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What is Obamacare? Part I: Exchanges

By  +Follow September 19, 2013 9:13AM
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Republicans in the House of Representatives fired another salvo on Wednesday in their ongoing effort to destroy 2010’s Affordable Care Act, passing a bill that ties continued funding of the government to the defunding of the health care reform. Like past efforts, it appears dead on arrival, but just the fact that Republicans are willing to launch this H-hour attempt to kill the law speaks to how controversial it’s become.

However, despite no lack of strong opinions, what might be most notable about health care reform is the confusion surrounding it. Despite a raucous public debate, a great many people still fail to understand the most basic elements of the law. A recent Pew/USA Today poll found that 51 percent of responders didn’t realize that low-income individuals and families would be eligible for subsidies with another 49 percent believing that there wouldn’t be an exchange in their state (every state will have an exchange).

Whatever the end result, health care reform should have a major effect on the health care sector and the economy overall. So, in the first of a series, here’s a look at Obamacare in all its glory (or lack thereof).

One Giant Risk Pool

The basic operating principle in the creation of health insurance exchanges was the expansion of risk pools. In the past, when insurance companies agreed to insure someone, it involved a careful consideration of risk and how much it’s likely to cost them. Unfortunately, this meant that if you had obesity, diabetes, high blood pressure, and depression (which was understandable given your obesity, diabetes, and high blood pressure), an insurance company would most likely refuse to insure you for anything less than a small fortune. You were a risk pool of one, and it was a very risky pool indeed.

However, if you got a job at a major corporation and joined their health plan, your employer would pay a much lower rate to insure you than you could ever hope for on your own. That’s because despite your sky-high medical costs, the guy in the cubicle next to you with his green tea and daily yoga sessions is costing the insurance company next to nothing, basically balancing you out. And once you spread everyone’s risks and costs out across a few hundred or a few thousand people, your insurance company could come back with a reasonable rate for everyone that wouldn’t break the bank for your employer and wouldn’t run the insurance company into financial ruin.

Now, the government is essentially getting the insurance industry to treat everyone in America without insurance through their job as one giant risk pool, evening out premiums in the same way they would in the large group market. To do this, the law creates a system of incentives to convince uninsured people to get health insurance as well as a central hub in each state, the exchange, where customers can go to shop for health plans.

Obamacare Subsidies

For many, if not most, uninsured Americans, one of the primary barriers to getting insurance has always been cost. To combat this, the law has created subsidies available to any individual or family making between 133 and 400 percent of the federal poverty level. The poverty level varies depending on family size (or if you live in Alaska or Hawaii), but that’s between $15,281.70 and $45,960 for an individual and between $31,321.50 and $94,200 for a family of four.

The size of the subsidies are on a sliding scale based on income, but they will essentially cap premiums for the exchange’s “benchmark plan” (more on this later) at between 3 percent and 9.5 percent of income, with the government picking up any cost of premiums that would exceed that level. So if you make $15,281.70 a year, you could get the benchmark plan at the exchange, pay $458 a year (3 percent of your income) in premiums, and the balance would be paid by Uncle Sam. And if you make $45,960 a year, you would pay up to $4,275 a year (9.5 percent of your income) for the benchmark plan, and the rest of your premium (if any) would be paid by the subsidy.

For people making less than 133 percent of the poverty level, the law initially expanded Medicaid to give them coverage at no cost to them. However, the Supreme Court ruled that the federal government didn’t have the authority force states to accept this expansion. So, for those states rejecting the expansion, subsidies will extend down to anyone making the federal poverty level (with premiums for the benchmark plan capped at 2% of income for those making between 100 and 133 percent of the poverty level). However, some individuals making less than $11,000 a year won’t have access to federal insurance subsidies to purchase their own insurance and won't be eligible for Medicaid.

Individual Mandate

While the availability of subsidies is likely more than enough to attract many of those currently uninsured, many others may still not see the need. Even with the lower post-subsidy rates, many young, healthy people could look at the premiums and decide that they’re better off foregoing coverage. This may not seem like a major issue, but it would be something of a disaster for the whole idea of one massive risk pool. The reason risk pools are advantageous is because there are healthier people who are more profitable for the insurer to balance out the less healthy people who are costing the insurer. This is even more important now because the Affordable Care Act says that insurers can neither reject an individual or family for coverage nor charge them a different rate because of their medical history. Meaning they don’t really have a choice in the matter. And if no young, healthy people decide to get insurance, it would leave insurance companies with a much riskier pool than they signed on for.

To combat this, the law created a new tax on people who don’t have insurance. The idea being that it would create a financial incentive for even the youngest, healthiest people to go out and get insurance and balance out the risk pool for the higher-risk, higher-cost people who don't need any extra incentive. The penalty is going to be the higher of either 1 percent of an individual’s income or a flat fee of $95 for the 2014 tax year, increase to the higher of $325 or 2 percent of income for the 2015 tax year, and settle into the higher of $695 or 2.5 percent of income for the 2016 tax year and beyond (though the fee will be adjusted as time goes on based on certain federal benchmarks). So, someone making $50,000 a year and opting not to get health insurance should pay $500 the first year, $1,000 the second, and $2,000 thereafter. Certain group are exempted, but the majority of those people who are uninsured could have a nasty surprise on their tax bill if they don't take action.


The final piece of these new risk pools comes in the form of the exchanges. Each state will have its own marketplace where consumers can go to shop for health plans. Health plans will be organized into metal tiers, with plans being categorized as bronze, silver, gold, or platinum (so it's like the Olympics, but better). These tiers reflect how much cost-sharing the plans include in the form of things like copays, coinsurance, and deductibles. Bronze plans will have the highest cost-sharing, but this should mean that they’ll also have the lowest premiums. Platinum plans, meanwhile, will require relatively little cost-sharing but should have much higher premiums. The “benchmark” plan used to set the size of a person’s subsidy would be the second-cheapest plan at the silver level. This means that, once the size of the subsidy is set using the benchmark plan’s premiums and the purchaser's income, that person can still opt for lower-premium bronze plans (or that one cheaper silver plan) without reducing the size of their subsidy.

Every state will have an exchange, but states had the option to run their own exchange, run an exchange as part of a partnership with the federal government, or let the federal government run the exchange. So, even if your state's governor has spent the last three years railing against Obamacare, your state will still have an exchange. 

How Will Obamacare Affect Insurance Companies?

Among those watching what happens on Oct. 1 the closest will be insurance companies, including industry leaders like Unitedhealth Group, Inc. (UNH) , WellPoint, Inc. (WLP) , Aetna, Inc. (AET) , Cigna Corp. (CI) , and Humana, Inc. (HUM) . These companies are participating in different state exchanges on a selective basis, carefully trying to determine just what the new individual markets will look like. In many cases, they’ve already set the premiums on the plans they will offer and can only wait and watch.

On the one hand, these exchanges could represent a major opportunity for insurers, with their customer base rapidly expanding to include a large portion of those 30 million Americans currently without insurance. However, along with the tax penalties incentivizing Americans to purchase insurance come a slew of new regulations and taxes. And if too many young, healthy Americans decide they would still rather just pay the penalty than shop for insurance, it could result in a risk pool that disadvantages insurers.

However, it’s worth noting that, regardless of what happens in the exchanges, the individual market constitutes a relatively small portion of the health insurance market as a whole. About 85 percent of those people currently insured by private companies obtain their insurance through their employer.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.

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