Death Spirals



Money-Spiral-Image-for-PostA death spiral occurs when pricing in an insurance market spins out of control. If an insurance pool turns out to be more expensive than originally thought, the insurer must raise its premiums. As the premium rises, some healthy people drop their coverage. With a sicker group of enrollees, the average cost per enrollee will be higher and premiums must be increased again. That leads more healthy people to drop out—leading to more premium increases.

This cycle continues until the only people left in the pool are very sick and very expensive. They must be charged a premium that roughly equals the cost of their care. But this is a premium they can’t afford, of course, and so it is a premium the insurer cannot collect. The ultimate end of a death spiral is the insurance pool equivalent of bankruptcy.

The most common reason for a death spiral is government price fixing, usually in the form of community rating and guaranteed issue (where everyone is charged the same premium and the insurer must take all comers). Healthy people leave the pool because they are being over-charged. Sick people remain because they are being under-charged. This would not occur if each enrollee were charged a premium that reflects his/her actuarial risk.

Death spirals can also happen in an unregulated insurance market. It can occur, for example, if insurers offer to renew coverage indefinitely without adjusting individual premiums for changes in health conditions, while the enrollees are free to leave and find cheaper insurance if their health condition is better than average. (See the description here and note that “change of health status insurance” would eliminate this problem.)

Why is this topic important? Because the Obamacare exchanges are in danger of experiencing death spirals. The most obvious reason is the difficulty of enrolling. Unless things improve, only the sickest and most desperate customers will persist long enough and hard enough to successfully enroll, while the young and the healthy will find better things to do with their time. As Yuval Levin explains:

People who are highly motivated to get coverage in a community-rated insurance system are very likely to be in bad health. The healthy young man who sees an ad for his state exchange during a baseball game and loads up the site to get coverage—the dream consumer so essential to the design of the exchange system—will not keep trying 25 times over a week if the site is not working. The person with high health costs and no insurance will.

Even if the glitches get fixed and the exchanges operate as smoothly as originally envisioned (buying insurance was supposed to be as easy as buying an airline ticket at Travelocity), Obamacare faces a triple whammy that almost no one is paying attention to.

Here are the problems:

  1. State risk pools and the Obamacare risk pools are about to officially close and dump their high-cost enrollees on the health insurance exchanges.
  2. Both public and private employers are about to dump their retirees on the exchanges.
  3. Employees who are trapped by job lock will leave their employer plans and head toward the exchanges as well.

In all three cases, people with above-average health care costs will be attracted to the plans in the exchanges, and odds are they will go for the gold and platinum plans while they’re at it—because this insurance will look cheap, compared to their expected health care costs.

Before going on, let’s stop to reflect on how monumentally stupid the designers of Obamacare were in even allowing the possibility of what is about to happen. More on that below.

On January 1, 2014, the state of Texas will formally end its risk pool and the 23,000 people who are enrolled there are expected to seek insurance in the Texas (Obamacare) exchange instead. It will be a good deal for the state, which has been spending more than $12,000 per enrollee operating the pool. Other states will follow suit. So will the Obamacare risk pools—some run by state governments and some run by the federal government—which currently insure about 107,000 people.

Then there are city governments throughout the land that have promised post-retirement health care benefits to retirees who are not yet eligible for Medicare. This is the age group that is the most expensive to cover. Under health reform, not only are there federal subsidies in the exchanges, the law limits the premiums charged to no more than three times the premium charged to enrollees in their twenties (although the actual cost of coverage is more on the order of six to one). Detroit, for example, is trying to send 8,000 city retirees to the Michigan exchange.

Similar efforts are expected in the private sector. According to a Towers Watson survey, more than half of employers that offer health care benefits to pre-65-year-old and post-65-year-old retirees plan to discontinue them.

Then there are those currently trapped in jobs they would like to leave but don’t because their health condition would cause them to pay very high premiums or perhaps be denied insurance altogether. Here is liberal columnist Wendell Potter:

An untold number of Americans for all practical purposes are indentured servants in large corporations, locked into jobs they don’t like but won’t dare quit because of their employer-subsidized health coverage.

By making the discriminatory practices of insurance firms unlawful, which will bring to an end their ability to cherry pick only the policyholders they want—the young and healthy—the Affordable Care Act will give American workers the key to that lock.

I’m confident that this newfound freedom—taken for granted in every other developed country—will usher in an era of entrepreneurship and new business development, the likes of which we’ve never seen before. Our best and brightest will be able walk away from the jobs they’ve been shackled to and go into business for themselves or go to work for a smaller company—even one that doesn’t offer health care benefits—without fear of being uninsured.

Okay, even allowing for a lot of hyperbole, I think Potter is right about one thing. Millions of people will leave their employer plans and enroll in the exchange—paying premiums well below the expected cost of their care.

[There is a fourth whammy: Employers that self-insure (covering more than half of all insured workers) will find ways to dump their sickest employees on the exchange. The methods are somewhat complicated and it will take them a while to figure it out, however. So I'll reserve that for another day.]

What should the Obamacare designers have done? Here are four common sense suggestions:

Same subsidy for everyone. Any time the government subsidy is greater in the exchange than it is at work or in a risk pool, adverse selection is virtually guaranteed. The way to prevent that is to make sure the subsidy is uniform.

No dumping. In general, no health plan should be able to gain financially by dumping their sickest members on some other plan. If Detroit wants to send its retirees to the exchange, then insurers ought to be allowed to charge Detroit retirees a special premium equal to the average cost of that group. Similarly for risk pools—whether state or federal. They should have been required to maintain their previous level of effort, either by continuing their pools or by paying supplemental premiums for those members who go to the exchange.

Enforce a COBRA Rule. People coming to the exchange from an employer plan should be required to exhaust their COBRA benefits before being eligible for a new plan. This is another way of discouraging some health plans from dumping their sickest enrollees on other plans.

Penalize Gaming. Medicare Part B, Medicare Part D, and Medigap insurance are all guaranteed issue and community rated. Yet they have no mandate. The reason that works is because people are penalized if they do not enroll when they are eligible. Under Medigap, the person who waits to enroll until he has a health problem can be medically underwritten in many cases. If this had been done with Obamacare, the controversial mandate (the one that went all the way to the Supreme Court!) would never have been necessary.

[Cross-posted at Psychology Today and John Goodman's Health Policy Blog]

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