On March 6, the Republican House leadership finally released a draft plan for repealing and replacing the Affordable Care Act (ACA). It is, of course, only a draft, subject to revision. As this is written, with the ink not yet dry, influential Republicans are already calling it a “framework for reform” or a “work in progress.” Still, it is not too early to address one question: will the draft plan, or anything like it, stop the death spiral in the individual insurance market that is at the heart of the ACA’s problems?
Going by the draft plan in its initial reform, the answer is “No.” Here is why.
What is the “death spiral”?
Just how does this notorious “death spiral” work? Start with a basic truth: A private insurer can profitably offer healthcare coverage to a pool of customers only if it can find a premium that is low enough to be affordable, yet high enough to cover expected claims and administrative costs, with enough left over to keep shareholders happy. In order for that to happen, the pool of customers must contain enough healthy people to keep claims and premiums low.
If premiums are too high, healthy people begin to drop out and take their chances covering their own medical costs. Fewer healthy people in the pool raises the claims per member—a process that economists call adverse selection. Soon, premiums have to be raised further. That causes still more people to drop out until only the sickest people are left in the pool. At that point the insurers themselves pull out, and the death spiral is complete.
Features that enlarge the pool
Two features of the draft Ryan plan would tend to enlarge the pool of those seeking insurance in the individual market. One is the repeal of the mandate for larger employers to provide coverage. Workers who lose job-related coverage will end up in the individual market. In addition, a separate set of provisions that tighten eligibility for Medicaid would push some low-income households into the individual market.
On the face of it, enlarging the individual insurance pool would make the system more stable. However, that would be true only if the individuals who actually purchased individual policies after being displaced from employer coverage or Medicaid were of average or better health. However, those displaced are likely to be of lower than average income. Medicaid is already limited to households below or just above the poverty line, and companies would be more likely to stop healthcare coverage for their marginal employees than for their best workers. Lower income households not only tend to have more health problems, but are more likely to forego coverage unless they are very sick—that is, more likely to succumb to adverse selection. If so, the apparent enlargement and stabilization of the individual insurance pool might not materialize.
The ACA tries to combat adverse selection with subsidies, varying by income, that cover a percentage of premiums for people who buy individual coverage through the exchanges. The GOP draft plan replaces the ACA subsidies with a set of flat tax credits that vary by age, rather than income, up to household incomes of $150,000—that is, for the great majority of households. The question is whether the GOP tax credits will be more effective, or less effective, than the ACA subsidies at preventing adverse selection.
There are two reasons to think they will be less effective. One is that the flat tax credits expose people to the full effect of any premium increases, rather than only to a part of them, as under the ACA. Consider an example: Suppose Joe Smith has an income that qualifies him for a 50% subsidy under the ACA and, at age 35, qualifies him for a flat $2,500 tax credit under the GOP plan. Suppose that in Year 1, his premium is $5,000, for a net cost of $2,500 under both the ACA and the GOP plan. In Year 2, insurers find they don’t have as many healthy people in the pool as they would like, so they raise the premium to $6,000. Under the ACA, Joe’s net cost goes up to $3,000, an increase of 20 percent. Under the GOP plan, his net cost goes up to $3,500—a 40 percent increase.
The exact numbers in our example don’t really matter much. No matter what they are, the percentage increase in a household’s net premium will be greater under the Republicans’ fixed tax credit than under the ACA’s proportional subsidy. As a result, once adverse selection gets under way, the death spiral will develop faster and be more quickly fatal under the GOP plan than under Obamacare.
The second reason is that the GOP plan bites harder for older households than for younger ones. Under the ACA, insurers can charge a 60-year-old person no more than three times the premium it charges for a 20-year-old. Under the GOP plan, the ratio goes up to five-to-one. Yet the subsidy for a 60-year-old is only double that for a 20-year-old: $4,000 instead of $2,000. That means that older households will be even more susceptible to adverse selection than younger ones.
The apparent age discrimination in the draft plan is so completely crazy that it will probably be changed in committee. Someone seems to have forgotten that older citizens voted more heavily for Republican candidates than younger ones. Can it really be that the party intends to selectively punish its own voters? That’s not possible, is it?
Inadequate penalties for non-insurance
Another feature of the GOP plan that would aggravate adverse selection is the way it handles guaranteed issue—that is, the ACA’s requirement that insurers provide coverage to people with pre-existing conditions. Guaranteed issue has proved to be by far the most popular feature of the ACA, so the draft plan retains it. Unfortunately, guaranteed issue is pure poison when it comes to adverse selection. Why should healthy people buy insurance at all if they can wait and sign up for coverage later if they do get sick?
To combat this problem, the GOP draft allows insurers to put a 30 percent surcharge on the first-year premium of anyone who has been uninsured for two months or more prior to enrollment. That is not much of a penalty. Just do the matter for our Joe Smith. His premium is $4,000 per year, so his net cost is $2,000 after taking his tax credit. Suppose he goes uninsured and stays healthy in Year 1, and then gets sick and signs up for coverage in Year 2. His Year 2 premium will be $5,200, raising his out-of-pocket cost to $3,200. Over the two-year period, he saves $800 by staying out of the pool until he gets sick. Why would he sign up while he is still healthy?
Still another feature of the GOP draft plan that would aggravate adverse selection is its encouragement of high-deductible policies. In the name of choice, the draft plan will allow insurers to sell “catastrophic only” coverage with very high deductibles, and without coverage for frills like maternity care. Those policies will be very cheap, especially for people that don’t use them, but they do count as coverage.
Let’s do the math again for Joe, under the assumption that he can now buy a plan with very skimpy coverage but with a premium of just $2,000. As long as he is healthy and has no out-of-pocket costs, that plan costs him nothing. His tax credit covers the full premium. If he later gets sick, he can now switch to a more generous plan without even paying the 30 percent penalty. He would be a fool not to take advantage of this possibility.
The bottom line
Yes, the ACA has its problems. This post is not a defense of Obamacare. One of the most serious problems of the ACA is the combination of guaranteed issue plus inadequate penalties for remaining uninsured. That combination is gradually destabilizing the individual market. Already premiums have risen, and this year many counties have just one insurer still offering coverage. Even if Hillary Clinton had been elected, along with an all-Democratic Congress, we would be talking about the need to do something to stop the death spiral.
What an absurdity, then, that the GOP has put forth a plan that, rather than solving this serious flaw in Obamacare, actually makes it worse. Some tinkering in committee may fix some of the more obvious flaws of the draft, such as the failure to let subsidies rise in proportion to premiums as people get older. Even so, there is no getting around the fact that the combination of guaranteed issue with freedom of choice to remain uninsured is simply not economically viable.
Maybe the March 6 draft plan will already be dead before this is posted. If so, that will be proof that its flaws are too great to be fixed without much more radical reform than what House Republicans have produced this time around.