The Simple Arithmetic of the ACA Individual Insurance Marketplace

If you have been following the news you know that 2016 has been rife with major health insurance issuers leaving the health care exchanges, i.e. Obamacare.  Some have thrown the entire line of business under the bus claiming that it will always be unprofitable.  Others like Aetna, that is the most recent exit, were less pessimistic in the long run but were losing gobs of money in the short run.  Their CEO blames Risk Adjustment saying it wasn’t properly reimbursing them for their relatively unhealthy population.  This is of course a stupid thing to say and I will point out why.  The interesting question in my mind is still whether there is a stable profitable equilibrium for the individual marketplace and this post will explore the simple arithmetic for determining this.  The answer will become particularly important if some markets are reduced to having only one issuer.

So I said simple arithmetic.  That is because the profitability of the marketplace as a whole is really quite simple, money in has to be greater than money out.  The input is member premium and government subsidies (Advanced Premium Tax Credit and Cost Sharing Reduction).  Money out is medical claims cost.  You will notice Risk Adjustment (RA) is not in there.  RA is a zero sum transfer between insurance issuers, it does not affect the sustainability of the market as whole, only the profitability of an individual issuer.  It also becomes moot if there is only one issuer.  When Aetna whines about RA they are essentially saying that they want a piece of their competitor’s profits.

Now both sides of our expression are variable based on which members are purchasing insurance.  Even with a tax penalty, not everyone will buy insurance.  So if you jack up the premium, your healthier population will likely take the penalty and you lose their premium while medical costs will only go down slightly as sicker individuals that incur most claims will continue to purchase.  Thus the question simplifies to: is there an equilibrium premium that keeps enough healthy people paying premium to cover the medical costs of the unhealthy people?

This is slightly complicated by the government subsidies which are mutable based on the marketplace.  The CSR depends on the out-of-pocket (OOP) limits of the plan.  This will induce more healthy people to purchase insurance (since the benefits are greater) and issuers are really only on the hook for very sick patients that blow through their OOP expenses.  A plan design that maximized the Max OOP expenses will extract the largest subsidy from the government.

Similarly, the APTC is based off the second lowest cost silver plan.  If issuers become monopolies in their market they could potentially set the price of this plan to whatever they want and thus determine the APTC.  This allows them to extract whatever they want from the government.  And much like CSRs we would expect more people to purchase insurance if the issuer sets the APTC such that it covers a large portion of a bronze or lowest cost silver plan.

People talk about the pillars of the ACA: no underwriting, subsidies and a mandate.  The first requires a mandate in order for healthy people to subsidize sick people.  Otherwise healthy people opt out because the premium price is higher than their expected value from insurance.  However, the presence of subsidies suggests the writers of the ACA think even the tax penalty is not enough to create a market equilibrium where expected medical costs are lower than expected premium.  In other words, the writers of the law think the only way private health insurance that covers everyone with no underwriting can be profitable is essentially if the government is the one supplying the profits!

The conclusion then is that health insurance for all is not profitable and furthermore the current design of the ACA is probably not welfare maximizing.  The tax penalty is inducing people to purchase insurance that is costlier to them than not having insurance.  This is a classic situation for government provision of a public good and instead we have a system that BY DESIGN requires the government to pump money into it for private insurers to be profitable.

Thus the only rational next step is a public option/single payer system.





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