Most of the recent news of the Affordable Care Act (ACA) has been centered on its effects on insurance premiums throughout the country. The information has been mixed. Some stories highlight premiums that will skyrocket, yet others show that some insurance premiums will be lower.
For instance, New York State released data showing that premiums would drop by 27 percent throughout the state, while data from Virginia shows that premiums for some people will increase by more than 60 percent.
Of course, both supporters and opponents of Obamacare latch on to each of these stories both say: “see, I told you so!” So what gives? Can both sides be right?
Due to the nature of current state insurance regulations and their interactions with Obamacare, some states will see higher average premiums and others will see average lower premiums. In other words, what happens to your insurance premiums depends on where you live and what insurance regulations existed in your state before Obamacare.
There are three major insurance regulations that are part of Obamacare that—when taken all together—are supposed to even out the costs of healthcare across the entire population.
Community Rating: One can think of this regulation as a restriction on pricing people based on their risk. Down to the fundamentals, insurance is priced based on a person’s likelihood of incurring a large cost. Suppose you have a 5 percent chance of getting very ill any given year and this illness will cost you $10,000. In order to protect yourself from that large, unexpected cost, you are willing to pay the insurance company a premium of $500 a year (5% times $10,000). If you do get sick, the insurance company will pay.
Community rating limits the amount an insurance company can charge an individual based on their expected risk. Suppose lawmakers think a $500 premium is too much for one person, no matter what their risk, and decide that an individual’s premium can no longer exceed $400 dollars. Since the insurance company can no longer charge an actuarially fair premium (a fancy term for charging based on risk level), it will lose $100 per year on this high-risk individual. In order to stay in business, it needs to raise premiums for everyone else to make up for the loss.
Currently 18 states have Community Rating regulations on health insurance. It is also worth noting that how states do this differs.
Guaranteed Issue: This regulation is what President Obama refers to when he says that no one will be turned away with “preexisting conditions.” This prevents insurance companies from turning anyone away that may be very expensive to insure.
This regulation ties into community rating. As you can imagine, with community rating, insurance companies have an incentive to turn-away very sick individuals because they are not allowed to adjust their premiums according to their risk. There is a 100 percent chance a person with preexisting conditions will cost the insurance company money. If companies are forced to insure these people, this will also drive up average premiums throughout the market, as insurance companies spread the cost of these individuals to everyone.
Before discussing the final regulation, it is worth mentioning the effects that these two regulations have on insurance markets. Not only do these regulations drive up insurance premiums for everyone except the very ill, they also drive healthy people out of the insurance market.
Economists refer to this as “adverse selection.” Simply put, this is a situation in which healthy individuals drop from the insurance market, thus leaving only sick and expensive individuals in the insurance pool, driving up premiums for those left in the market.
How does this happen? First, this assumes that people have a certain willingness to pay for insurance based on their risk. If I know I have a high chance of illness or injury due to my lifestyle, I am more willing to pay a higher premium. The opposite is true for safer individuals. They know that they won’t get very sick due to their lifestyle, they are not willing to pay a lot for insurance—and they probably won’t need the coverage.
With the regulations, however, some people are forced to pay higher premiums for their coverage than they want to. Specifically, community rating raises the average premium for everyone. Those who are low risk will not be willing to pay the new higher premium, so they will drop out of the market entirely.
It doesn’t stop there though. Since there are fewer people in the market now, average premiums will need to increase again because there are fewer people to share the cost of the very sick. Thus, another round of people will drop out of the insurance market. This continues until the only ones left in the market are the most expensive to insure, leaving insurance premiums very high.
So if you believe that these regulations are positive reforms, how would one stop this “adverse selection death spiral?” That brings us to the last regulation.
The Individual Mandate: This is the center piece of the Affordable Care Act. Without this, Community Rating and Guaranteed Issue would drive people out of the insurance market and drive prices up due to “adverse selection.” However, if you force people to stay in the market, it prevents the insurance market from going into the death spiral. The individual mandate tries to do this by imposing a fine (now a taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ) on those who do not have insurance.
As some mentioned, though, this fine is probably not substantial enough to keep everyone in the market. This may be one of the reasons why one study found that 26 million people still won’t be insured under Obamacare.
Put these all together, and you get an insurance market that spreads risk across all individuals. It has the effect of redistributing costs from older, sicker individuals to younger healthier individuals.
As mentioned before, some states have community rating and some have guaranteed issue, but none of the states (except Massachusetts) have an individual mandate. So you would expect these states to have higher than average insurance premiums due to these regulations.
For example, Maine (until very recently) had community rating and guaranteed issue, but no individual mandate. The result: people dropped out of the market, leaving only older and sicker individuals. Thus, Maine has very high premiums in the individual market. In fact, the average premium in Maine for a 27 year old is $1084 a month, while New Hampshire (which does not have these regulations) had average premiums of $219 a month: A huge difference even while the demographics in each state are similar.
So what happens when you introduce the individual mandate into Maine’s insurance market?
Theoretically, it will force people back into the market, and lower the average premiums for the states. In fact, according to data from the Manhattan Institute, premiums for 27-year-olds are predicted to drop by 80 percent to $216 a month.
What about a state that does not have any of these regulations?
Virginia, which has neither community rating or guaranteed issue, will be subject to all three of these regulations come 2014. What will happen to their prices? It depends on what group of people at which you are looking. As you would suspect, premiums for the elderly (64-year-old and up) will see rate reductions of 19 percent due to community rating, which prevents excessively high premiums for high risk individuals. However, those who are 27 or 40 years old will see price increases as the cost of the elderly will be redistributed to the younger, healthier individuals. On average, though, premiums will increase in the state.
Bottom line: premiums will go up or down depending on a state’s preexisting insurance regulations. So it isn’t exactly accurate to say that Obamacare will lower or raise premiums for all states, if you assume that everything in the law will go as planned. So keep these factors in mind when reading about the premium data released by states in the coming months.
If you want to keep track of the premium changes in your states, the Manhattan Institute has an excellent map that shows how premiums will move due to the Affordable Care Act.
Another article that discusses this: hereShare