The Affordable Care Act (ACA), or “Obamacare,” has generated controversy from its inception. Republicans vow to repeal it. Democrats vow to defend it. Yet, unfortunately, many ordinary Americans seem not to know what it does or why some people want to reform it.
What does the ACA actually do?
At its heart, the ACA did three things.
First, it expanded health insurance coverage. It did so primarily by expanding Medicaid, the government’s (mostly) free health insurance plan for the poor, and by providing subsidies to the almost-poor so they could buy health insurance on the ACA’s “insurance exchanges.”
These insurance expansions are projected to cost roughly US$1.4 trillion over the first 10 years after the ACA’s implementation and cover between 22 and 32 million additional Americans. This expansion in coverage represents one of the, if not the, signal achievement of the ACA.
Second, the ACA loosened the link between health insurance and jobs. As a result of an idiosyncratic IRS ruling from World War II, health care premiums – the amount employees contribute from their paychecks for health care insurance – are tax-exempt if your employer pays them on your behalf, but not if you buy coverage on your own.
This is why the overwhelming majority of privately insured Americans have traditionally gotten their health insurance through their employers.
Economists have long criticized this arrangement, because it locks workers into jobs purely to preserve their health insurance coverage.
The ACA’s insurance exchanges allow uninsured individuals to buy coverage without having to go through their employers. In addition, the ACA took a few halting steps toward reversing the tax-exempt status of employer-based health insurance. The so-called “Cadillac tax” eliminated the tax exemption on health insurance premiums above a certain threshold.
Third, the ACA aimed to lower the price of insurance for the very sick by regulating the health insurance market. At its core, the health insurance market works by bringing together a pool of diverse people, charging each of them a premium and using the proceeds to pay for all the care that ends up being needed by this pool of people. The ACA regulates this process by requiring that insurance companies charge all individuals in the insurance pool the same price, regardless of how likely each is to need care.
This regulation is known as “community-rating,” because the entire community of individuals gets charged the same rate. Without it, sicker people would pay higher premiums than healthy people because they cost more to insure. By equalizing premiums for all, community-rating ends up lowering insurance prices for the sick but raising them for the healthy.
While this approach protects the sick, it penalizes the healthy people who are subsidizing their coverage by paying premiums that exceed their true cost of health care. Faced with this problem, either insurance companies retain the healthy by devising plans that discourage sick people from enrolling, or healthy individuals drop out of coverage.
In either case, however, the sick end up paying a higher price for insurance. Economists call this “adverse selection” and it is a direct result of community-rating.
Mandated coverage - for insurers and individuals
To head off this adverse selection problem, the ACA imposes two other regulations.
One requires insurance companies to accept all individuals into a pool, even if they have preexisting conditions (code for “even if they are sick”). This regulation protects individuals seeking new coverage or seeking to renew existing coverage.
The other regulation is the “individual mandate,” which requires that all individuals – including the healthy – purchase insurance. Taken together, these regulations allow the sick to enter an insurance pool with healthy people, and make it harder for the healthy to exit the pool.
The ACA statute contains a litany of other provisions in its 906 pages of text. These include regulations on how insurance companies spend their premiums, what services insurance companies must cover, how health care providers should be organized (Accountable Care Organizations), and a number of experiments on how Medicare pays providers.
While these are all significant, they are smaller in impact compared to the ACA’s expansion of insurance coverage, its efforts to delink employment and health insurance, and its effort to ensure community rating.
What problems need solving?
The ACA’s coverage expansion has come at a cost. Each additional person covered by the ACA costs roughly $5,185 in government expenditures per year – i.e., $1.4 trillion in cost over 10 years to cover on average 27 million additional people. And this does not include private expenditures by people who get only partial or no subsidies at all for insurance.
What’s more, although the ACA coverage expansion made the U.S. health care system more progressive in some ways, it made it less progressive in others and consciously failed to eliminate regressive aspects features of the system that pre-dated it.
While poorer Americans benefit from Medicaid and subsidies for the purchase of insurance on exchanges, the individual mandate imposes burdens upon the young who, while healthy, are typically less wealthy than older Americans.
Although it was a step in the right direction, the ACA’s Cadillac tax failed to eliminate even half the federal income tax break for employer-sponsored insurance, which disproportionately benefits the middle and upper class workers in high tax brackets.
Likewise, the ACA’s insurance regulations are complex and ineffective. As we explained earlier, the ACA’s community rating requirement necessitated a range of other regulations to make sure the insurance market did not unravel. Each of these other regulations has to work for community rating to survive.
At least one of them is failing for economic reasons: the individual mandate. To ensure the ACA’s political viability, the penalty for those who violate the mandate was set to be relatively low. As a result, some healthy individuals are deliberately choosing to pay the penalty and avoid insurance pools.
The result is a vicious cycle of rising insurance premiums as more and more healthy (low-cost) consumers drop out of the market. This dynamic is partly responsible for the double and even triple digit increases in premiums on ACA insurance exchanges.
Another regulation is failing for political reasons. The ACA’s “risk corridors” were designed to protect insurers against larger-than-expected losses during the first three years of the program.
Insurers who attracted more sick enrollees than expected would be covered against those losses. In theory, this should have made them less likely to discourage sick patients from enrolling.
Unfortunately, losses ended up being larger-than-expected because fewer healthy people enrolled. As a result, the federal government accrued a larger bill that has so far gone at least partly unpaid.
In any event, the risk corridors program was designed as a temporary measure, not a permanent solution to the problem of encouraging insurers to enroll the sickest patients.
Repealing the ACA wholesale would leave tens of millions of Americans without insurance coverage. We are hard-pressed to find anyone who thinks this would be good news.
Yet, it would be equally naïve to declare the ACA an unmitigated success story, and reforms are needed. Reform should focus on making health insurance more attractive to healthy consumers, and simultaneously making sick consumers more attractive to insurance companies. And, we still have a long way to go when it comes to leveling the health insurance playing field for poorer and more vulnerable Americans.