The Affordable Care Act, monly known as “Obamacare”, is a strange law from the perspective of economic theories of insurance markets. Still, one can see where its designers were starting from. The individual mandate may be onerous from a liberty standpoint, but it makes sense if you understand that insurance markets are vulnerable to a phenomenon known as the “death spiral.”

The idea behind the death spiral is based on the recognition that insurance is a risk management scheme. panies, despite their best efforts, are less knowledgeable about its customers’ health than are their customers. As such, the prices an pany charges are based on the average risk that a customer will need care.

Imagine (we’ll use simple numbers since the point is to illustrate a concept) that there are 10 customers in an insurance market, with a chance of needing $10 care of 11%, 12%, 13%, and so on. On average, the pany observes that its customers will have a 14.5% chance of needing $10 care. The price they would charge to its customers to break even, then, would be $1.45.

Now, if you’re any of the people who know, or suspect, their risk is lower than 14.5%, your incentive is to not purchase the care from pany. Maybe you want to move into a lower risk pool, or maybe forgo insurance altogether. Whatever the case, the people with 11%, 12%, 13%, and 14% risk leave the market because to them the price is too high. Well, the pany eventually notices that the average risk in their pool has increased. In this case, the risk has risen to 17.5% and the price follows to $1.75.

You may have already figured out that this new price will make the people with 15%, 16%, and 17% risk want to leave the policy. And you may now realize that the process will continue to spiral in this fashion, until eventually the only people left in the policy are high cost customers.

Obamacare’s creators seem to understand this issue in the sense that it has provisions that force people to buy insurance. However, while they acknowledges this process they seem to ignore a fundamental truth about insurance: it is a tool of risk management, not service provision.

Take, for example, the worrisome conscience violating mandates for contraception and abortifacients (National Review‘s editors noted that many provisions went into effect yesterday). Setting aside the important religious implications for a moment, we can see that these services make no sense from a risk management perspective. What is the risk anyone will need contraception? It’s almost entirely dependent on their lifestyle choices. This being the case, why should an pany provide something like this, rather than having those that would use it either pay for it, or alter their lifestyle accordingly?

The argument is that there are some limited uses for birth control pills other than merely contraceptive purposes. However, this is really only convincing in cases where women are diagnosed with the conditions that would lead them to need the medicine. A blanket mandate to provide birth control because a smaller subset of people may find it medically useful does not make sense.

Unfortunately, the most popular provision of the ACA is the one that makes the least sense when one realizes that insurance is about risk management, not care provision. This is the mandate to cover pre-existing health conditions. Is it really health insurance if you know that you’re going to use particular services ahead of time?

While we should obviously be sympathetic and charitable towards the sick, this requirement, bination with the individual mandate, may be what breaks the insurance markets. The “tax” included in the individual mandate may actually be too low to entice younger, poorer, and healthier Americans into buying insurance.

By law, panies are going to be forbidden from charging elderly customers more than three times the price of insurance for younger customers. A likely e of this will be increased costs of insurance on the young so that panies can charge their older, more expensive customers more.

Now, if I’m young, healthy, and deciding to buy insurance, here are the facts that I am likely to face in making that decision:

The fine is $695 or 2.5% of my e, whichever is higherInsurance costs much more than this per yearIf I do not buy insurance and get seriously sick, I can then buy insurance because I cannot be denied for an existing condition

It’s often said that it is easier to criticize e up with a plan. And it’s true, I do not have prehensive plan for fixing health insurance, but I can give some principles for fixing the health insurance market.

To the greatest extent possible, people should pay for elective health decisions out of pocket. If it is not a matter of life and death or a serious challenge to quality of life, it should not be managed by insurance.Competition and choice should be encouraged. Congress should strike as many of its restrictions and mandates on panies as possible. Allow customers the freedom to choose packages of coverage of prehensiveness.End the ties between employment and coverage. Remove incentives that tie insurance to the workplace. If people shopped for insurance, it would lead to petition. It would also reduce fears that being unemployed means being uninsured.Educate people on the difference between health insurance and health care. Too many people seem to have this issue confused. A health pany provides care. A health pany manages the risk that you need care.

This last point is why I view the Obamacare law as being based on tortured logic. On the one hand, the only way that anyone could understand the death spiral problem is to recognize that insurance is about managing risk. On the other hand, the provisions that call for covering pre-existing conditions and routine lifestyle-related issues cannot be consistent with this understanding.