California's Coming Health Insurance Death Spiral
by David Hogberg, Ph.D.
Will relatively young and healthy people purchase health insurance from the ObamaCare exchanges? After the release of alleged insurance premiums by California's ObamaCare-mandated health insurance exchange—"Covered California"—the participation of the Golden State's youth is the topic of serious debate.
Covered California put out a misleading press release saying that the proposed rates on the exchange would not be much higher than existing rates.1 The problem was that officials were comparing the rates in the exchange only to rates in the small-employer market. Critics of ObamaCare rightfully pounced, pointing out that the proper comparison was between the exchange and California's current individual market.2 Avik Roy, who did the most extensive analysis of costs, found that rates were likely to rise for almost everyone who participates on the California exchange.3 Faced with rising insurance costs, it's logical to expect that many younger and healthier California residents will choose the pay the cheaper ObamaCare fine.
Jonathan Cohn, one of the ablest defenders of ObamaCare, replied that the critics overlooked the tax credits that exchange participants would get to help subsidize their premiums. That, he contended, would ameliorate the supposed "rate shock" for many people.
Before examining Cohn's argument further, it's important to first review some of the regulations governing premiums on the exchange.
The two most important regulations regarding whether younger and healthier people will participate are known as community rating and guaranteed issue.
In its strictest form, community rating means that insurers must charge everyone the same premium, regardless of factors such as health status and age. ObamaCare uses a modified form that doesn't allow insurers to vary rates based on health status. It does allow, however, for modification of premiums if one smokes and to compensate for age (although in a more restricted manner than the market currently does).
Guaranteed issue, in its strictest form, means that an insurer must sell a policy to a consumer anytime. Again, ObamaCare employs a modified form of this that requires insurers to sell to all comers but only during the annual open enrollment period from October to December.
Both of these rules give young and healthy people big incentives to forgo insurance coverage altogether. Community rating means young people have a reduced incentive to buy insurance since they will pay a premium that is above the market rate. Guaranteed issue gives them even less incentive to buy insurance while they are healthy because when they get sick an insurer will have to sell them a policy.
A handful of states tried to reform their individual markets this way in the early 1990s. Of course, many young and healthy people did drop out of those markets as a result. That meant that those who remained in the insurance pools were older and sicker, a factor that drove up the rate of premiums. As premiums rose, even more young and healthy people dropped their insurance. Insurance pools got even sicker and older, and rates continued to rise. The phenomenon became known as the "death spiral," and was chronicled in the late Conrad Meier's monograph "Destroying Insurance Markets."4
The architects of ObamaCare hoped to avoid the death spiral in two ways. The first is the individual mandate that requires an individual to buy insurance or pay a fine. In 2014, the fine will be $95. It is slated to increase to $395 in 2015 and then to $695 in 2016.5
The other means of avoiding a death spiral is tax credits. Individuals and families who do not qualify for Medicaid and are under 400% of the federal poverty level will receive a tax credit to help pay for insurance on the exchange. The tax credits are based on a sliding scale, with higher tax credits going to those with lower incomes.
Cohn focuses on this last aspect in order to claim that many people will pay less through Covered California:
…look what happens when we think about somebody making less money. If this young man's annual income was $25,000, he'd pay just $1,184 a year [after the tax credits are included]. That's basically the same as the eHealthInsurance bids, give or take a few six packs of beer. Dude! At $20,000 a year in earnings, the expected bronze premium comes all the way down to $481 a year. And at $15,000 a year, insurance is free. That's right, the premium would be zero dollars.6
First off, Cohn's comparison is a bit misleading. The tax credits will be based on the second-lowest-cost silver plan on an exchange. Cohn used the silver plan in the Kaiser Family Foundation calculator that assumes an annual premium of $3,030 for a single 25-year-old.7 But using data from Covered California shows that the second-lowest-cost silver plan for a 25-year old will be about $2,771.8 Thus, people on Covered California will receive smaller tax credits than the ones Cohn uses in his examples. To be fair to Cohn, he was likely using the KFF calculator out of convenience since making tax credit calculations is difficult.
