Friday, September 3, 2010

Centrally Planning a Market Failure

Cross-posted from Critical Condition on National Review Online.

Earlier this year, Robert Book of the Heritage Foundation published an article that highlights a deeply troubling aspect of the Patient Protection and Affordable Care Act: the law gives the executive branch the power to wipe out the entire private health insurance industry.

At the time Book’s article was published, this problem got lost in the overall froth of the Obamacare debate. But as HHS Secretary Kathleen Sebelius moves to fill out the hundreds of thousands of pages of regulations that will define our new health care landscape, the issue is worth revisiting.

It sounds crazy, doesn’t it? How could the government destroy an entire industry? Here’s how PPACA gives the feds that power:

Forcing cost increases. Obamacare gives HHS regulators the authority to define minimum benefit packages for all insurance plans: should plans be required to cover psychiatrists’ bills? Fertility treatments? Etc. As these benefits cost money, the more requirements that HHS piles on to the “minimum” package, the more expensive your basic insurance plan will be.

Forcing price increases. The new law requires that insurers spend between 80 to 85 percent of the premiums they collect on health care, leaving 15 to 20 percent for fraud prevention, directly provided services like nurse hotlines, administrative costs, and certain taxes. (The definition of “health care” for this purpose is far more complicated than it sounds, and is at present the subject of hotly contested deliberations among state insurance commissioners.) Since it’s really hard for insurers to cut the 15-20 percent, they will be forced by the law to raise premiums to cover the 80-85 percent. Insurers that don’t meet these “medical loss ratio” targets, or MLRs, will be forced to send rebates to policyholders to cover the difference.

Taxing expensive health plans. The “Cadillac tax” on health plans applies a 40 percent excise tax on plans with total premiums initially exceeding $8,500 for individuals and $23,000 for families. Because these dollar amounts are indexed to consumer inflation, not health-care inflation (which rises at a significantly faster rate), Towers Watson has estimated that more than 60 percent of large employers’ existing plans will qualify as Cadillac plans by 2018. The tax is paid by the insurer, who will then pass the extra costs onto beneficiaries, increasing premiums.

But employers’ existing plans won’t be legal under Obamacare: they will have to change significantly to accommodate the law’s blizzard of mandates and regulations. And as plans get more expensive, and insurers are forced to pay the Cadillac tax, they will have to raise premiums to pass the costs along. As Book calculates, “any premium greater than $13,600 [for an individual plan] would require a loss for the insurance company, regardless of how efficiently they operate,” effectively setting a ceiling on how expensive a health plan can be. (Critical to exactly how this math will play out will be Secretary Sebelius’ determination as to how the medical loss ratio must be calculated.)

On the other side, by requiring minimum benefits for all plans (which demagogic politicians always strive to expand), the law effectively sets a floor as to how cheap a health plan can be. Benefits cost money; the more benefits you require for the minimum plan, the higher the price of a minimum plan becomes.

Book rightly asks the obvious question: “What happens when the ‘floor’ is above the ‘ceiling’?” It’s pretty simple: private insurers will be unable to break even, and will go out of business, leading to predictable lamentations from the left that the “market has failed” and that it’s high time for a government-run single-payer system to come to the rescue.

Tellingly, the most powerful committee chairmen in Congress, like Henry Waxman, Max Baucus, and Sander Levin, are striving to accelerate this process, by requiring that income taxes paid by insurers count against the medical loss ratio targets. Aside from the manifest unfairness of such a ploy—the taxes that insurers pay have nothing to do with insurers’ efficiency in providing medical care—it is contrary to the plain language of PPACA, which excludes most taxes from the MLR calculation.

This is what happens when you put the fate of an entire industry in the hands of politicians.


  1. I am not following this line of reasoning. Are insurance companies in states with more requirements going away? As log as you have a level playing field, wouldn't they just compete on that basis? If you are asserting that insurance will eventually become too expensive for anyone to afford, it looks to me as though we are already on that path as health care costs are ahead of inflation.

    As to the Cadillac tax, I favor tax on total compensation anyway, as I fail to see why we should subsidize those who can afford health care insurance. For that matter, do away with the mortgage deduction.


  2. Avik, the MLR regulations being drawn up by the NAIC are even more onerous than most people realize, especially during the transition period from 2011-2013. I apologize in advance for the bit of actuarial wonkery that follows:

    The loss ratio will be calculated at the state and legal entity level, slicing up the blocks of business into smaller and inherently more volatile pieces. To account for that they allow adjustments depending on the size of the block of business, and any block with fewer than 75,000 members in one year is considered not fully credible. If a block of business is not credible the loss ratio will be calculated using up to three years of experience, but here is the catch: any rebates paid do not count in that calculation, so you will be penalized twice on the exact same experience, effectively making the required minimum loss ratio even higher than 80%.

    Some actual numbers will clarify this a bit. Let's say in 2011 you have a block of business that is small enough to not be fully credible, with a loss ratio of 70%. You'll pay a 10% rebate for that year. Then in 2012 the block has a loss ratio of 75% (many insurers are not at the 80% yet, and it will take some time for them to get there so this is a perfectly reasonable example of how a typical insurer's experience will look over the nest few years) but it is still not credible so you have to combine the experience for 2011 and 2012. Since you cannot count the rebates paid for 2011, the loss ratio for the two years combined is 72.5%, and you have to pay a rebate of 7.5%.

    When you now look the total picture, you've collected $1M in premium in each year, paid out $700K and $750K in claims, and paid $100K and $75K in rebates. So the total effective loss ratio (claims plus rebates divided by premium) across those two years is not 80%, but 81.25%, because you've been forced to double-count the sub-80% loss ratio from 2011, despite the fact that the rebate you paid has already made that year's experience compliant with the law.

    The fact that this is double-counting and leads to the actual minimum LR being higher than 80% was brought up to the NAIC, but to no avail. It is going to be very difficult for some smaller insurers to quickly ramp up to the 80% minimum LR, the fact that the rules being drawn up for the calculation make that number even higher than 80% does not bode well for the marketplace.

  3. AB: Thanks for this useful info. I had hoped that the NAIC was not going to require MLR calculations at the state/legal entity level, because that would obviously be way too onerous (and the NAIC can sometimes be somewhat sensible). This is not good news, nor is the double-counting phenomenon you mention.

    Steve: insurers aren't going away in state with more requirements, what happens is insurance gets more expensive. The key is when you *combine* the additional requirements with price controls. For example, in Massachusetts, all of the major insurers are losing money this year, because of the combination of mandates plus price controls. This will eventually lead insurers to exit the market.