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Confronting Fears of the Obamacare Death Spiral

November 02, 2016
Obamacare’s individual mandate has been one of the most controversial parts of the legislation. But what does the individual mandate entail? What is a market death spiral? In this piece, Wonk Tank’s Health, Education, and Welfare team explores the topic.

Background

Since its passage into law in 2010, Obamacare’s success has been inextricably tied to the online healthcare marketplace, Healthcare.gov. The website currently provides health insurance for over 10 million previously uncovered Americans. Just like online shopping, individuals can browse for plans that work for them while comparing prices. In theory, the scheme lowers the costs of healthcare by increasing competition among insurers – forcing them to lower premiums to attract more customers.

But why then, has Obama’s administration announced that premiums will rise on average up to 25% over the next year? Many fear that Obamacare will be lost in a cycle of ever increasing costs termed the “death spiral.”

According the death spiral model, rising costs will force relatively healthier people with less medical expenses to drop out of coverage. Healthier customers pay similar premiums as the sick, but are less likely to consume healthcare – thereby chipping in to insurer’s profits. As the insurance companies lose their healthy and profitable customers, they have to hike up their premiums to stay in business.  The premium hikes then lead to the continuation of the cycle.

The Debate

 While the premium increases may seem unjustified to the public, they are due to a recalculation of costs as insurance providers get data from the first years of Obamacare. Experts predicted some of the rising costs, but underestimated the effects of the following three causes: (1) the immediate healthcare needs of the newly insured, (2) the low rates of young individuals joining the marketplace, and (3) the withdrawal of many insurers from the marketplace.

Misjudging New Enrollees

One of Obamacare’s most popular policies is that of ending discrimination based on pre-existing conditions. Previously, insurers could deny coverage to those who were already ill because they could predict the high costs of their medical expenses. As these costly-to-insure people rejoined insurance, they immediately began to use their coverage to consume healthcare that they desperately needed. In addition, many people who never had insurance before caught up on the healthcare they already needed.

Both of these groups inflicted high initial costs on insurance companies, and even drove some to shut down. Those that stayed in the marketplace are now calculating the effects of the first few years, and are raising their premiums to cover their losses.

Meanwhile, not enough young, healthy, and profitable individuals joined the marketplace to dilute the expensive, high-risk pool of newly insured people. Obamacare includes an individual mandate that requires all people to buy health insurance, and charges a fine on those who forgo coverage. This policy prevents people from joining insurance plans only when they get sick. 

Many young people who do not get insurance through their employers opt to pay the fine, which is still far cheaper than buying insurance. They prefer to take the risk of facing medical expenses out-of-pocket instead of spreading out their risk through insurance. Since young people are healthier than older folk, they are the most profitable age group for companies to insure. By forgoing insurance plans offered on the marketplace, they drive up premium costs by not weighing them down. 

Fewer Insurers, Less Competition

Lastly, many insurers are either pulling out of the market or shutting down, leading to a notable disparity in the number of regionally available insurance companies. As previously mentioned, the immediate costs of the newly insured has led some insurance providers to either close or withdraw coverage from unprofitable locations. Additionally, Aetna and United Health Care, two massive insurance companies, recently withdrew from the marketplace. This has left states like Alaska, Wyoming, Alabama, South Carolina, and Oklahoma with only one insurer on the marketplace for 2017. Furthermore, seventeen of the twenty-six co-ops initiated by the federal government to provide insurance have failed. As the numbers of insurers on the federal marketplace declines, less competition has allowed for companies to charge higher premiums.

A Second Glance

While the rising premiums certainly imitate the beginnings of a bleak death spiral, a second glance at their driving forces provides some consolation. Much of the costs imposed by the newly insured are limited to the short-term, as enrollees utilize healthcare to catch up on tests and treatments. Once they are caught up, their expenses will normalize, and premiums may drop again. Additionally, campaigns to enroll young folk on the online marketplace have been initiated, and their successful fruits may lead to lower premiums as well.

On the other hand, insurers pulling out of the marketplace could lead to long-term premium hikes as competition drops. This muddies the optimistic prospects of lower premiums in the future.

Only time will reveal if Obamacare will descend into a death spiral of rising costs. Much of its survival will depend on the results of the November election and the ability of policy makers to patch up the holes in its design.

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  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.

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