Why Republicans Should Focus on Fixing Community Rating

by Reihan Salam

Ramesh Ponnuru, who warned against the defund strategy in late July, briefly addresses ways Republicans might seek to improve Obamacare in his latest column for Bloomberg View:

Obamacare’s supporters often suggest that Republicans should try to improve the law rather than junk it. (They say this more and more as the law’s flaws become clearer.) The prospect of improvement, though, is mostly an illusion. It’s not as though some set of major modifications to the law would command bipartisan support. Nor can the law really be pushed in a more conservative direction while retaining its basic character.

A few conservatives have suggested deregulating Obamacare’s exchanges to make it easier to provide policies with high deductibles. But that would mean offering people what the law’s advocates call “skimpy” coverage, which Health and Human Services Secretary Kathleen Sebelius has said isn’t real insurance. Deregulation would also fit poorly with the law’s requirement — one its supporters consider very important — that insurers treat sick people and healthy people exactly the same. Enforcing that rule requires a lot of regulation: What if an insurer offers policies that appeal more to healthy people? If you have a different view of how health insurance should work, you’d need to rewrite the law so much that you’d effectively replace it with something new. [Emphasis added]

Earlier this year, Avik Roy and Douglas Holtz-Eakin called for replacing or reforming Obamacare’s exchanges, and in doing so they criticized community rating, i.e., limitations on the ability of insurers to charge different customers different premiums, based on the expected cost of insurance coverage. In 2012, Avik explained the issues at stake as follows:

Young people are, on average, much healthier than older people, and consume less health care services. Ordinarily, therefore, young people are much cheaper to insure than older people. Under free-market conditions — what insurance pros call experience rating — the typical 18-year-old costs one-sixth what it costs to insure the typical 64-year-old.

But Obamacare, in a sop to the AARP, requires that insurers only charge three times as much to their costliest beneficiaries what they charge to their least-costly ones. As the illustration below shows, this increases the cost of insurance for the young by 75 percent, while offering only a modest 13 percent subsidy to older Americans.

At the same time, young people tend to earn lower incomes than older people. Caroline Porter of the Wall Street Journal reports that on average, young workers are 30 years old when they first earn a median-wage income of $42,000, and that the labor force participation rate of young people reached its lowest level in four decades last year. The implication, as Avik explains, is that limiting age rating will tend to increase the cost of the Obamacare subsidies:

What makes this doubly bad, in terms of policy, is that Obamacare spends trillions of dollars subsidizing the cost of insurance for the uninsured. And most people who are uninsured are young. In other words, Obamacare will more than double the cost of health insurance for many young people, and then the law will turn around and spend taxpayer dollars to subsidize the purchase of this newly costly insurance. Only in Washington does this make any sense.

Data from the Census shows that 55 percent of all uninsured Americans are under the age of 35. 72 percent are under the age of 45. The principal reason why they go without insurance is because it’s already too expensive, prior to the imposition of Obamacare. Young people usually have lower incomes, and far less savings, than older people do.

It would be interesting to see how the Congressional Budget Office would score a version of Obamacare in which younger people were able to buy experience-rated insurance products, with greater access to high-deductible plans and health savings accounts. My guess is that, if Congress repealed community rating, Obamacare’s subsidies would cost much less than they are expected to today.

If the Obamacare exchanges allowed insurers to charge up to six times as much to older people as they do to younger people, premiums for younger people would decline while premiums for older people would increase. As Porter reminds us, however, older people tend to earn higher incomes than younger people. They are also more likely to receive employer-sponsored coverage. Older people who lack access to employer-sponsored coverage and who earn low incomes would be eligible for subsidies. I’m hard pressed to understand why we wouldn’t allow for greater scope for experience-rated insurance products, unless we value keeping down unsubsidized insurance premiums for relatively affluent older people much more than we value holding down the costs of coverage expansion for the young. Even if we do place a high premium on protecting the economic interests of affluent older workers, failing to contain the cost of subsidies for the young will presumably lead to higher taxes on affluent older workers.

