Why Premiums Should Grow Faster than Health Costs under ACA; and, Why a Staged Rollout of Health Insurance Exchanges is a Feasible Budget Compromise

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Richard Evans / Scott Hinds / Ryan Baum

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@SecSovHealth

October 26, 2012

Why Premiums Should Grow Faster than Health Costs under ACA; and, Why a Staged Rollout of Health Insurance Exchanges is a Feasible Budget Compromise

  • The Affordable Care Act (ACA) subsidizes eligible households’ purchase of health insurance; in the first year of operation subsidies are geared to keep households’ premium costs below certain percentages of income
  • Subsidies are subject to two layers of indexing: ‘regular’ and ‘additional’. ‘Regular’ indexing applies in any year that health costs grow faster than wages – a condition that should be met in all or very nearly all of the next ten years. The consequence of regular indexing is that households’ premium costs grow at almost exactly the same rate as growth in health costs, thus under regular indexing we expect households purchasing health insurance on the exchanges to see premium cost growth of +/- 6 percent, v. wage growth of +/- 3 percent
  • ‘Additional’ indexing applies in 2019 and beyond if health costs grow faster than CPI; however if federal subsidies exceed 0.504 percent of GDP additional indexing applies before 2019. Because peak Medicaid eligibility probably will be closer to 100 percent of the federal poverty level (FPL) than the 138 FPL originally envisioned, many households between 100 and 138 FPL are likely to purchase heavily subsidized insurance on the exchanges right away, pushing federal subsidies above the 0.504 limit in the first year of exchange operations – if all states begin operating exchanges in the same year
  • Additional indexing constrains growth in subsidies such that households’ premium costs grow substantially faster than both wages and health costs. Expecting additional indexing to factor in immediately, we expect households’ premiums to grow at +/- 10 percent in the first decade of exchange operations, as compared to health cost growth of +/- 6 percent and wage growth of +/- 3 percent
  • The economic result is that over time fewer households purchase coverage, and households that do purchase coverage choose less and less generous plans; the political result is that the ACA becomes less and less popular
  • This strengthens our conviction that the ACA ultimately produces less gains in overall healthcare demand than generally expected – in fact we expect ACA to actually slightly reduce total healthcare demand
  • This also raises the possibility of a staged ACA roll-out – the 0.504 fail-safe can be avoided for several years – and deficit projections can be considerably reduced – by a staged roll-out of health insurance exchanges, rather than the current plan for all exchanges to start in the same year (with 2014 still standing as the technical deadline, though the odds of an all-state 2014 start are increasingly remote). We view a staged roll-out of the exchanges as a politically feasible means of: 1) reducing 10-year deficit projections (we estimate federal spending on subsidies of more than 1.3 trillion (in 2012 dollars) in the first decade of exchange operation); 2) avoiding the inconvenient truth that few states are prepared to meet the 2014 deadline; and, 3) avoiding (or delaying) a scenario in which households’ premiums grow substantially faster than health costs. Under a staged roll-out, not only would we expect ACA effects on demand to ultimately be very small (in fact slightly negative); we would also flatten / spread out any immediate unit demand ‘boost’ that would have been associated with a simultaneous 50-state roll-out of exchanges

The Affordable Care Act (ACA) provides subsidies to eligible households (incomes between 100% and 400% of the Federal Poverty Level or ‘FPL’) that purchase health insurance on the health insurance exchanges (HIEs). Subsidies are set such that a household’s share of premiums for the second lowest cost ‘silver’ (0.70 actuarial value) plan is no more than a given percentage of income. The maximum percentage of income paid by a household for the benchmark silver plan varies by income; households between 100 and 133 FPL pay no more than 2.0% of income; households between 300 and 400 FPL pay no more than 9.5% of income (Exhibit 1)

