Last week, the Congressional Budget Office weighed in on the biggest economic imponderable in the health care debate:  how private health insurance premiums will behave under health reform. Building on its December 2008 CBO health insurance market analysis,  CBO forecast largely benign effects from health reform’s private market reforms and subsidies on the vast majority of the presently insured (e.g. voting public). 

According to CBO, only 17% of Americans in the so-called nongroup market–largely individuals–would see premium increases in 2016 (the CBO reference year), because they would be required to purchase fatter benefits with less economic risk.  CBO believes that the other 83% of the presently insured will see little or no change.

Analysis of how the health insurance market will behave under health reform has become ferociously politicized.  After the infamous PriceWaterhouseCoopers study sponsored by health insurers suggested possible large premium increases, the CBO report might provide cover for members of Congress who are contemplating irreversibly tying the federal budget to a volatile “private” insurance market.  I think the fiscal risks of a partially federalized private health benefit are significantly greater than CBO has suggested.

Estimated premium subsidies in proposed legislation–$574 billion over ten years in HR 3962–are pegged to estimated private health insurance premiums.  If, as a result of legislative intervention, premiums actually rise by, say, double the forecasted rates, Congress will be under fierce political pressure to match the increases, or throw millions of people who depend on subsidies back into the ranks of the uninsured.   Where that additional money would come from in 2016, with trillion-dollar deficits, Social Security transitioning to negative cash flow, and baby boomers flooding onto Medicare, becomes a large question. 

What we’re really talking about is trying to predict the fluid dynamics of a $900 billion lake of money–the private insurance premium pool. Lake volume is determined by how private insurers price their products, which, in turn, is determined by how their actuaries forecast both variables that will be politically controlled (such as which benefits are offered, how those benefits are priced, tax rates on insurance premiums or on employers who do not offer coverage, and how much inducement people will be offered to accept coverage) and variables that are beyond political control (general inflation, wage and income pressures, health care use, new technology adoption, and providers’ pricing behavior).

The Landscape Of Health Reform: Terra Incognita For Actuaries 

Actuaries made these assumptions in past years largely by looking in the rear-view mirror–by analyzing immediate past cost growth and its trajectory. Under health reform, the federal government will aggressively restructure insurance underwriting practices.  Insurers will be required to issue policies to anyone who applies, to cover a (politically determined) “essential benefit,” to not cap the benefit for those with catastrophic medical expenses, to not charge more than two or three times the least expensive rate to the oldest or sickest in the pool, to add people in their twenties to their parents’ policies, and a host of other factors. There is no actuarial roadmap through this completely restructured insurance marketplace.  It’s terra incognita, properly labeled “Here There Be Dragons!”

Health reform will also create a new Boulder Dam to hold back the lake–a system of health insurance exchanges that become the gateway to the private market, not only for those presently uninsured, but for a large number of the currently insured population.  The exchange’s rules will be the de facto regulatory hurdle health plans will have to surmount to reach the rest of us.

“Nobody Knows Anything”

Some humility is appropriate here for all forecasters: the behavior of that lake of money is a classic complex phenomenon.  It’s about 7% of the total U.S. economy we’re talking about!  For all the comforting semblance of objectivity, the CBO’s analysis is just a guess–an educated guess–about how the lake will behave if you completely restructure its boundaries.  You can model the heck out of it, but all you really do is reframe your uncertainties.  As a famous Hollywood screenwriter, William Goldman, once said about predicting the movie business: “Nobody knows anything.”

CBO makes some truly debatable assumptions that lead to their benign forecast.  One is that there is little provider cost shifting in the present market, and will be less in the future because of all the newly covered folks.  CBO also assumes that there will be limited risk selection risk from those who take up coverage–that more healthy people will take up coverage in the most volatile nongroup segment because of premium subsidies.   In addition, CBO assumes only modest increases in health care use due to the legislatively mandated reduction in cost sharing by subscribers, and little or no inflationary impact on health care prices of increased demand for health care from the uninsured.  It is actually hard to construct a rosier scenario than the one CBO created.

Let’s contrast CBO’s rosy scenario with what’s happening right now in the market segments with the greatest risk–individual and small-group coverage–and speculate (since that’s all we can do) about why it’s happening.  Presently, the private insurance cost trend is between 8 and 9% across the health system, and rising.   Large groups are seeing rate quotes for 2010 below that number–in the mid-single digits.   Individual and small-group clients are seeing, according to colleagues, analysts and news reports in this space, mid- to high teen rate increases for 2010. 

What accounts for the widening spread between inflation and health costs, and between cost and rate quotes, in the nongroup market segment health reform will restructure? Actual health care demand–hospital admissions, physician visits, prescriptions filled–remains pretty soggy(flat or low single digits), so whatever is pushing up rates isn’t driven by primary demand.

That Suspiciously Busy House Is A Cathouse, And Those Providers Are Cost-Shifting

Cost shifting is certainly a rising contributor to both spreads–cost above inflation, rates above cost trend.   CBO seems to think that just because providers charge insurers higher rates than Medicare and Medicaid doesn’t mean that they are shifting costs. That’s like saying that we don’t know for sure whether that suspiciously busy house is actually a cathouse and all those paunchy middle-aged men pulling up outside are actually going up and having sex.  I’ve been delivering coffee to that cathouse for years.  Take my word for it: they are up there having sex.  It isn’t pretty. 