But even if Cohn's numbers are accepted at face value, they still show that the young and healthy are not likely to buy insurance from the exchange in sufficient numbers to avoid a death spiral. First, notice both the young man making $25,000 annually and the one making $20,000 will have a financial incentive to forego insurance and pay the fine because the cost of coverage exceeds the penalty. Only in 2016 will the fine finally exceed the premium for the young man making $20,000 a year. For the one making $25,000, he's going to have nearly $500 worth of incentive (okay, $489 to be exact) to forgo insurance indefinitely after 2016. That incentive, of course, increases as income rises above $25,000.
Then there are the people who are eligible for insurance at Covered California but who will receive no tax credit. Apparently there are a lot of them.
The pamphlet for Covered California notes repeatedly, "If you are one of the 2.6 million uninsured Californians who does not qualify for a subsidy, you can still purchase high quality affordable health insurance through Covered California."9 But why would they pay the full premium, which will almost always be more than paying the fine? Not all of them are young and healthy, but many of them are. According to the latest Census Bureau numbers, just under 40 percent of the uninsured are between the ages of 18 and 34.10
Cohn might respond that the young and healthy would sign up because the "benefits will be better." Presumably he means that the policies will have to offer the list of "essential benefits" required by ObamaCare.
But benefits aren't limited to services and procedures; they also include choice of physicians and hospitals. On that facet, the new policies on the California exchange leave something to be desired. As the Los Angeles Times reported, to hold down costs, many insurers on the exchange will limit access to networks of physicians and hospitals. California officials tried to "blunt that criticism…pointing out that the 13 health insurers selected will offer access to about 80 percent of California's practicing physicians and hospitals." That means people with exchange plans will not have access to about one in five physicians or hospitals. That's not exactly a good start.
But it gets worse, according to the Times:
People who want UCLA Medical Center and its doctors in their health plan network next year, for instance, may have only one choice in California's exchange: Anthem Blue Cross. Another major insurer in the state-run market, Blue Shield of California, said its exchange customers will be restricted to 36 percent of its regular physician network statewide.
And Cedars-Sinai Medical Center, one of Southern California's most prestigious and expensive hospitals, said it's not included in any exchange plans at the moment.11
Americans have already had experience with private insurance policies that restrict choice. In the late 1980s, as the employer-based market moved to managed-care to control costs, more employees found themselves in restrictive Health Maintenance Organization (HMO) plans. HMOs proved unpopular with many employees, and employers eventually dropped them in favor of less restrictive plans. In 1996, HMOs held 31 percent of the employer market. In 2012, that had fallen to 16 percent.12
How, then, will today's "Amazon.com generation"—young Americans who are accustomed to a wide array of instant choices at low prices—react to finding that health plans limit access to physicians and hospitals at a high cost? It's probably a safe bet that they will see little value in such plans, giving them further incentive to forgo insurance.
A lot of young and healthy people will likely discover that it costs less to pay the fine than pay the premiums for plans offered on California's health insurance exchange, even ones who qualify for a tax credit. Furthermore, they'll discover that many of the plans they can choose from restrict their access to physicians and hospitals. Is that a formula to entice lots of young and healthy consumers into joining the exchanges? No, but it seems like a pretty good one for a death spiral.
California Leaves its Sickest Residents in Worse Condition
On a different but related note, Cohn earlier wrote that residents in many states may end up seeing much worse rates that those in California. He says this may happen
because state officials there are doing nothing to help and quite a bit to hurt implementation. But if that happens, blame won't belong with the heath care law or the federal officials in charge of its management. It will belong with the state officials who can't, or won't, deliver to their constituents the benefits that California's officials appear to be providing theirs.13 (Italics added.)