These limits on households’ premium costs as a percentage of income are subject to two types of indexing: ‘regular’, and ‘additional’. Generally speaking, regular indexing causes households’ premium costs to grow at or near the rate of growth in health costs[1]. Under regular indexing, the percentages in Exhibit 1 are increased by a factor equivalent to 1 plus the excess of health cost growth over wage growth. For simplicity assume a family earns $100 and is subject to a 4 percent of income premium maximum; in the first year the family’s maximum premium obligation is $4. If health cost growth is 6 percent and (national average) wage growth is 3 percent, the family’s premium cost in the second year is (.04) x (1.03), or 4.12 percent of income. Assuming the family’s income grew at the national average rate (3 percent), the family’s second year max premium is $103 x 4.12%, or $4.24. Thus the family’s max premium grew by 6 percent, exactly in line with health cost growth[2]. Regular indexing applies in any year during which health cost growth exceeds national average wage growth; we expect health cost growth to exceed wage growth for the foreseeable future, and thus expect regular indexing in practically all of the next ten years

‘Additional’ indexing increases the limits on households’ premium costs as a percentage of income by a factor equal to 1 plus the excess of health cost growth over CPI, i.e. by 1 plus the real rate of health cost growth. Additional indexing applies in years after 2018, unless total federal subsidies exceed 0.504 percent of GDP, in which case additional indexing applies as soon as the 0.504 threshold is breached

We expect the 0.504 threshold to be breached in the first year of exchange operation (Exhibit 2). In the wake of the SCOTUS ACA ruling, states are no longer likely to expand Medicaid to 138 FPL[3]; as a result many – perhaps most – households between 100 and 138 FPL now are likely to purchase subsidized coverage on the exchanges. Federal subsidies are larger for lower income households, thus the previously unexpected subsidy costs of households between 100 and 138 FPL are quite large – and more than likely large enough to push total federal subsidies over the 0.504 GDP limit in the first year of exchange operations

Where the effect of regular indexing was to grow households’ premium costs at roughly the rate of health cost inflation, the effect of additional indexing is to assure households’ premium costs grow substantially faster than health costs[4]. Depending on the year and on incomes as a percent of FPL, household premium costs grow at roughly 10 to 12 percent annually, as compared to nominal health cost growth of roughly 6 percent (Exhibit 3)

As a consequence, households’ participation on the exchanges is likely to decline with time; and, those households that do participate are likely to be increasingly biased toward less and less generous plans. Such an outcome is an amplified version of what we’ve already seen in the employer sponsored insurance (ESI) market: as health cost growth has exceeded wage growth, more and more households have defended their ‘net’ wages by either foregoing health coverage, or where possible by purchasing cheaper coverage (Exhibits 4, 5). Importantly, the observed decline in ESI uptake and generosity is the consequence of +/- 6 percent premium growth v. +/- 3 percent wage growth in households across nearly all income ranges; the headwind to uptake and generosity on the exchanges will be the consequence of +/- 10 percent premium growth v. +/- 3 percent wage growth among households in lower-middle (100 to 400 FPL) income ranges

The political consequences of subsidy-eligible households facing low-teens premium growth as soon as their second year of enrollment are obvious, and add to the growing list of reasons that a staged roll-out of the health insurance exchanges may be more palatable than the current plan that all exchanges begin operating in 2014. Very few states are prepared to begin exchange operations in 2014, and a staged roll-out would reduce both federal deficit projections and red-state political resistance to the ACA. Given the option of cutting popular current entitlements or delaying the implementation of a relatively unpopular planned entitlement, the likely choice seems rather clear

  1. This assumes no difference in the actuarial value or medical loss ratios of plans purchased in the years being compared
  2. For simplicity we ignore the fact that the family’s income grew faster than the FPL brackets, which grow at CPI. Because most households in subsidy-eligible income brackets will have income growth in excess of CPI, and because this growth tends to increase the household’s max premium, most households in subsidy eligible income ranges should actually see premium costs that grow faster than underlying health costs
  3. We expect most states to cap eligibility at 100 FPL for most beneficiaries; please see: “Medicaid Eligibility Capped at 100 FPL: The Logical Outcome of the SCOTUS ACA Ruling” SSR, llc; July 27, 2012
  4. Exhibit 3 uses Congressional Budget Office (CBO) figures for wage growth and inflation; we use our own estimate of health cost growth (3.9% in real terms), which is not substantially different from CBO’s long-term assumption
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