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The Individual Mandate: We Hate It, but We Need It

By Sean Williams - Updated Dec 11, 2017 at 3:16PM

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If the GOP eliminates the individual mandate, it'll make a bad situation even worse for millions of folks insured through Obamacare.

Big change is afoot in Washington, and it has nothing to do with the weather. Republicans in both houses of Congress have passed their respective version of tax reform, and now are working on a few pretty sizable speed bumps that separate the two proposals from being a cohesive bill.

For example, the Tax Cuts and Jobs Act, passed by the House, proposes reducing the number of individual tax brackets from seven to four. Meanwhile, the Senate's bill, which passed on a narrow 51-to-49 vote, would keep the seven brackets intact, albeit with adjusted income ranges and a modifications to some of the effective tax rates for those income ranges.

A man in a suit holding up a business card that says tax reforms.

Image source: Getty Images.

Another sticking point is the corporate tax rate, which is one of the core components of both bills. The Senate bill would reduce the peak corporate income-tax rate from 35%, one of the highest in the world, to 20%. However, it wouldn't kick in until 2019. Meanwhile, the Tax Cuts and Jobs Act moves the corporate peak income tax rate to 20% immediately in 2018. There have also been rumblings of pushing the corporate tax to 22% instead of 20% in order to pay for a few add-ons in the Senate's version of the bill.

The individual mandate: We hate it, yet we need it

But one of the more intriguing debates will be over what happens to the Affordable Care Act's individual mandate. The individual mandate is the actionable component of Obamacare, as the ACA is more commonly known, which requires individuals to purchase health insurance or pay a penalty, known as the Shared Responsibility Payment (SRP). Removing the individual mandate from the equation, and thus no longer dangling a monetary penalty over the heads of those who remain uninsured, is expected to result in 13 million fewer Americans being insured after a decade. It would also mean fewer outgoing subsidies in the form of Advanced Premium Tax Credits, which would save the federal government $338 billion over the next 10 years. 

It's no secret that the GOP doesn't like Obamacare, and President Trump has been campaigning practically since day one to have Obamacare repealed and replaced. Nevertheless, as much as we hate the individual mandate and being forced to buy health insurance at the threat of a financial penalty (66% of respondents in a February 2017 YouGov poll were opposed to the individual mandate and SRP), it's very much needed.

The reason we need the individual mandate is simple: Healthy folks are the key to a successful for-profit health insurance system like Obamacare.

A magnifying glass held over an Affordable Care Act plan.

Image source: Getty Images.

When Obamacare was signed into law, one of its many changes required insurers to accept patients regardless of their health. This meant folks who'd previously been excluded from the system could now find health coverage, even if it meant hefty costs to health-benefit providers. In order to counter this influx of sicker people (also known as "adverse selection"), insurers relied on the individual mandate to do its job and coerce younger and healthier folks to enroll. The premium dollars of younger folks who are less likely to be sick and/or go to the doctor are critical to helping offset the higher costs of treating sicker patients.

Unfortunately, the individual mandate and Shared Responsibility Payment failed to fully do their job, hanging most insurance companies out to dry with hefty losses. This is precisely why UnitedHealth Group (UNH 2.03%), the largest insurer in the country, slashed its state-based coverage by more than 90% and why Aetna (AET) and Humana (HUM 2.65%) decided to exit the ACA's marketplace exchanges entirely by 2018. The loss in revenue for UnitedHealth, Aetna, and Humana is minuscule compared to the margin improvement they'll see from not being a part of the ACA exchanges. 

Two reasons the individual mandate hasn't lived up to expectations

The failure of the individual mandate is really tied to two aspects of its financial penalty for noncompliance, the SRP.

Arguably, the biggest issue with the SRP is that the penalty amount doesn't come close to representing the actual costs of purchasing a health plan over a full year. In 2017, the penalty amounted to the greater of $695 or 2.5% of household modified adjusted gross income. For most uninsured folks, this would amount to a penalty of around $1,000. While that's not a drop in the bucket, it's nowhere near the cost of a health plan for an unsubsidized individual. According to HealthPocket, the average bronze plan in 2017 ran about $311 a month, or more than $3,700 a year. This suggests that the average healthy American who wasn't likely to visit a doctor could save around $2,700 by simply remaining uninsured and paying the penalty. Instead of encouraging enrollment, the SRP had the opposite effect.

A frustrated woman with her hand on her head in front of her laptop.

Image source: Getty Images.

What's more, the Internal Revenue Service had its hands tied with regard to collecting the SRP. For the 2015 and 2016 tax season, the IRS accepted tax returns even if line 61 (which is where you state if you were insured and what you paid in SRP if not) wasn't filled out. In 2017, the IRS was going to put its foot down and require taxpayers to fill in line 61, or it wouldn't otherwise accept the return. However, a Trump executive order in January eased the burdens of Obamacare, thus allowing taxpayers another year of potentially skirting their SRP responsibility. 

On top of this, the IRS has no recourse to garnish wages or seize property if it's determined that the SRP is owed but unpaid. The IRS is within its rights to withhold a portion or all of your federal income tax return to cover your SRP, but it can't do a darn thing other than to request you pay your bill if you aren't owed a refund.

Put plainly, without the individual mandate, there will be even less incentive for healthier young adults to enroll for health insurance under the ACA, making it tougher for insurers to offer sustainable plans. At this point, considerably higher premiums are the only recourse for insurers if the individual mandate disappears, which would bring Obamacare one step closer to what seems to be an imminent death spiral.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool recommends UnitedHealth Group. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Aetna Inc. Stock Quote
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UnitedHealth Group Incorporated Stock Quote
UnitedHealth Group Incorporated
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Humana Inc. Stock Quote
Humana Inc.
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