If it weren’t for cost shifting, most providers who have margins wouldn’t have them. Private insurance is where all their profits come from. When Medicare flattened costs under the Balanced Budget Act (BBA) in 1997, the result was a lagged surge in private insurer costs, which peaked in 2003.  Coincidence?  I don’t think so.  I and consulting colleagues have spent this fall telling providers that it’s time to stay home with their wives, for example, learn to make money at Medicare rates, because health reform could eventually shut the cathouse down by forcing insurers to restructure their contracts or by capping their rates.

Right now, cost shifting is under way in earnest, not only because of bad debts, but also because Medicaid plans all over the country, but particularly in the Sunbelt (Florida, California, and so forth) are cutting provider payments. Some portion of rising insurer costs is likely attributable to more uncompensated care being shifted to private insurers.  Uncompensated care in hospitals has been rising for three years.

Medicaid Could Be Ugly For Providers: Enrollment Up And Rates Down

Medicaid cuts will probably accelerate next year when the eighteen-month Medicaid stimulus funding pulse runs out. Since Medicaid enrollment could increase by more than 30% due to health reform, we can expect low Medicaid rates to be a potent cash-flow offset to all of those new privately insured people. So the Medicaid trend is ugly for providers: enrollment way up, rates down, perhaps sharply. Almost half of those newly enfranchised by health reform will be Medicaid patients. There will also still be 25 million uninsured in 2016 according to CBO.

Further, providers expect Medicare to cut their rates, as well as their disproportionate-share hospital (DSH) subsidies.  So providers, where they are able, will increase their rates to private health plans to compensate for these anticipated losses. Since many of them–hospitals and specialty physicians–are in monopoly or quasi-monopoly positions in their markets, they can still get net cash flow from private insurance rate increases. Cost shifting is a powerful tidal force despite the planned reduction in uninsured.    (CBO could use some providers on their Healthcare Advisory Panel! It might affect its findings.) 

Another contributor to the spread between the 8-9% cost trend and mid- to high-teen rate increases is insurers trying to float their overhead (which is being whittled away at, rather than energetically cut) on a smaller base of profitable risk business.  These plans may have lost as many as 9 million risk lives in the past two awful years, and if it were not for hefty Medicare Advantage enrollment gains, a lot of the bigger plans would be in a heap of trouble.  Since Medicare Advantage margins will be sharply cut by health reform, we may be seeing some anticipatory rate increases to small-group and individual subscribers.

There are many opportunities to cut health insurance overhead, but not because reform will simplify their business, as CBO assumes.  Insurers will need smaller sales forces, pay fewer brokerage commissions, and see some standardization of benefits, thanks to the exchanges.  But they will also hire more lawyers, lobbyists, and “managers” of exchange relationships, and will increase advertising to the mass market to influence exchange purchases.  The biggest efficiency gains for insurers will eventually come from completely digitizing their provider contracting and payment systems, a process that is taking forever.

The Threat Of Worsening Adverse Selection Under Health Reform  

I think that adverse selection has accelerated during this recession because many people who are dropping coverage they cannot afford are those who expect not to use it, and those keeping coverage are those who expect to need it.   Unlike CBO, I believe that a lot of young people will pay the modest fines (if they pay taxes, that is) and remain uninsured, and that boomers will pile into the subsidized end of the exchange-mediated marketplace because the 2 or 3-to-1 rate bands in the legislation will make baby boomers’ coverage a relative bargain.  The tight rate bands will absolutely inhibit uptake among younger, healthier people. 

Another contributor to the spread is the below-trend pricing in the large group insurance market.  The money to subsidize large group retention has to come from somewhere–and the best place to get it is from those with the fewest choices–individuals and small groups.   Finally, I think that many health insurers are trying to rebuild reserves damaged by last fall’s stock market crash, and perhaps build up a little cash cushion for the coming uncertainties.   If price controls via the exchanges were even a remote possibility, it also wouldn’t be surprising if building up the rate base weren’t going on as well.

Health reform puts the private insurance benefit in the sweaty hands of a political system not known for its ability to say “no.”  Tom Daschle had enough sense of the possibilities for benefits creep to advocate putting the private benefit, not just Medicare’s benefit, under a non-congressional authority. The recent fiasco with mammography strongly suggests that Congress will bend over backwards to be generous on what we’re all “entitled” to, evidence be damned.   

All in all, the fiscal risks from an open-ended new entitlement to premium subsidies are likely to be significantly larger than CBO estimates.   Instead of neat economic models with ten variables, we need something closer to chaos theory to explain how the nearly trillion-dollar Lake Mead of money will behave when we completely re-engineer its flow pattern. Perhaps the Corps of Engineers can lend CBO some staff.  Behavioral economists would add that anxious health insurance and provider executives would behave differently, perhaps, than entirely rational actors, and act aggressively to preserve their franchises and operating margins.  I wouldn’t bet the farm on moderation of present cost and rate trends.  All the big risks are on the upside.

Note: The author has no consulting ties to the health insurance industry.  Two of his 28 paid speaking engagements in 2009 were with health insurance audiences (both non-profit).  His only continuing economic relationship to the health insurance system is paying his premiums every month.