Why 'Rate Shock' Is An Essential Part Of Health Care Reform

Josh Barro

Once Obamacare is implemented, America's health insurance system will be a thicket of subsidies and transfers that benefit some people and harm others.

Critics of the law have seized on this observation, noting the existence of "rate shock": some people (especially young and healthy ones with moderate and high incomes who buy insurance in the individual market) will pay more than they used to, so others can pay less.

But here's the thing: Before Obamacare, our health insurance system was already a thicket of subsidies and transfers. The law doesn't simplify the system, but it does make the thicket of subsidies and transfers more sensible: directed more at people who have low incomes or high health needs, and greatly shrinking the share of the population that doesn't have health coverage at all.

Making the thicket more sensible will mean that some people's costs go up, producing "rate shock."

Take a look, for example, at Sen. Ted Cruz (R-Texas). Cruz has frequently noted that he declines the health plan that is offered to him as a member of Congress. Instead, he is covered through insurance that his wife gets as a Managing Director at Goldman Sachs.

Health care economist Austin Frakt ran the numbers on that Goldman plan. As of 2009, Goldman's health insurance coverage for employees at the managing director level and higher cost a stunning $40,000 per family. (The typical cost for a family health insurance plan in the United States is around $16,000).

Health insurance benefits are not taxable income, so Cruz and his wife get a big tax break on that plan. The break cut their tax bill by about $15,000 as of 2009, the last year for which we know the plan's value. The Cruzes aren't alone; every American who gets health insurance coverage through work gets this tax break, but the Cruzes enjoy an especially large one because their plan is so expensive and their tax rate is high.

For comparison, Medicaid coverage for two adults and two children cost about $11,000 in 2010, meaning (unless Goldman has radically changed its health benefits since 2009) Cruz is getting a tax break worth more than the benefits a family on Medicaid gets — even though he is a Senator and his wife is a highly paid investment banker and they have no need for subsidies to obtain health coverage.

This is insane health policy, and the Affordable Care Act changes it.

Starting in 2018, the law will impose a "Cadillac Tax" on high-cost health plans of the sort the Cruz family enjoys. The 40% tax on the portion of family plan premiums exceeding $27,500 will serve partly to raise revenue by offsetting the income tax exclusion for insurance. It will also encourage firms like Goldman to offer less-generous plans (which will reduce upward pressure on health care prices) and pay more of their employees' compensation as taxable salaries (producing additional new revenue).

Those new revenues will be spent on things like expanding Medicaid and offering subsidies to low- and moderate-income Americans who buy health plans in the Obamacare exchanges: that is, people who actually need financial assistance to get health coverage. And the Cruzes will still be enjoying a big subsidy since the first $27,500 of their health benefits will be shielded from tax.

Not everyone who will lose out on benefits is in as unsympathetic a position as Cruz. Yesterday, the Los Angeles Times looked at how many Californians who currently get health insurance through the individual market are facing higher premiums. But here's the most important part of the article:

A number of factors are driving up rates. In a report this year, consultants hired by the state said the influx of sicker patients as a result of guaranteed coverage was the biggest single reason for higher premiums. Bob Cosway, a principal and consulting actuary at Milliman Inc. in San Diego, estimated that the average individual premium in 2014 will rise 27% because of that difference alone.

It's a lot cheaper to provide health insurance coverage if you exclude a lot of the people who need it most. Making insurance available to people with pre-existing health conditions costs money. Obamacare funds this transfer to the chronically ill in part by raising premiums on healthy people.

There are other ways this transfer could have been funded. For example, we could have a single payer health care system. That would provide disproportionate benefit to people with chronic illness, and it would be funded with some sort of broad-based taxation, almost certainly meaning people with higher incomes would pay the lion's share of the cost.

I don't think conservatives would like that solution, or other solutions that have the government directly take on the cost of insuring the chronically ill. Republicans in the House of Representatives have shown no enthusiasm for high-risk pool plans, sometimes touted by conservative health wonks, which would use government subsidies to provide care to people with expensive chronic conditions who get left behind by current insurance markets.

In the absence of a direct subsidy approach, Obamacare's cross-subsidy approach is a pretty good way to get care to people who need it.

Some healthy people are facing premium increases above and beyond the cost of making coverage available despite pre-existing conditions. The Times further notes:

Individual policies must also cover a higher percentage of overall medical costs and include 10 "essential health benefits," such as prescription drugs and mental health services. The aim is to fill gaps in coverage and provide consumers more peace of mind. But those expanded benefits have to be paid for with higher premiums.

Again, this is just a transfer. Healthy adult women have higher medical costs than healthy adult men. Mandating coverage for things like materinty and contraception, and mandating that premiums not vary based on sex, provides a transfer from men to women to adjust for that fact. Is that fair? I think it's reasonably fair.

The Times continues:

The federal law also adjusts how rates are set by age, a change that gives older consumers a break and shifts more costs to younger people. Rates by age can vary by only 3 to 1 starting next year as opposed to 6 to 1 in some cases now in California. People in their 20s just starting their careers may earn so little they qualify for subsidies. But that might not be the case for consumers who are slightly older and earning more.

"It has the effect of benefiting people in their 50s and 60s and shifting costs to people in their 20s and 30s," said Patrick Johnston, president of the California Assn. of Health Plans. "Benefits are being increased for all, but it's not government subsidies for all. Some will pay more."

This, I think, is the most assailable part of the cross-subsidies in Obamacare. The young are being asked to subsidize the old. It would have been better not to cap premium variation on the basis of age, and rely on Obamacare's exchange subsidies to keep insurance affordable to older people with lower incomes. If you're a high-income person in your 50s, you could be expected to pay for the fact that a 50-year-old is more expensive to insure than a 35-year-old.

The new system of subsidies and cross subsidies that Obamacare sets up is far from perfect. But perfect is not on the table. The question is "is it better than the old system, where huge subsidies go to people with no need for them and tens of millions are left uninsured?" That answer, if you consider the costs and benefits honestly, is yes.

But conservatives don't do that.

For the last few weeks, I have seen a vast outpouring of conservative sympathy for young, healthy, prosperous people whose health plan premiums are going up. These poor, poor things. How could Barack Obama do this to them?

It's true that some of these people are worse off. Others are getting major offsetting benefits; Kevin Drum notes that one woman who complained to the Los Angeles Times about her rising premiums is pregnant and likely to see big near-term returns from her more comprehensive plan.

But what about the tens of millions of Americans who currently lack health insurance and are about to get access to available, affordable coverage? Where is the conservative sympathy for people who would be worse off if the law doesn't go forward?

Nowhere. Because for all the needless complexity of liberals' approach to improving health insurance and helping the sick, conservatives don't have one at all.

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