer deny coverage to those with pre-existing conditions
• New government health insurance exchanges are to be set up to determine the type and cost of plans available to consumers
• Large employers are required to offer employee health coverage
• All plans must cover the 10 essential benefits of health insurance
• Annual and lifetime limits on employer plans are banned
• Plans are only affordable if the cost is less than 9.5% of family income

The act also carried with it an individual mandate, the requirement that all uninsured Americans must to purchase a health insurance policy or pay a fine, although there were hardship exemptions put into place for those who couldn't afford coverage. Signed in 2010, the individual mandate went into effect in 2014. There was a reason behind this. People who were generally fairly health would decline coverage in order to save the added expense of a health insurance premium. In order to compensate for lost revenue, insurance companies would raise rates, putting more financial stress on those who had coverage. Under the mandate, anyone who didn't have coverage would pay the penalty through their federal income tax return.

2017 TCJA Changes

That mandate was repealed after the passing of the Tax Cuts and Jobs Act in 2017. The new law eliminated the fine imposed on people without health care coverage beginning in 2019. Despite this, there are still several states that require residents to be have coverage.

Restricting costs, mandating employer coverage and requiring minimum benefits further drive a wedge between the consumer and the real cost of health care. Premiums have predictably spiked since passage of the Act, consistent with economic theory about moral hazard.