(A version of this Health Alert was published by Forbes.)
Yesterday was the last date for open enrollment in Obamacare’s third season. Since October, at least six independent and credible sources have confirmed rate increases will be in the double digits. However, these are gross premium hikes. Net premium hikes paid by enrollees are distorted by tax credits paid to insurers. These badly designed tax credits have a number of perverse consequences. It is widely understood that they impose disincentives to work.
What is less well understood is that the tax credits are so badly designed that they impose a ratchet effect causing net premium hikes greater than the gross premium hikes. According to new research published by the National Center for Policy Analysis, this effect is concentrated among Obamacare enrollees in the lowest income brackets.
Plans offered on Obamacare exchanges are classified by metallic tiers: Bronze, Silver, Gold, or Platinum. Plans must cover a number of “essential benefits” (as defined by the Affordable Care Act, which established Obamacare). Insurers estimate how much it will cost to provide these benefits (“actuarial value”). Bronze plans cover 60 percent of actuarial value, while Silver plans cover 70 percent, Gold plans cover 80 percent, and Platinum plans cover 90 percent. Most analyses focus on Silver plans because tax credits are based on the premium of the Silver plan with the second lowest premium in a rating region.
This has significant implications for the actual rate increases experience by the majority of enrollees who stay with their 2015 plans in 2016. Tax credits are determined by an enrollee’s income and the benchmark (second-least expensive Silver) plan in his rating region. This introduces a ratchet effect, which can increase the net premium by a significantly higher percentage than the increase in gross premium.
Here is an actual example to further illustrate the problem, which emphasizes how volatile and unstable net premium changes are. Covered California, a state exchange not operated by the federal government, has six insurers offering Silver policies in the East Los Angeles rating region. In 2015, the gross annual premium for a 40-year old buying the lowest cost Silver plan was $2,760, offered by Health Net. The second-lowest cost Silver plan cost $3,084, offered by Anthem. It cost 12 percent more than Health Net’s plan. However, the 40-year old earning 150 percent of the FPL only paid $380 net premium for Health Net or $704 for Anthem. If he had chosen the most expensive Silver plan, offered by Kaiser Permanente, he would have paid a net premium of $1,064. For a 40-year old earning 250 percent of the FPL, the premiums would have been $2,039 for Health Net, $2,363 for Anthem, or $2,723 for Kaiser Permanente (See Table II).
For 2016, the lowest cost plan remains Health Net. However, the Health Net subscriber earning 150 percent of FPL sees a premium hike of 58 percent! This is because the second-lowest cost plan switches to Blue Shield, which had been the second-highest cost plan in 2015. (Anthem now takes that position, having increased its premium by 6.6 percent.) Blue Shield actually dropped its premium by 9.3 percent. By shrinking the gap between the lowest cost and second-lowest cost plan from 12 percent to just one percent, Blue Shield has also shrunk the relative value of the tax credit (which is based on the second-lowest cost Silver plan) when applied to the lowest cost plan.
Further, because of leverage introduced by the tax credit, the Anthem enrollee earning 150 percent of the FPL sees a net premium hike of 38 percent, while the enrollee earning 250 percent of FPL sees a net premium hike of 13 percent. Because of the design of the tax credits, the lower an enrollee’s income, the worse the ratchet effect.
Of course, the Blue Shield subscriber greatly benefits from this leverage. If he stays with Blue Shield, his premium goes down significantly. However, Blue Shield had previously been the second-highest cost plan. Few people enrolled in Silver plans with initially high premiums. Instead, 65 percent of 2014 enrollees signed up for the lowest or second-lowest cost plan. The number of people who benefit from having enrolled in an initially high cost plan that drops its premium will be much smaller than those who experience a significant premium increase for an initially low cost plan.
This previously unexamined ratchet effect explains why Obamacare enrollees are even more frustrated by their experience than most policy experts can explain. Any replacement or amendment to Obamacare will have to fix the way tax credits are allocated, if it is to win popular support.