Death spirals loom for health insurers

Obamacare enrollment is already millions of people below original forecasts, and we could see two sorts of death spirals in the insurance exchanges of the Affordable Care Act because of premium inflexibility mandated by law and partisan unwillingness to make the necessary compromises to fix it.

It helps to think first about buying car insurance. If auto insurers were mandated to subsidize higher bad-driver premiums with lower good-driver premiums, and the penalties for not carrying insurance were negligible, good drivers would see insurance as a bad deal and would begin leaving the market. Eventually, only the bad drivers would be left, and the premiums would be so high that the car insurance market would collapse.

Now think of selling health insurance. The worst cases mean paying hundreds of thousands per patient for expensive drugs for multiple chronic illnesses and repeated hospital admissions and specialist consultations every year. In health care, the difference between a “safe driver” (i.e., a consumer who might spend a few hundred dollars a year on medical care) and a “risky driver” (i.e., a very sick consumer) is far greater in terms of costs. For every 100 health insurance customers, the rule of thumb is that just one of them will account for 30 percent of all costs, and that just five of them will account for 50 percent of all costs.

As an insurer, you don’t know how sick your customers could end up, and you’re on the hook if you get it wrong. Worse, with the ACA’s state insurance exchanges, you’re limited to pricing the riskier, sicker older customers at no more than three times the least-sick customers. That makes it a bargain for the sick and a bad deal for the young healthy customers. While the penalty for not having health insurance is the maximum of either $695 or 2.5 percent of family income, that’s a lot less than the cost of health insurance.

If an insurer gets its pricing wrong, it will make a loss and be forced to exit the business or increase premiums. But if you raise prices, those customers who don’t value your services as much as others will drop out. And who will be left? The sicker customers who know they’re going to get a better deal by staying insured with you.

But to make a profit, you also need those healthier folks onboard, contributing premiums but using fewer medical services. Without them you’ll make more of a loss, or you’ll fall victim to the death spiral of rising premiums, declining customers and higher costs. This isn’t theoretical; a generous Harvard health plan experienced such a classical death spiral some time ago.

Also, the same way a death spiral can occur within a health insurance company, it can also occur among a bunch of health insurance firms operating on the ACA’s insurance exchanges, like Covered California. If individual firms make a loss on their business or fail to make enough profit, they will withdraw from the insurance exchange. Their previous customers would seek insurance from the remaining participants, who can’t decline them. This would reduce the other firms’ profits and potentially prompt them to leave, too.

Could such a uber-death spiral occur in the insurance exchanges? Chances are yes, despite ACA design features to share losses. We know United Healthcare lost $2 million a day on that business in 2015; Highmark, $1 million a day; and Aetna lost 3 percent to 4 percent on each dollar of ACA business. Blue Cross and Blue Shield of North Carolina may lose more than $400 million on its Obamacare business and is sharply limiting ACA enrollment.

What can be done? On one extreme, a Medicare-for-all approach such as Sen. Bernie Sanders’ proposal dispenses with insurance completely. A more realistic market-based alternative would remove the mandate to purchase insurance and provide credits to poor, high-risk customers. Still other policies could include increasing competition by allowing insurers to sell across state boundaries, or better meeting customers needs by changing plan benefits and making them more affordable.

In an industry as important as health care, we need good, stable trajectories. But with the relentless partisan fights over Obamacare, don’t count on Republicans helping to prevent these ACA death spirals from speeding up.

Joel Hay is professor at USC School of Pharmacy. Marco Huesch is an assistant professor at USC Price School of Public Policy. Both are affiliated with USC’s Leonard D. Schaeffer Center for Health Policy and Economics.