A Primer on Replacing Obamacare

“For every complex problem, there is a solution that is clear, simple, and wrong.” – HL Menken

“Nobody knew that health care could be so complicated.” – President Donald J. Trump

For the last six years, congressional Republicans have had a clear, simple, and wrong solution to fixing the Affordable Care Act (ACA or “Obamacare”). They voted umpteen times to repeal it and offered no measure to replace it.

The law, as many laws are, is a complex compromise between aspiration (mostly by Democrats) and legislative reality. It was not perfect at birth and, like a six-year-old car that has had no maintenance, is in worse shape today. Had Republicans spent the last six years fixing the problems in Obamacare, it would be in much better shape. But that is all past. We must look to the future.

With Trump’s election as president, Republicans suddenly became the dog that caught the Obamacare car. What do they do with the thing? In my Open Letter to President-elect Trump and the Members of the 115^th Congress (on repealing Obamacare) I closed with these words:

If you do not have sufficient experience with the actuarial and underwriting principles that underpin the individual insurance marketplace, I urge you to work with the American Academy of Actuaries to understand how those principles relate to any proposed legislation before casting your vote.

Perhaps had President Trump reflected on my open letter he would not have been so surprised about the complexity of health care.

Fortunately, Congressional leaders recognized that the wrong approach of repealing without replacing a law that runs to 906 pages (and tens of thousands of pages of regulations) would lead to multiple disasters. With healthcare, even the minutia has minutia.

However, there are several broad truths about heath care that are important to keep in mind as we evaluate the Republican’s proposed replacement.

The total cost of medical insurance =

the total cost of medical benefits provided, plus

administrative costs, plus

profit

To reduce the cost of medical insurance requires reducing some or all of its three components.

Reducing corporate profits is not part of the Republican (or Democratic) agenda.

Everyone would like to reduce administrative costs, which everyone agrees are too high. There are very few incentives in place to reduce administrative costs. Obamacare forced certain insurers to rebate to their policyholders a portion of paid premiums if overhead, including profits, exceeded 20% (15% in the large-employer market) of premiums collected. I received a rebate related to my premiums for 2015 from my large-deductible medical care policy.

Moving to a one-payer system would probably reduce administrative costs. It has for other countries; but the U.S. has its unique issues, so I am not making promises. Shifting policies to give consumers a larger choice of insurance options will not materially affect administrative costs—and may increase marketing costs.

Which leaves us with reducing medical costs as the only practical method to reduce overall premiums.

Reducing the cost of medical benefits provided can be achieved by

(a) reducing costs charged to patients or their intermediaries (insurance companies or the government),

(b) shifting the costs from covered insurance to some other source of payment, or

(c) eliminating utilization of the benefit.

Reducing Costs Charged: Competition without collusion usually reduces costs. Republican proposals to allow insurance carriers to operate over state borders could offer additional competition and marginally reduce administrative costs. (Insurance companies often must keep separate corporate entities and books for each state in which they operate.) Changing laws to provide greater competition on drug prices would address that aspect of cost. Three steps Congress could take to reduce drug costs incurred are to allow Medicare to negotiate costs with drug companies, to outlaw the ability of a drug patentholder from paying another company to withhold a generic from the market, and to allow the public to import drugs from other countries when they are the same drug sold at a lower price.

Regulating provider prices (as Congress has tried with Medicare reimbursement rates) often leads to shortages of providers when doctors make the economic decision to stop accepting Medicare patients and concentrate instead on private insurance payments.

Shifting Costs from Covered Insurance: One of the most popular approaches to reducing medical insurance premiums is to shift costs from the policy elsewhere. The two major approaches are to increase the policy deductible and to cap expense reimbursements.

Before I became Medicare eligible, I purchased high-deductible insurance. I was healthy and gambled that my out-of-pocket medical costs would be less than the insurance costs of a low-deductible plan. However, if something major happened, I didn’t want to pay for that out-of-pocket. My insurance costs were significantly reduced – BUT at the cost of taking on considerable risk. (My gamble paid off for the fourteen years I had individual coverage.)

My behavior was affected, however. I thought twice before going to a doctor or agreeing to a test or procedure. This is a double-edged sword. Because I had monetary skin in the game, I was a more careful consumer. However, studies have shown that when people defer routine healthcare, the long-term costs of chronic diseases increases because the individual enters the health care system at a more advanced stage.

The two ways of limiting reimbursement is to impose a lifetime maximum or reimburse fixed amounts for a particular benefit (for example $200/day in the hospital). As costs increase and reimbursement does not, more of the total costs are shifted from the plan to the covered individual. (The same will happen to states if they receive block grants. Unless Congress continues to increase the block grants to match cost increases, the states must either pick up the tab or cut benefits to those covered.)

Eliminating Benefit Coverage: There are multiple ways to decrease benefits and reduce costs. Health care policies could exclude certain procedures now covered. They could decide to eliminate coverage for organ transplants, or abortions and birth control, or sex-change procedures, or wellness exams, or any drug that costs over $1,000 a year, or whatever was deemed legal. The United States could effectively ration health care by limiting the number of procedures performed each year. This is the approach Canada has taken to reduce costs: fewer procedures equals lower costs.

Reducing the number of covered individuals: Finally, the easiest way to reduce costs is to reduce the number of individuals covered. Increase Medicare’s eligibility age to seventy from sixty-five and you’ve eliminated five years of costs. Eliminate medical coverage for Medicaid-eligible individuals, and cut those costs.

