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Replacing Obamacare: Two elephants in the room

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As the Republicans scramble to repeal and replace the Affordable Care Act (ACA), they’re bumping into two unavoidable elephants in the room: basic actuarial and underwriting principles, and the high cost of medical care. Simply repealing Obamacare is relatively easy, but replacing it will be much more difficult because any new solution will need to grapple with these elephants head-on.

Basic actuarial and underwriting principles

With any type of insurance, you have to buy it before you need to make a claim. Any insured population faces the risk that sometime in the future, they may incur an event that would cause them significant financial stress, but they don’t know when that event may occur. So they buy insurance to protect themselves and their family. 

When they incur a claim, it’s funded by the premiums of the other insured people who aren’t making a claim. It’s called insurance risk-sharing.

Obamacare repeal underway 02:17

Think about it: You can’t buy life insurance if you wait until you get a diagnosis of a terminal illness. You can’t buy flood insurance when the forecast calls for a hurricane. And you can’t buy health insurance only when you get sick or suffer an accident and think you’ll need to make a claim.

If an insurer allows people to wait until just before they think they need the insurance to start paying premiums, it will go broke because it likely hasn’t collected enough money in premiums to cover the claim payments. That’s why before the ACA became effective, insurance companies were allowed to deny coverage to new applicants if they had preexisting medical conditions, or they were allowed to charge higher premiums for people who had such conditions.

Exclusions due to preexisting conditions were very unpopular before Obamacare, and eliminating them was one of its goals.

If an insurer incurs claims in excess of the aggregate premium payments, it needs to raise premiums for the current insured population. This could cause some people to drop coverage, which in turn might cause yet another premium increase as healthy people drop out of the insured pool. In the insurance business, this is called a “death spiral.”

Dismantling Obamacare 01:51

There are two realistic ways to broadly cover people who aren’t otherwise eligible for group health insurance through an employer:

  1. Implement incentives, penalties or mandates for individuals to buy insurance, like the ACA does. This is necessary if you want to prohibit unpopular exclusions for preexisting conditions while offering health care coverage broadly.
  2. Implement a single-payer system that requires coverage for everybody, for example, by expanding Medicare to cover all citizens, not just those age 65 and over.

A third approach also is possible, which has been tried without much success. That’s sponsoring high-risk medical plans with higher premiums to reflect the increased risk for people with preexisting conditions. Predictably, enrollment in such plans has been low because the premiums are often out of reach for the target audience (see below).

Any effective replacement plan for the ACA will need to include features of one of these solutions.

The high cost of medical care

Simply put, premiums for a basic health care plan are beyond the budgets of many low- and middle-income Americans. For example, according to a recent survey conducted by the Kaiser Family Foundation and the Health Research & Educational Trust, the average annual total cost of employer-provided health care for a family of four was $18,142 in 2016. On average, workers paid $5,277 toward the cost of that care, and employers subsidized the difference -- $12,865 per year. 

Trump on Obamacare 00:55

The average cost for single coverage was $6,435, with workers paying, on average, 18 percent of that cost, or $1,158. Again, employers subsidized the difference -- $5,277 per year.

To state the obvious, most low- and middle-income families can’t afford to buy health insurance without a huge subsidy from their employer.

Another subsidy is in play with employer-sponsored health care plans: Employers are allowed to deduct the cost of providing health care to employees when they file their taxes. By reducing their corporate income taxes, they’re effectively enjoying a subsidy from the federal government.

In most situations, individually purchased health insurance isn’t a tax-deductible expense, so individuals can’t enjoy the subsidies that are available to employers and their workers.

Stark choices

Some politicians advocate offering tax credits to purchase individual health insurance or allowing citizens to put money away for insurance in health savings accounts. At best, these are band-aid solutions to America’s health care challenges. They don’t come close to overcoming the two health care elephants, particularly for low- and middle-income citizens. 

The choices are pretty stark. If we don’t have universal coverage or an individual mandate, we need to be ready to allow hospitals, doctors, and health care providers to turn away uninsured patients. Otherwise, they won’t receive the revenues they need to keep their doors open.  As a society, we would need to accept that the uninsured won’t be treated.

Regarding the cost issue, it’s an inescapable fact that collectively the institutions, employers or citizens who have money will need to subsidize some portion of medical costs for the citizens who don’t. Otherwise, as a society, we need to accept that the less fortunate among us won’t be treated.

If the Republicans repeal Obamacare without an immediate effective replacement plan, it’s an admission that they’re unable or unwilling to wrestle with these big elephants.

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