Well, California officials treated some of their constituents less equally than others. People who need specialty drugs—high-cost drugs engineered to treat complex, chronic conditions—got the shaft. According to the Associated Press, "Such 'specialty drugs' can cost thousands of dollars a month, and in California, patients would pay up to 30 percent of the cost. For one widely used cancer drug, Gleevec, the patient could pay more than $2,000 for a month's supply, says the Leukemia & Lymphoma Society."
In response, Dana Howard, a spokesperson for Covered California, said "We are trying to keep the insurance affordable across the board. This is just part of trying to manage the overall risk of the pool."14
As a list of specialty drugs from Express Scripts shows, those who need specialty drugs are some of the sickest of the sick, including (but not limited to) transplant recipients and those with blood cell deficiency, cancer, immune deficiencies, and multiple sclerosis.15
Presumably, these are the types of people for whom ObamaCare is supposed to provide the most protection against major health-care costs. So why did California officials—those generous, compassionate, concerned-only-with-the-best-interests-of-their-constituents officials—permit insurers to charge huge co-pays to very sick enrollees in order to keep premiums low?
The officials running Covered California work directly for the state assemblymen and state senators, who must win reelection. If millions of people find their insurance is much more expensive on the exchange, then California's elected class could face major headaches on Election Day.
On the other hand, only about one in 100 users of commercial insurance need these expensive specialty drugs.16 If we assume, as Covered California does, that about 5.3 million will use the California exchange, then only about 53,000 people will need specialty drugs. To calculate the average number of people taking specialty drugs who are likely to be in a given state Assembly district and a given state Senate district, divide 53,000 by 80 and by 40. You get about 663 and 1,325, respectively. The average general-election margin for state Assembly in 2012—excluding races where candidates ran unopposed—was over 35,300. For Senators, it was more than 84,900.17 Six hundred sixty-three and 1,325 wouldn't even make a dent in that. Most politicians will have little to worry about from people who take specialty drugs and who are looking to hold someone responsible for the shabby deal they get through Covered California.
Furthermore, people on specialty drugs are probably too sick to engage in the sorts of activities necessary to make changes in policy – activities such as get-out-the-vote drives, protests and lobbying. Thus, California's officials probably don't have to worry much about specialty-drug consumers stirring up trouble.
There will undoubtedly be more examples of this inequity as ObamaCare unfolds, because, as government expands more and more into a health care system, the health care available is determined less by need and more by political clout. In general, the sicker one becomes, the less political clout one has. Few people get seriously ill each year, meaning that they are not a substantial number of voters. And most are in no physical condition to be actively engaged in politics.
So when it comes time to cut costs, guess who is going to feel the brunt of it? Covered California just provided a prime example.
David Hogberg, Ph.D., is a health care policy analyst for the National Center for Public Policy Research.
1 "Covered California Announces Plans and Rates for 2014," Covered California News, May 23, 2103, at http://www.coveredca.com/news/press-releases/pr-05-23-13-plans-anounced.html (June 6, 2013).
2 Philip Klein, "Don't be fooled by California's premium claims," Washington Examiner, May 23, 2013, at http://washingtonexaminer.com/dont-be-fooled-by-californias-premium-claims/article/2530379 (June 10, 2013); and Lanhee Chen, "California Fudges the Math on Obamacare," Bloomberg, Many 24, 2013, at http://www.bloomberg.com/news/2013-05-24/california-fudges-the-math-on-obamacare.html (June 10, 2013).
3 Avik Roy, "The War on Bros: Exchange Subsidies Won't Protect Young People From Obamacare's Higher Insurance Premiums," The Apothecary at Forbes, June 7, 2013, at http://www.forbes.com/sites/theapothecary/2013/06/07/the-war-on-bros-exchange-subsidies-wont-protect-young-people-from-obamacares-higher-insurance-premiums/ (June 8, 2013).
4 Conrad F. Meier, "Destroying Insurance Markets," Council for Affordable Health Insurance and The Heartland Institute, 2005, at http://www.cahi.org/cahi_contents/resources/pdf/destroyinginsmrkts05.pdf (June 4, 2013).
