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

To see how the Patient Protection and Affordable Care Act, or "Obamacare," affects moral hazard in the health insurance industry, it is first important to understand moral hazard and the nature of the health insurance market. The Act inflates existing moral hazard in the industry by mandating coverage and community ratings, restricting prices, establishing minimum standards requirements and creating a limited incentive to compel purchases. Moral hazard existed in the U.S. insurance markets before Obamacare, but the Act's flaws exacerbate, rather than alleviate, those problems.

Moral hazard is a bit of a misnomer. There are no normative, morality-based elements to the economic sense of moral hazard. Instead, 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. The aggregate effect of moral hazard in any market is to restrict supply, raise prices and encourage overconsumption.

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, or 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."

The Act is 2,500 pages long; it is difficult to discuss its impact with any brevity. Some of the basic provisions are that 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, and plans are only "affordable" if the cost is less than 9.5% of family income.

Additionally, all uninsured Americans are required to purchase a policy or pay a fine, although there are many "hardship exemptions" to the fine. Knowing the risks and costs to insurance companies would skyrocket, this mandate is intended to keep them in business by forcing low-risk consumers to buy.

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.