Obamacare increased overall covered costs by including additional benefits in plans, decreasing the acceptable size of deductibles in order to avoid a tax-penalty (I had to pay a penalty the first year because my high-deductible plan did not qualify), and significantly expanding the number of individuals covered under medical insurance by allowing children to remain much longer under their parents’ policy and expanding Medicaid edibility for those states who accepted it.

Republicans currently claim their proposal will decrease medical costs. The question that we need to answer is how will they do it? What are the tradeoffs they are proposing? Whose ox is gored?

The truth about pre-existing conditions

I pay house insurance every year and I hope to lose money every year because I don’t want my house to burn down just so I can win. Even though I have “lost” money on my housing insurance every year, it’s reasonably fair. Actuaries and underwriters price my insurance based on my house’s size, structure, safety measures, type of wiring, how far it’s away from a fire hydrant and fire station, and so on. They can reflect all the pre-existing conditions of my house in determining the premium.

In the past, we have done the same thing with individual medical insurance. If you are a young, healthy male, don’t smoke, do drugs, or engage in risky avocations (motocross racing, for example), your medical insurance can be inexpensive. Your biggest risk is from accidental injury; you rarely get sick. And you don’t get pregnant, which is why individual insurance for women used to cost more than for men.

Until as a society we decided that wasn’t fair, and eliminated sex as a basis for determining premiums. Men now subsidize women in this regard.

Many group medical insurance plans charge the same premium regardless of age. Older folks have more medical issues than younger ones. The young subsidize their elders. This is also the case for Medicare. Young(er) beneficiaries generally cost less than their older compatriots, yet premium costs are the same.

Even where plans reflect age in their premiums, they may not reflect health status. All Medicare beneficiaries pay the same premiums (ignoring extra premiums paid based on income status). Healthy beneficiaries subsidize sicker ones.

When we turn to the individual insurance market, healthy people think premiums should be based on their age and health. Why should they pay to cover someone who is older, or overweight, or has diabetes? It’s a fair question and one that needs an answer.

Under Obamacare, the answer was essentially that the young and healthy had to join plans and pay more than their fair share as part of a societal good. The same extra costs that are buried in group plans now became embedded in individual plans. Younger individuals either joined and paid these extra costs through their premiums or chose not to join and paid the costs through a tax. Because Obamacare provided a financial mechanism for supporting the extra costs of those with pre-existing conditions, they could require insurance companies to provide coverage for those sicker people. It was up to insurance companies to enroll enough of the younger, healthy individuals to break even on the deal.

What happens under such a system? The sick sign up in a New York minute: it’s a great deal for them. It’s up to insurance companies to enroll enough healthy folks to pay the tab for the sick ones. Insurance companies set rates based on an assumption of how many sick and healthy people they could attract. Where they were unable to enroll as many younger healthy individuals as they planned, they lost money. To make up for those losses, they raised premium rates. In those areas of the country where states supported the new marketplaces, lots of younger people joined the plans. Competition remains and premiums increases are moderate. Where states did not support the new marketplace, enrollment was well below expectations, resulting in subsequent huge rate increases and carriers dropping out of the market.

The death spiral of individual plans

Those of us involved in employer group medical insurance saw this death spiral when employers first introduced optional higher-deductible plans in an attempt to lower their insurance costs. Back in the 1970s and early 1980’s, most plans had no or very small ($100 individual/$300 family) deductibles. Increasing the deductible to $250 or $500 produced significant savings relative to the costs at the time. Employees chose the plan that made the most economic sense to them. Healthy individuals and families rushed to the higher-deductible plans. Older and sicker individuals stayed with the old no-deductible plans.

At the same time, companies first introduced Flexible Spending Accounts, seeding them with money for those employees choosing the higher-deductible plans and allowing employees to set aside tax-free money to pay for the costs they would now need to pay out-of-pocket.

Note what employers did: they lowered plan costs and provided “tax credits” to help pay for the plans. The very same elements Republicans currently promote (although we do not yet know the details). How did that work?

The next year, the costs of the no-deductible plan increased significantly. It included sicker folks after all, and in the second year, those on the margin dropped their expensive coverage and selected the higher-deductible plan. Those folks in the high-cost plan were on average even sicker. In a short time, the high cost plan had astronomical premiums and the companies dropped those plans altogether.

Deductibles for everyone have continued to increase, as have premiums, but at least under the group plan concept, those with pre-existing conditions can still receive coverage, and that coverage is subsidized by their fellow employees.

Take the same scenario to the individual market and no such protection will exist for those with pre-existing conditions. With multiple insurance plans to choose from, the healthy will make economic decisions that will cause people with pre-existing conditions to experience that same cost death spiral. Sure, they won’t be denied insurance, but they won’t be able to afford it.

Squeeze the Balloon

Visualize medical costs as a balloon. Each new drug, each new treatment, each new test, each new procedure, each administrative change either blows more air into the balloon or lets a little out. Total U.S. medical expenses only decrease if we find ways to let air out of the balloon. Squeezing the balloon simply shifts who pays for it and makes the one doing the squeezing “good” by pushing costs away from their sector of the balloon.

Propositions such as changing Medicare from a single-payer system to a system in which all covered members receive a credit grant to allow them to shop for their own insurance does not affect the size of the balloon. It will affect who pays the costs, and, depending on its implementation, may create its own death spiral similar to the corporate experience of the 1970s and 1980s. Block grants shift responsibility and burdens from the Federal government and introduce additional inequities between states.

Conclusion

Above all, ignore the pretty words (and titles) politicians use to describe their laws.

When evaluating health care proposals, consider the specifics: how costs are being reduced, who will subsidize whom and by how much, and what incentives will counteract the inherent inequities in paying for medical plan costs.

~ Jim