David Frum

11.04.13

The Obamacare Death Spiral

For people with high incomes, rising insurance rates are a hassle. But for the struggling young, they’re a real problem. Here’s how the whole thing could come undone.

For me, Obamacare will mean $200 a month in higher premiums and almost a $2,000 higher deductible for my family. I'm not alone. Every day brings a new report by someone in a similar situation. 

On Friday, Jonathan Chait boldly argued that all this is as it should be. 

[I]t is true that some people actually are getting decent individual health insurance, and have to pay more under Obamacare. Before, insurers could charge them a rate based on their individual likelihood of needing medical care, and some people are lucky enough to present a very low actuarial health risk. Now those people will have to pay a rate averaging in the cost of others who are less medically fortunate.

On Twitter, Chait phrased his idea less delicately:

"[T]here are different ways of robbing @davidfrum's financial health bonus, but to cover the sick, rob it you must.

(Jonathan Chait is seldom happier than when he can sound like the villain in an Ayn Rand novel.) 

The trouble is that the particular way in which Obamacare raises costs to the healthy likely will mean that the sick don't get covered at all.

Put my case to one side for the moment. I'm 53. It's dangerous for me to go without coverage. Plus, I've got the extra $200. So I'll pay up. But suppose instead I were 27 and single, earning $40,000 a year in the District of Columbia. Pre-Obamacare, a Carefirst plan with a $2,700 deductible would have cost me $111 a month, according to the ehealthinsurance site. Even at that price, at 27-year-old earning $40,000 would have had to think very hard: 3.3 percent of pretax income is a lot to pay for health coverage for a fit young person.

Under Obamacare, however, a silver plan with a comparable deductible would cost this hypothetical 27-year-old 5.42 percent of pre-tax income—and at $40,000 with no dependents, he'd earn too much to qualify for a subsidy. (These numbers courtesy of the Kaiser foundation's subsidy calculator. )

What's that person going to do? One possible answer: he's going to drop out of the insurance market altogether. True, he'll face a theoretical penalty of up to $300. But evading that penalty is easy: the IRS has no power to force payment; it can only withhold that penalty from any income tax refund our scofflaw may be due. By underpaying tax during the year, this young man can drop out of the insurance market altogether.

And if he does, that's very serious. The economic logic of the individual insurance market under Obamacare does not depend very heavily on "robbing David Frum's financial health bonus." But it does depend on "robbing" the financial health bonuses of America's under 30s. If they defect from the system, prices will rise—and as they rise, more people will defect. This is the notorious "death spiral" that Obamacare critics warned about from the start. One look at today's health exchange prices suggests that the death spiral is already beginning.

The individual insurance market is only a small part of the overall health market. But it nicely dramatizes the incentives that all participants in the system will soon face. 

Employers, for example, can drop out by cutting hours of their least valuable workers, a process well underway, as reported by Jed Graham of Investors Business Daily.

Meanwhile, Obamacare creates new opportunities to "drop in" in ways that will also test the system. Because the exchanges are novel, they attract the most media attention. But even as designed, Obamacare was as much an expansion of Medicaid as it was anything else. With the exchanges proving so unattractive, it may happen that the majority of new coverage under Obamacare will amount simply to an expansion of the Medicaid rolls. 

Obamacare had its priorities upside down: it put coverage expansion first; cost control a very distant second.

Medicaid expansion is expensive, but that won't be the worst problem. Medicaid systematically underpays doctors and hospitals. Yet federal law makes it practically impossible for hospitals to refuse Medicaid patients. They compensate, therefore, by raising charges to other patients—an invisible subsidy that will now inevitably grow even larger than before—and that will show up, among other places, in yet higher costs on the exchanges, inducing more people to drop coverage, accelerating the death spiral.

Chait is right that some degree of redistribution is inherent in the very concept of insurance. Redistribution is not the core design flaw in Obamacare. The core design flaw is that Obamacare had its priorities upside down: it put coverage expansion first; cost control a very distant second. What we are discovering now is that without cost control, coverage expansion quickly devours itself. 

That self-devouring is the process dramatized by the price shock on the exchanges…but the real harm will come in the months ahead, less visibly, as employers confront the same stark shock that the individual purchasers are confronting today. Employers can't shirk the fines as easily as individual purchasers can. But they can still make the rational choice to pay the fine and dump their employees into the exchanges, where they will encounter the same hostile math that I faced last week. The sick will sign up; the well will drop out; and the prices will keep rising and rising and rising—until either the system crashes or else the government steps in to assume an ever-expanding role as cost controller and price subsidizer. 

If designed right, the health-care exchanges would have provided an alternative to government health care monopoly. As is, they now look ominously instead like that monopoly's prelude and farcical first act.