Exchanges Can Survive End of Individual Mandate

One of the many scary trial balloons being floated by the Administration as part of its first 100 days is to abolish enforcement of the individual mandate. That mandate imposes a penalty of $695 per person, or 2.5% of income per family, for people who fail to obtain qualified health insurance. It isn’t much of a penalty because about half of the uninsured can get exemptions and the penalties are small relative to premiums. Whether to pay a fine of $695 or a premium of $5,000 for a policy with high deductibles will force the higher income uninsured minority to choose between paying a little something for nothing or a lot for a little something. While the penalty will tip some of them into buying, it is no sledgehammer.

The puny nature of the penalty has, however, not stopped a paroxysm of handwringing that there might be an exodus of low risk individuals from the exchanges. Since the substantial excess of premiums over low risk average claims is needed to cross subsidize lower premiums for high risks, their departure could lead average premiums to rise, thus leading to the dreaded “death spiral.”

That is what insurance economists would predict to happen in an unsubsidized market where premiums are “community rated” and averaged across all risks. But it won’t happen to exchanges—because the generous subsidies to premiums received by 90% of exchange buyers mean that what those buyers pay now and would pay if premiums rose is not tied to premiums. Instead, their payment obligation is linked to a share of their income (up to 9.5%), and is not affected when premiums spike—so even for low risks the subsidies make insurance such a good deal that there is no additional reason for them to walk away. The premium might jump to $7,000, but the person’s premium would stay put at a few hundred dollars a month.

The worst-case scenario for the exchanges is thus limited to the 10% without subsidies—for them there might be a death spiral as the premiums they have to pay without help increase (and make the mandate penalty even less effective). But nearly all of the users of exchanges still have as much reason to stay in as they ever did. The market may shrink for some of the 10% (though many of them are high risks who will hang in there), but if nothing else changes exchanges can continue to function in their usual clunky  way. In effect, exchanges could become a government-run health insurance program for lower income people, more like an extension of Medicaid. A more serious threat is if insurers, in anticipation of being pilloried for high and rising premiums, abandon this sliver of the private insurance market (almost everyone who gets private insurance gets it through their job) and leave the exchanges bereft of options. But even a single insurer can offer many different plans, so the slightly shrunken outposts of Obamacare can continue to survive this threat, and wait for the greater threat of across the board repeal-and-replace.