The Affordable Care Act’s (ACA) health insurance exchanges are just one mechanism to expand coverage that primarily benefits low-income individual market policyholders and those with pre-existing conditions who cannot afford or access employer-sponsored health insurance.
For Obamacare’s exchanges to remain viable, the federal health law makes health insurance compulsory, sets premium caps for high-risk policyholders, and distributes subsidies that offset cost sharing and premiums for eligible consumers.
However, these very mechanisms are also triggering adverse selection for insurers due to the following factors:
Health Status — Under the ACA, guaranteed issue restricts insurers from denying coverage to applicants with pre-existing conditions. Further limits on risk-adjusting a policyholder’s premium based on health status benefits high-risk customers whose premiums are less than their risk status would justify at the expense of low-risk customers whose premiums are higher than their risk status would justify.
Market economist Paul J. Feldstein provides a contextual explanation of how these regulations induce adverse selection:
If 100 people were in a risk group, each with a 1 percent chance of needing a medical treatment costing $100,000, the pure premium for each (without the loading charge) would be $1,000 (0.01 x $100,000). Each year, one member of the group would require a $100,000 treatment. Now, if a person who needs that particular treatment (whose risk is 100 percent) is permitted to join that group at a premium of $1,000 (based on a mistaken risk level of 0.01), that high-risk person receives a subsidy of $99,000, as her premium should have been $100,000 based on her risk level. Because the $1,000 premium was based on a risk level of 1 percent, the insurer collects insufficient premiums to pay for the second $100,000 expense and loses $99,000.
Unanticipated enrollment mix — The market for ACA non-group policyholders could remain on precarious footing for the next few years. Severe instability ensued prior to the exchanges’ first enrollment period in October 2013. To mitigate a public backlash regarding plan cancellations for millions of Americans, the Obama Administration urged insurers to extend these "subpar" policies until 2017. This unilateral decision produced an imbalance between anticipated and actual individual market risk pools starting in 2014. Many policyholders — especially the young and healthy — decided to hold onto these plans, creating a higher-risk enrollment mix leading to another adverse selection problem.
Community Rating —As a promise made by the Obama administration for health premiums to be affordable for those with pre-existing conditions, the ACA enforces tighter government price controls in which a high-risk individual cannot be charged more than three times the amount of a low-risk individual’s health insurance premium. Higher premiums burdening low-risk individuals as a means to subsidize the cost of the chronically ill discourages low risk customers from purchasing federally approved health coverage. The entire scheme is unsustainable if younger, healthier individuals are not in the system to subsidize those who are older and less healthy.
A weak individual mandate — Viewed as the centerpiece of the federal health law, some health economists perceive the individual mandate as, "the best way to eliminate the problem of adverse selection." Yet the law’s penalty lacks muscle. According to the Treasury Department, approximately 7.5 million people were subject to an average $200 fine for opting out of coverage in 2014. The penalty for not having government-approved insurance in 2014 was the greater of either $95 or one percent of annual income.
Click here for the Health Care Update archive.
You can unsubscribe to this and all future e-mails from the John Locke Foundation by clicking the "Manage Subscriptions" button at the top of this newsletter.
