Everything You Need to Know About Obamacare and 'Death Spirals'

Are you 30 years old or younger and in good health?

If you answered yes, congratulations, the future of Obamacare depends on you. If you buy insurance, premiums shouldn't rise too much overall, and the system should work. But if you don't, premiums could spike and create a "death spiral." That would be bad. 

How bad? Well, bad enough to destroy the individual insurance market—which would destroy reform. See, our healthcare system is really four different systems that range from efficient, to not-efficient, to non-existent. There's a government system for the old, poor, military, veterans, and some children. Or, as you might know them better, Medicare, Medicaid, Tricare, the Veteran's Health Administration, and the Children's Health Insurance Program. A subsidized system for people who get insurance through work. An individual system for young, healthy people who don't get government or employer-provided insurance. And effectively no system for sick or older people on the individual market. Taken together, this patchwork system is a mess that costs us more as a share of GDP than any other rich country, without even covering everybody like they do. The question then is how we can stop paying more for less.

The answer, both sides agree, is ending the inefficient employer-based system. In a perfect liberal world, we would eliminate the subsidized system and move everyone to a government one—single-payer health care. And in a perfect conservative world, we would eliminate the employer-based subsidized system and move to an individual-based subsidized system that would compete with the government one. But, of course, we don't live in anybody's perfect world. So, even though conservatives refused to negotiate back in 2009, we got a compromise—Obamacare.

How Does the Obamacare Labyrinth Work?

Here's Obamacare in three steps. First, it expands the government system to include people making up to 138 percent of the federal poverty line ($15,850 for singles and $21,400 for couples). Second, it reforms the individual system, and subsidizes it for people making between 100 and 400 percent of the federal poverty line (from $11,490 to $45,960 for singles and $15,510 to $62,040 for couples). Third, it gradually taxes the subsidized employer-based system to slow its growth and help pay for the law's new subsidies.

Now it's the individual system where Obamacare will either either succeed or fail. About two-thirds of the law's expanded coverage is supposed to come from the individual system, since so many states are rejecting the Medicaid expansion. But that will require turning the individual market into something other than the horribly dysfunctional system it is today. As Consumer Reports put it in 2009, individual insurance is "unaffordable at best and unavailable at worst" for all but the youngest and healthiest of people. In other words, insurers price out the old and turn down the sick.

So How Can We Fix the Individual Market?

Well, Obamacare uses a three-legged stool. First, insurers are banned from discriminating against people with preexisting conditions. They have to offer everyone the same policies at the same prices regardless of health status (though not age)—and they have to offer policies that meet minimum standards. But there's a problem here. If people know they can't get turned away when they're sick, some might wait till they're sick to buy insurance. And that "some" could then turn into more. It's what healthcare economists call an insurance "death spiral." Suppose some healthy people decide to wait till they need insurance to buy it. Then the overall insurance pool would have a higher percentage of sick people in it, and premiums might rise. Those higher premiums might make more healthy people decide to drop their insurance until they need it—which would make the insurance pool sicker still. Premiums would rise again, and more healthy people would drop their coverage again, until eventually only sick people had insurance. That's why, second, there's an individual mandate that penalizes people who don't have insurance. The idea being, of course, that healthy people would rather pay for insurance than pay a tax. But it's not fair to penalize people for not buying insurance if they can't afford it. So, third, there are subsidies to help people afford coverage.

But Will It Turn Into a Death Spiral?

This brings us back to healthy twentysomethings. As we mentioned before, if they sign up for insurance, there won't be a death spiral. But if they don't, there might be. So why wouldn't they buy insurance? Well, there are two possible reasons. First, the website might not let them sign up. And second, the individual mandate might not really force them to sign up. Let's think about both.

(1) Why the website (probably) won't doom Obamacare... But the website is important. It's the exchange where people can buy individual policies—if, you know, it actually worked. But it doesn't, mostly. See, people can buy coverage on Healthcare.gov, but only if they're willing to try over and over and over again. And who's willing to try over and over and over again to buy insurance? The people who need it most. As Yuval Levin points out, this "difficult but not impossible" sign-up is almost perfectly designed to set off a death spiral. Indeed, insurers are already reporting that early buyers are older than expected.

How worried should we be?

Not too much. At least not yet. As Ezra Klein and Jonathan Cohn explain, Obamacare has fail-safes built in to prevent any one insurer from gaming the system that should save the system. There really isn't much risk of a death spiral in the law's first few years, which should give Healthcare.gov the time to fix things before there's irreparable damage. Here's how these fail-safes work.

