The one industry affected the most by Obamacare is the health insurance industry. Easily. The industry faces a slew of new regulations, requirements, and taxes that hamstring their ability to do business in the way they previously had. However, the industry’s now bolstered by a law that funnels billions of dollars in federal subsidies into the industry and creates a new tax on those people who opt not to purchase their products. It places the health insurance in a very unique new place in the American economy.
In the end, no one can be completely certain how this will play out. Health care reform is, on some level, a large economic experiment involving the insurance industry. And the success of this legislation rests on the long-term health of said industry.
Guaranteed Issue, Pricing Requirements
Functioning as a health insurance company is going to be a lot more difficult, moving forward. For starters, some of the fundamentals of running an insurance company are changing. Basic application of actuarial values are going out the window. Where an insurance company used to take each individual or group and apply risk factors to them before pricing their product competitively, the law now presents a rigid new set of standards that redefine the act of writing policies.
For starters, insurance companies can no longer refuse a customer because of their history or health status. This means, in effect, that insurance companies are going to be forced to take a loss in certain situations. Certain people that they can be certain represent a losing business proposition to insure are going to be written policies anyway.
What’s more, how they price those policies has been redefined. Where companies could, in the past, charge much higher premiums for more-expensive customers. Now, insurance companies can’t use one’s health status to determine the price of their plan. What’s more, they also can’t charge older and typically more-expensive customers as much as they used to. The law limits the difference between the price of premiums for the plans offered to young adults and the elderly to a factor of three, meaning Grandpa Harald, at age 87, can’t be charged more than three times what 21-year-old Harald, Jr. is. Given that current age bands are closer to a 5:1 ratio, that’s a big change.
What's more, there's now a whole slew of defined parameters for every policy insurance companies write on the indivudal market. It's a whole new ballgame.
A Death Spiral?
It’s also one that’s most likely going to lead to dramatically increased premiums for the so-called “young invincibles.” And this core issue is one that the law is depending on, and one that is among its most hotly contested issue. The new law basically requires insurance companies to take a pretty steep loss on the very ill and the elderly. And to offset this, the companies will be reaping much larger new profits on policies written for young, healthy individuals. In order to remain profitable, companies will have no choice but to charge higher premiums for the young. Because whatever they charge for their youngest adult customers is also going define what rate, and the resulting margin, they can expect from their elderly customers.
And this is where the law could run into serious trouble. Experts have describe a “death spiral” where companies have to keep charging higher premiums for individual plans in order to make their offerings profitable, and those higher premiums, in turn, drive away the young, healthy customers needed to balance out the market. Which means higher premiums. Which means fewer healthy customers. Which means higher premiums. And so on, and so forth. The law’s solution to this is the individual mandate, which creates an extra financial incentive for those young, healthy folks to go out and get insurance. However, critics have pointed out that the penalties (starting at 1 percent of income in the first year and increasing to 2.5 percent by the third year) may remain low enough that it’s significantly cheaper to simply take the hit on one’s taxes. This is something to keep an eye on, because what the nation’s uninsured 20-somethings decide to do is going to determine whether or not this whole experiment is a success.
Required Medical Benefit Ratios, New Taxes
Two other parts of the law are going to make life considerably more difficult for insurance companies. The first is the new medical benefit ratios. Insurance companies are now required to spend 85 percent of the premiums they collect on large group plans on medical care or services, and 80 percent of premiums collected for individual and small group plans. Companies are required to report these ratios and if a certain plan ends up failing to meet these ratios, they’ll be required to write checks to the plan’s members to make up the difference. This is meant to ensure that insurance companies aren’t making too steep a profit off of their insurance offerings.
There’s also a series of new taxes on insurers and insurance plans that are meant to help offset the cost of federal subsidies and pay for the new system. These includes fees charged to plans that help pay for a new institute researching the effectiveness of various medical devices and treatments (the Patient-Centered Outcomes Research Institute, or PCORI), a tax on benefit-rich “Cadillac” plans, and the tax on medical device makers that was most recently featured as one of the pawns in the debt-ceiling showdown. However, probably the most prominent of these new taxes in the insurer tax, which is charged to insurers as a percentage of total premiums collected.
It’s Not All Bad
All of this is enough to ahve American health insurance company executives reaching for antacids. It’s likely to make the health insurance industry one of the single most regulated industries in the countries. For crying out loud, they now have their own profit margins limited by law!
However, the reason there are so many new government limitations to the way these companies do business is because Uncle Sam’s doing a lot for their industry. Two major pieces of the law should do a lot to help ensure these companies will be able to keep operating in the black for the foreseeable future.
The Individual Mandate
Insurance companies now have nearly every adult in America getting charged a tax for NOT purchasing their product. That’s a business/government relationship that’s fairly unique at the federal level, and one that presented the primary legal challenge to the law when it went before the Supreme Court. Regardless of how you feel about the constitutionality of such a tax, its benefit to the insurance industry should be clear. The appeal of their product should be pretty clear to start with, protecting people against the risk or potentially catastrophic medical costs in the future. But now every person making a decision about getting insurance has to consider that the decision not to will essentially mean they’ll pay a certain chunk of their income to the government and get nothing back for it. If it cost you $100 to NOT get an iPhone, pretty much everyone in America would probably decide it was worth it to get one. And that’s the concept at play here. Whether or not the penalties will be large enough remains unclear, but insurance companies clearly believe it’s a benefit to them in the long run.
The track record for business with federally subsidized products is less mysterious. The agricultural industry in the United States has historically relied on a variety of price controls and a large chunk of federal change to support its profitability. And now, for those Americans who previously couldn’t afford their product, the insurance companies are looking at government money to help them pay for it. A lot of government money. Federal subsidies are expected to pump an additional $23 billion into the industry in 2014, and that number’s expected to rise to over $100 billion a year by 2018.
What’s it All Mean?
In the end, the insurance industry, like the rest of the country, is in a watch and wait mode (except for those congressional Republicans who are in a “stop-at-all-costs” mode). The industry’s getting billions of dollars of cash injected into the marketplace by the federal government, and tens of millions of new customers headed their way. And there’s new financial incentives created to drive the most profitable customers possible to their products.
However, those same companies are now saddled with new regulations, new limits on their profit margins, and the considerable issue that those profitable customers they need to make things work may not end up being there for them in the end.
All told, the health insurance industry is in the midst of what’s likely to be the biggest period of flux it will endure for a generation. And no one knows what lies on the other side.
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