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An Insurance Death Spiral?



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The severe technical problems that continue to plague the federal Obamacare exchanges (and some state-run ones) have got people contemplating some pretty extraordinary scenarios.

Some of these have to do expressly with the fact that people cannot readily obtain coverage. The idea of delaying the individual mandate, which not two weeks ago was dismissed by the Democrats as a right-wing fantasy, is now being advanced by some Democratic senators, since you can’t very well fine people for not being able to use a site that doesn’t work. We may (and should) soon be talking about “grandfathering” all 2013 insurance plans, too, as millions of people in the individual market have their coverage cancelled with nowhere to go.

But the scenario most frequently talked about is the possibility of an “insurance death spiral” in the exchanges. And here I think two kinds of misunderstanding have been rampant — one that might cause us to understate the danger and another that might cause us to overstate it. Major adverse selection problems in the exchanges are, and always have been, likely, but a death spiral as it is usually understood is not. 

An insurance death spiral, or adverse-selection spiral, would be a kind of second-order consequence of the website fiasco: The fact that it is so difficult to sign up for exchange coverage may mean that only highly motivated consumers do sign up, and those are likely to be people with high expected health costs. If the exchanges end up containing too many people in poor health and not enough people in good health, insurers could take massive losses in 2014 and be forced to dramatically raise premiums for 2015 plans to better price the risk they would be taking on. Those higher premiums would cause even more healthy people to avoid getting coverage, leaving the risk pool in even worse shape and so driving even further premiums hikes, and the cycle would continue. Several states have seen this kind of catastrophic degradation of insurance risk pools over the years when introducing insurance rules like those that will govern the exchanges (most notably New York and Washington State, as Peter Suderman noted this week), and many observers (not to mention insurers) now fear we may see it in the new exchange system.

The first kind of misunderstanding of this risk understates it by attributing it fundamentally to the website problems. But while the danger of badly imbalanced risk pools in the exchanges may be exacerbated by the technical difficulties with online enrollment, it is first and foremost a function of the very poor design of the exchange system itself. The system was already precariously perched at the edge of disaster and the website’s woes may push it over the edge, but they are not responsible for the danger in the first place.

This helps explain some of the bafflement of Obamacare’s supporters at the extent of the trouble the program suddenly seems to be in. There was always a possibility of technical problems with the rollout, of course. Senator Max Baucus famously warned of a coming “train wreck” six months ago (and many lowlier observers did too). Obamacare’s champions didn’t deny there could be problems, but how could they run this deep? How could mere website snafus cause so much trouble? 

The president’s plaintive insistence this week that “the product is good” even if the website is bad is a form of this perplexity, and its tone is understandable. If you believe the exchange system was well-suited to achieve its goals, then surely technical challenges to enrollment should not send it reeling. But the fact is that the system was not well-suited to achieve its goals. To provide affordable insurance to people with preexisting conditions, it depends on attracting millions of young, healthy Americans, many of whom do not currently have health insurance because they do not think it is worth their while to buy it, and yet it makes insurance both more expensive and less valuable for precisely those same people. The new insurance rules mean that sick and healthy people are charged essentially the same for coverage, which means healthy people will often need to pay more in the new system than in the old and that the value of the protection from the risk of high future costs afforded to the healthy is diminished, since that risk is diminished. (I took up the reasons for this in more detail here last month.) 

The economics of this always struck many people as implausible, and neither the individual mandate nor the exchange subsidies are self-evidently adequate to change that for young and healthy people. Well before the rollout of the exchanges proved disastrous, then, the potential of the exchange system to attract enough healthy clients seemed at the very least an open question. In that context, it is easier to see how the additional hit of the technical failures — and the resulting increased risk of an imbalanced risk pool — could threaten the viability of the system. It is not just the magnitude of the technical problems but also the prior design problem of the exchange system that raises the possibility of an adverse-selection disaster.

But that possibility takes us to the second misunderstanding evident in some (though of course not all) of the coverage of this problem. The talk of a death spiral in recent days has often overlooked a crucial feature of the exchange system that provides a major cushion against the effects of cascading adverse selection, though not against a whole host of other related problems. 

This protection is not a function of the law’s explicit risk-sharing and anti-selection provisions — which are designed to protect against insurers’ cherry-picking healthy customers, rather than an exodus of the healthy from the risk pool altogether. Rather, the protection is a function of the design of the law’s exchange subsidies.

An insurance death spiral is a feedback phenomenon — a bad risk pool in Year One causes drastically higher premiums in Year Two which causes an even worse pool that year and on and on. The key to it is that it causes consumer premiums to go up so that only people with high expected health costs (for whom the high premium is still less expensive than staying uninsured) stay in and drive the cycle on. But in the Obamacare exchanges, the subsidy system is intended to prevent people from feeling the effect of annual premium increases after the first year. The subsidies are designed to make sure that each recipient pays only a certain percentage of his income in premium costs. That percentage stays essentially the same year after year, so if premiums get more expensive the government covers the difference.

In other words, if premiums for coverage purchased in the exchanges were to double or triple in 2015 because of severe adverse selection, people eligible for subsides would still pay the same amount they did in 2014 (assuming their incomes didn’t change) and the federal government would pay for the entirety of the increase. Subsidized beneficiaries would therefore not feel the effect and the healthy among them would not necessarily have much reason to flee the exchanges. 

The Congressional Budget Office estimates that about 86 percent of the people who buy coverage in the exchanges in 2014 will receive subsidies. The technical problems limiting enrollment may mean that figure is even higher (since the incentive to enroll is much greater if you’re eligible for subsidies than if you’re not). Those individuals would not feel the effect of second-year premium spikes, which means the result of such spikes, if they were to happen, would likely not fall into the usual pattern of an adverse-selection spiral.

Instead, the sort of severe adverse selection the exchanges may experience would dramatically increase federal spending and would drive unsubsidized exchange participants (other than those in very poor health) and many insurers out of the exchanges. It could also destabilize the portion of the individual market that remains outside the exchanges, since it will not be possible to keep the parts of the individual market that are inside and outside the exchanges quite separate (in no small part because Obamacare requires insurers to treat plans they sell in those two markets as drawing on a single risk pool). And it would be difficult to shield the employer-based insurance system from such effects too; if the exchange system were to become simply an ultra-expensive and poorly formed high-risk pool, the entire insurance system would pay the price. 

The effects, in other words, would be very problematic, and may well make the exchange system unsustainable as a fiscal matter and the larger insurance system highly unstable and more expensive. But it may not be right to call those effects an insurance death spiral, as the absence of price effects for exchange consumers means that you would not necessarily see cascading selection effects year after year.

This may be one reason why the Obama administration seems to think it can ride out the enormous problems the system may now be facing even if the enrollment failures are not addressed quickly. They could well believe that getting to Year Two, whatever the cost, is the way to stabilize things if the problems now presenting themselves do turn out to be as serious as some fear.

Maybe they’re right, and maybe they’re not. The cost of just plowing through these problems could be very grave, not just for the exchange system but for the larger insurance and health-care systems, and it’s not clear that things would stabilize after a year of disorder. The administration may believe that the political costs to the president and his party of putting the new system or some large parts of it on hold would be even greater, though they may be underestimating the political costs of just pushing ahead.

No one can know how all this will go. We don’t know yet just how deep the website issues run and how long they will take to address, and the basic technocratic assumptions underlying Obamacare’s health economics are themselves of course much in contention. This could be worse than it seems or not as bad as it seems. But in considering how we got here and where we may be going, it is surely helpful at the very least to keep in mind the basic architecture of the law.



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