-- Risk Corridors. The insurance exchanges aren't just new for buyers. They're new for sellers too. This newness means insurers don't really know if their policies will attract more sick people than their competitors' (who might target healthier people). So the government has set up a system through 2016 that will protect insurers from ending up with too many sick people—and penalize them for ending up with too few.

As Adrianna McIntyre explains, each plan has a "target" cost based on how sick companies expect the insurance pool will be. If the actual cost turns out to be more than 3 percent higher than the target cost, the government will pay the insurer. Specifically, the government will cover half the cost of anything more than 3 percent higher, and 80 percent of anything more than 8 percent higher. The same applies in reverse if the actual cost comes in more than 3 or 8 percent below the target cost. In other words, there's basically a floor and a ceiling on much insurers can lose or make the first three years.

-- Reinsurance. The idea here is the same. That's reducing the financial risk of any insurance company ending up with too many sick people early on. But instead of the government paying insurers, this is insurers paying insurers. For the next three years, all healthcare plans (including employer-provided ones) will pay into a $10 billion reinsurance fund that will help cover the costs for any patients with over $60,000 in claims. That should keep insurers from losing as much money—and, as a result, increasing premiums—as they otherwise would.

-- Subsidies. Higher premiums probably wouldn't start a death spiral, because that wouldn't mean higher premiums for everybody. See, Obamacare limits how much you have to pay for the "silver-level" plan if you get subsidies. So your cost is fixed no matter the price—which means the subsidies rise as premiums do. These limits start at 2 percent of income for households making 133 percent of the federal poverty line ($15,280 for singles and $20,630 for couples), and rise on a sliding scale up to 9.5 percent of income for those making 300 to 400 percent of the federal poverty line ($34,470 to $45,960 for singles and $46,530 to $62,040 for couples).

In other words, higher premiums won't mean higher payments for a big chunk of the population. 

Why we should expect the mandate to work... Okay, so the botched website probably won't doom Obamacare (for now), but what about a botched individual mandate? Harvard professor Marty Feldstein, among many others, thinks the penalty isn't penalty enough. It's just 1 percent of your taxable income in 2014, unless $95 is more; 2 percent of your taxable income in 2015, unless $325 is more; and 2.5 percent of your taxable income in 2016, unless $695 is more. Feldstein fears that a simple cost-benefit analysis will tell too many young people to pay the fine and forgo insurance until they absolutely need it. Is he right?

Probably not. Feldstein might be right that a rational self-maximizer would calculate that the fine is a better deal, and drop his coverage. But people, real people, aren't rational self-maximizers. We have quirks. One of those quirks is we don't like to pay something for nothing. Another is we don't like to feel like we're doing the wrong thing. We like to follow the rules instead. Feel like we're a good person.

That's why calling it a "mandate" makes it work better than calling it a "tax." See, the word "mandate" implies a positive responsibility. It's something we're supposed to do. And we're more likely to do something we're supposed to do than not do something we're not supposed to do. That's what economist Keith Ericson found when he asked people whether they would rather buy a $2,000 (or $3,000) policy or pay a $700 penalty—and told one group that it was a "mandate" and the other that it was a "tax." When it was called a "mandate," 60 percent of people said they'd pay for insurance. When it was called a "tax," only 49 percent did. To give you an idea how big a deal this is, consider that there was an equal difference between people willing to buy $2,000 and $3,000 insurance. In other words, the word "mandate" increased enrollment as much as cutting premiums by $1,000 did.

But for whatever reason, we know a mandate can work. It did in Massachusetts. Take a look at the chart below, again from Adrianna McIntyre. It shows how many sick and healthy people signed up for insurance in the months before and after Massachusetts' mandate began. The first dotted line is when the mandate was phased-in, and the second dotted line is when it kicked in. As you can see, enrollment spiked when the mandate fully came into effect—and it spiked for healthy people.

Now, sign-ups didn't spike because Massachusetts had tough penalties. Romneycare's penalties were even weaker than Obamacare's penalties. So either weak penalties were incentive enough or people were buying insurance just because they were supposed to. The latter possibility is why the battle over enrollment is going to be a battle over political messaging. The Ericson paper found that calling the penalty a "mandate" got more people to sign-up than calling it a "tax," except right after the Supreme Court decision. Then there was no difference. So the political controversy over whether it was a mandate or a tax neutralized, at least for a little while, the benefit of calling it a mandate. It's no surprise then that the exchanges are talking up the value of having coverage, and not mentioning the penalty for not having it.

Good cop beats bad cop. Especially for millennials.