5 The actual fines are whichever is greater: in 2014, $95 or .5 percent of income; in 2015, $395 or 1.5 percent of income; and in 2016, $695 or 2.5 percent of income. For the sake of simplicity the article only uses the $95, $395, and $695 figures.
6 Jonathan Cohn, "Un-rigging the Rate-Shock Debate; The Truth About What Those Healthy 25-Year-Olds Will Pay," The New Republic, June 5, 2013, at http://www.newrepublic.com/article/113392/obamacare-rate-shock-debate-subsidies-make-huge-difference# (June 7, 2010).
7 "Subsidy Calculator; Premium Assistance for Coverage In Exchanges," The Henry J. Kaiser Family Foundation, at http://kff.org/interactive/subsidy-calculator/ (Jun 10, 2013).
8 To calculate the silver premium for a 25-year-old in California, I age-adjusted the premium for a 21-year-old in California. Premium for a 21-year-old available at "Health Plans & Rates for 2014: Making the Individual Market in California Affordable, Covered California, May 23, 2013, p. 30, at http://www.coveredca.com/news/PDFs/CC_Health_Plans_Booklet.pdf (June 1, 2013); Age-band rating available at Lind J. Blumberg and Matthew Buettgens, "Why the ACA's Limits on Age-Rating Will Not Cause 'Rate Shock': Distributional Implications for Limited Age Bands in Nongroup Health Insurance," The Urban Institute, March 2013, p2, at http://www.rwjf.org/content/dam/farm/reports/issue_briefs/2013/rwjf404637 (May 30, 2013).
9 "Health Plans & Rates for 2014: Making the Individual Market in California Affordable," Covered California, May 23, 2013, p. 33, at http://www.coveredca.com/news/PDFs/CC_Health_Plans_Booklet.pdf (June 1, 2013).
10 "HIB-2. Health Insurance Coverage Status and Type of Coverage—All Persons by Age and Sex: 1999 to 2011," U.S. Census Bureau, at http://www.census.gov/hhes/www/hlthins/data/historical/HIB_tables.html (June 1, 2013).
11 Chad Terhune, "Insurers limit doctors, hospitals in state-run exchange plans," Los Angeles Times, May 24, 2013, at http://articles.latimes.com/2013/may/24/business/la-fi-health-rates-deals-20130525 (June 1, 2013).
12 "Employer Health Benefits, 2012 Annual Survey," The Kaiser Family Foundation and Health Research & Education Trust, 2012, p.67, at http://kaiserfamilyfoundation.files.wordpress.com/2013/04/8345.pdf (June 2, 2013).
13 Jonathan Cohn, "California Will Be Spared The Obamacare Apocalypse. No Sticker shock here—just affordable insurance premiums," The New Republic, May 24, 2013, at http://www.newrepublic.com/article/113289/obamacare-california-no-sticker-shock-here (May 27, 2013).
14 Ricardo Alonzo-Zaldivar, "Huge Drug Cost Disparities Seen in Health Overhaul," Associated Press, May 13, 2013, at http://swampland.time.com/2013/05/13/huge-drug-cost-disparities-seen-in-health-overhaul/ (May 14, 2013).
15 "Specialty Drug List by Disease State," Express Scripts, December 14, 2012, at http://hrweb.mit.edu/system/files/all/benefits/publications/health_prescription_sdlist.pdf (Jun 7, 2010).
16 Ha. T. Tu and Divya R. Samuel, "Limited Options to Manage Specialty Drug Spending," Center for Studying Health System Change, HSC Research Brief No. 22, April 2012, at http://www.hschange.org/CONTENT/1286/ (May 14, 2013).
17 "California State Assembly elections, 2012," Wikipedia, at http://en.wikipedia.org/wiki/California_State_Assembly_elections,_2012 (June 10, 2013);
"California State Senate elections, 2012," Wikipedia, at http://en.wikipedia.org/wiki/California_State_Senate_elections,_2012 (June 10, 2013).