Essentially, Avik is calling for reforming community rating in a fairly limited way. A recent concept paper sponsored by the American Enterprise Institute — “Best of Both Worlds: Uniting Universal Coverage and Personal Choice in Health Care” — goes further:

The central innovation in our plan is the proposal to allow individualized pricing in the private insurance market. Neither the ACA nor the Ryan plan, nor any other alternative we are aware of, contemplates this shift in the marketplace. This tenet serves as the economic linchpin of our approach, which enables private markets to function without a mandate. The absence of individualized premium setting from the policy debate has hamstrung market-oriented approaches, which have relied on efficient markets but failed to solve the deep structural obstacles to a stable marketplace in which consumers will voluntarily purchase coverage. In addition to avoiding the need for a mandate, our plan makes the system of subsidies to the poor and sick more transparent, which we consider a virtue.

Although the progressivity of our model ultimately depends on subsidies, which are a political calculation, we anticipate that for any level of average subsidy our plan will be more progressive than the ACA. This is because the use of community rating to generate subsidies implicitly benefits relatively high-income individuals in poor health, whereas our model focuses subsidies on those with lower incomes. Yet, compared to the ACA, our plan focuses more heavily on the fiscal consequences for public spending and strives to reduce relative costs. As a result, we suggest the basic coverage be less than in the ACA, which typically strove to mandate coverage as generous as a typical plan. The subsidy system we propose is flexible so that it could be ratcheted up if desired, but our intent is to create a basic plan that includes incentives for consumers to be sensitive to the cost of care and means tests the subsidy so that individual medical spending is proportional to income.

There is much more to the “Best of Both Worlds” plan, which I hope to discuss at greater length in the future. It represents a dramatic break with Obamacare, and it includes a number of attractive ideas. Yet it is unlikely to gain political momentum, for a number of reasons. For example, it entails eliminating subsidies for employer-sponsored insurance, a step that would be met with intense resistance. Avik’s idea is modest in comparison, and quite easy to understand.

Rather than pursue a frontal attack on Obamacare, Avik and his allies favor a multi-pronged approach to use it as a vehicle for market-friendly health reform. As Ramesh makes clear, this will be challenging. But consider the following steps:

1. The individual mandate is very unpopular, yet Obamacare’s advocates claim that it is necessary, as the high cost of insurance might otherwise deter young, healthy people who earn enough to not be eligible for large subsidies yet who earn too little to be delighted by the prospect of paying for coverage. Allowing for broader age-rating bands would make insurance coverage far more attractive, thus reducing the need for the mandate. It might also significantly reduce the cost of subsidies.

2. The Christensen Institute has warned that tight regulations on insurance products sold on the Obamacare exchanges will limit low-end disruption opportunities, an issue I addressed in a recent Reuters opinion column. Ben Wanamaker and Devin Bean float the following idea for correcting this flaw:

As a hypothetical alternative, instead of subsidizing the purchase of [more comprehensive] Silver plans, patients could use subsidies to purchase Bronze plans coupled with a government-subsidized deposit into an HSA. This would enable payors to create disruptive plan, product, and service designs, rather than just funnel people into more costly Silver plans. However, as currently constituted, the ACA’s cost-sharing requirements will reinforce the incumbent reimbursement system and discourage disruptive innovation from the low end.

3. Reducing the bias against high-deductible plans might also make a low-cost “default coverage” strategy, as recommended by James Capretta, more viable.

4. And as Avik and Holtz-Eakin argue in their February op-ed, stable exchanges can become the foundation for shifting Medicare and Medicaid beneficiaries into a more competitive, cost-effective health system.

Right now, it’s hard to imagine Republican lawmakers embracing proposals like these. But if Obamacare proves durable, they will have to start thinking about how to keep its costs from spiraling from becoming unsustainable. The beauty of Avik’s focus on age rating is that it promises a tangible benefit to young people squeezed by the sluggish recovery and to taxpayers concerned about the cost of Obamacare subsidies.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.