Obamacare’s Bad Deal for Young Adults Led to Its Demise

Republicans didn’t kill Obamacare. Young adults killed Obamacare.

Many readers are sure to question that provocative statement, so let’s unpack it a bit.

The first thing we have to understand is that demographics matter a lot when it comes to insurance. Insurance only works when there are enough low cost, healthy people in the “risk pool” to offset the high cost, chronically ill people. Put another way, the lucky are asked to subsidize the unfortunate.

If there are too few healthy people, then the underlying costs of insurance become too high, and the risk-reward of going uninsured too good, which pushes healthy people off the insurance rolls. As unhealthy people make up greater percentages of the enrolled population, insurance costs continue to rise, and healthy people continue to become increasingly incentivized to go uninsured. This is what they call a death spiral. And that is what we happen to be in now.

Insurance is a finicky beast. Small changes in the demographical makeup of an insured population can be the difference between a sustainable risk pool, and one that tilts into death spiral territory.

But Obamacare didn’t suffer from a “close call.” It wasn’t as if the risk pool was just a smidge away from achieving the needed balance. No, it was off by a lot.

The Obama Administration’s built-in assumptions were that young adults—which serves as a corollary for the “healthy people” we talked about earlier—would make up 38 percent of the risk pool. But in reality, the number of young enrollees was closer to 28 percent, a 10-point deficit that was the impetus for insurers losing hundreds of millions of dollars, and ultimately pulling out of the Obamacare exchanges.

Why were there so few young adults? It’s not as if this was some coordinated boycott of a law they didn’t like, or a grand political statement to teach Democrats a lesson in free markets. This was much more fundamental. In short, Obamacare messed up the underlying economic incentives for young adults to purchase insurance. The bill dramatically raised their premiums, which Democrats knew would push down coverage, and tried to make up for it by including a penalty for being uninsured.

As it turns out the carrot of lower rates is much more powerful than the stick of a tax penalty.

To dig into the details a bit more, Obamacare fiddled with insurers ability to price risk by circumscribing their ability to charge based on anticipated costs. Broadly, this is called community rating. As it relates to young adults, Obamacare imposed a 3:1 limit on the difference that insurers could charge based on age.

The problem, as Avik Roy writes in Forbes, “is that the oldest individuals in the private market (those younger than 65), on average, spend six times as much on health care as the youngest ones do (those older than 18). Hence, 3:1 community rating forces the youngest people to pay 75 percent more for insurance, so that oldest people can pay 13 percent less.”

Unsurprisingly, Americans reacted rationally in the face of such economic incentives. Young adults, felt that the certainty of sharply higher costs wasn’t worth the uncertainty of illness or injury and decided to risk going uninsured. And older adults, who have a much higher risk of needing costly health care flocked to the exchanges to take advantage of substantially lower premiums.

The result was adverse selection, which was the root cause of the higher premiums and reduced choices that Americans dealt with over the last several years. So, in a way young adults’ collective decision not to make dumb economic choices was to blame for Obamacare’s demise.

Fortunately, the Republican reform plan squarely takes aim at the flawed incentives underlying the unsustainable insurance market. Among other things it widens the insurance age band, from 3:1 to 5:1, which means that insurers (if the actuarial analysis supports the decision) can charge older Americans five times what they can for young adults. As discussed above, this ratio still does not reflect the difference in health risk between the two populations, but it will go a long way toward lowering premiums for young adults.

Of course, the benefits ultimately extend well beyond young adults. By re-entering the insurance market they will revamp the risk pool, which can keep costs lower for everyone. In other words, only young adults can breathe new life into the risk pool they killed.