Will Obamacare tip the health insurance industry into a “death spiral” that ends in market collapse? While there is growing debate on that question, both sides seem to agree that, to avoid such a collapse, the Obamacare exchanges must enroll a sufficient number of young (and presumably healthy) adults. So, the other week when HHS released updated exchange enrollment data, the figure drawing the most attention was 24 percent—the share of enrollees between the ages of eighteen and thirty-four.
Ezra Klein, then still with The Washington Post , promptly weighed in with “ The Death of the Obamacare Death Spiral .” He began by noting that the young adult enrollment figure is “below the 38 percent that most people—including the Obama administration—estimate the law needs if it's to keep premiums as low as everyone hopes.” But he then followed that caveat with arguments for why young-adult enrollment is already sufficient to avoid a death spiral, and will likely increase in the coming months.
Yet, what Klein and others—including those who think a death spiral more likely—are missing is that market collapse is neither the only, nor the most probable, ugly destination for Obamacare. To understand why, it is helpful to start with some basics.
An insurance death spiral occurs when government imposes insurance regulations that skew a market’s normal risk mix, so that the resulting pool contains a larger share of “bad” risks. Insurers must then increase premiums to cover the costs of the additional bad risks. If the risk distribution is sufficiently skewed, a negative feedback loop can set in: the escalation in premiums becomes self-reinforcing and, over time, drives out all but the worst risks and the most deep-pocketed insurers. Eventually premiums reach levels unaffordable for even the worst risks, and any remaining insurers throw in the towel. With neither sellers nor buyers left, the market collapses.
However, when bad insurance regulations (as in Obamacare) are accompanied by government coverage subsidies (again, as in Obamacare), the “adverse selection” dynamic that drives a death spiral can still occur, but will take longer to play out, as the subsidies partially shield enrollees from the premium increases. Furthermore, if the subsidies are big enough, the spiral may never reach the point that all insurers exit the market. Rather, the market can stabilize with a few participating insurers dependent on large (and growing) public subsidies.
To illustrate, Medicaid includes lots of sick people, but there will always be a few insurers willing to cover them through Medicaid managed-care plans provided that the government subsidies are big enough. In such situations, the subsidy effects outweigh the selection effects. The fact that many healthy people who qualify for Medicaid don’t enroll makes little difference to Medicaid managed care plans. Insurers simply take it as given that the pool has a disproportionately high share of bad risks. They base their participation decisions on whether they will be adequately paid for taking on those risks, and will have sufficient flexibility to manage them, such that they can still make a profit.
Obamacare’s large subsidies mean that the program is likely to devolve into something much closer to Medicaid than to market collapse. Furthermore, the key determinant it is not just the presence of subsidies, but the design of those subsidies.
In that regard, Klein mentions another, more telling figure in the HHS data, but appears to miss its significance. According to HHS, 60 percent of enrollees chose a plan in the “silver” coverage level. Klein’s take is that, “People are opting for reasonably generous plans.” To support that interpretation, he quotes from Jonathan Cohn’s analysis at The New Republic , but he doesn’t include the sentence in which Cohn touches on the real explanation: “One reason for silver’s popularity may be that the law provides lower income people with extra assistance to handle out-of-pocket expenses, but only if they select silver policies.”
Actually, that is not one reason; it is the main reason.
While, reporting and commentary across the political spectrum has focused mostly on Obamacare’s premium subsidies, it is the cost-sharing subsidies that are a key driver of Obamacare’s unfolding dynamics—something I discuss at length in a recent paper .
Here is how it works. Obamacare requires a silver-level plan to have an actuarial value of 70 percent: the plan must pay 70 percent of the average enrollee’s total medical expenses for covered benefits, with the enrollee paying the rest through deductibles and copayments. In comparison, the actuarial value level for bronze plans is set at 60 percent, while those for gold and platinum plans are set at 80 and 90 percent, respectively.
But, the cost-sharing subsidies pay insurers to reduce the deductibles and copays for enrollees picking silver plans, based on each enrollee’s income. Obamacare stipulates that HHS is to pay insurers subsidies sufficient to cover the cost of increasing the actuarial value of a silver plan from 70 percent to 73 percent for those with incomes between 200 and 250 percent of the federal poverty level (FPL), to 87 percent (almost “platinum” level) for those with incomes between 150 and 200 percent of the FPL, and to 94 percent (higher than “platinum” level) for those with incomes between 100 and 150 percent of the FPL.