- Once the time value of money is taken into account, the average young person will be worse off under Obamacare
- Progressives have turned to a new argument to get those under 30 to act against their self interest by signing up for the Exchanges
- Community rating is unfair because it ends up transferring resources from healthy poor people to unhealthy wealthy people
Progressives are becoming increasingly concerned at the prospect of millions of uninsured young people deciding to push the easy button next year by simply paying a very small fine rather than obtain health coverage. Consequently, they have turned to a new argument to get those under 30 to act against their self interest by signing up for the Exchanges. Now we are being told that Obamacare will be a good deal for young people in the long run since whatever short-term losses they incur in the form of higher premiums will be more than made up later when they are older and get to pay lower premiums than they would in today’s market.
But those making these arguments haven’t offered any analysis to back up their claims. The conceptual point evidently is supposed to be intuitively obvious. As Ezra Klein puts it:
"Young people grow old. Healthy people get sick. Rich people become poor. The people overpaying to keep costs low today are the people underpaying 10 or 20 years from now."
As a health policy skeptic, I know that lots of intuitive ideas—such as that prevention saves money—turn out to be false upon closer examination. So when I did some actual analysis of this latest idea, it did not surprise me to learn that this claim is dead wrong. Once the time value of money is taken into account, the average young person will be worse off under Obamacare even if they live long enough to be a near-elderly person who pays premiums that are well below actuarially fair rates.
In the short run, millions of young will be better off without Obamacare
A recent study by the National Center for Public Policy Research shows that:
- About 3.7 million of those ages 18-34 will be at least $500 better off if they forgo insurance and pay the penalty.
- More than 3 million will be $1,000 better off if they go the same route.
Consequently, many more will opt to pay the extremely modest tax rather than fork over many thousands of dollars to purchase coverage that became substantially more expensive for young people thanks to the misguided pricing rules imposed by Obamacare. The risk that the law will fail in an “adverse selection death spiral” thus has gotten much larger. This claim is not in dispute. Instead, progressives argue it is too narrow. If only young people would consider the long run—when they too are old—they would discover that enrolling in Obamacare is in their self-interest.
But in the long run, the story is the same
It is relatively straightforward to test this claim empirically. My purpose is not to compare today’s premiums with those that will exist under Obamacare, since at least part of the expected increase in premiums is related to filling in purported gaps in coverage, such as eliminating lifetime limits and providing preventive health services without any cost-sharing. I don’t want to cloud the discussion with claims that these added benefits are somehow “worth” the higher premiums. Instead, I want to focus on the claim that the “pay me now, we’ll pay you later” adjusted community rating structure under Obamacare actually is a good deal when considered on a lifetime basis.
My strong preference for health reform—shared by highly reputable health economists such as Mark Pauly and Patricia Danzon at Wharton School, several others at Harvard (Amitabh Chandra, Michael E. Chernew, Anupam B. Jena Stanford (Jay Bhattacharya), University of Chicago (Anup Malani, Tomas J. Philipson) and University of Southern California (Dana Goldman, Darius Lakdawalla) —is that health insurers be allowed to price risk. Community rating can be shown (both theoretically and empirically) to be both inefficient and unfair. It is inefficient because it encourages low risk individuals (think young people) to remain uninsured rather than over-pay for health insurance. It is unfair because it ends up transferring resources from healthy poor people to unhealthy wealthy people. But this unfairness aspect might be undercut considerably if it turned out that from a lifetime perspective, young people who overpaid when young were more than compensated by their future savings from community rating once they got old.
So I first created a set of experience-rated premiums for every single year of age between 18-64). I then calculated the present value of these premiums over a lifetime—which in this case meant ages 18-64 since even under Obamacare, people are assumed to enroll in Medicare at age 65. I examined 4 different groups of young adults (age 18, 22, 25, and 30) using different discount rates. I then created a parallel set of premiums that were constrained to meet the Obamacare modified community rating rules, namely, that the premiums for the oldest plan members can be no more than 3 times as high as the premiums for the youngest members. If the present value of the Obamacare premiums is lower than the comparable figure for experience-rated premiums, then one could reasonably say that the intuition of Obamacare enthusiasts is correct: young people are better off under Obamacare since they ultimately will save enough on their premiums in old age to offset whatever “excess” premiums they are forced to pay in their young adult years. But as you can plainly see, for most age categories and most discount rates, the reverse is true. The lifetime cost of Obamacare is higher than under market-driven premium rates.
The only instance in which Obamacare is consistently a better deal is using a 0% discount rate. But a 0% discount rate implies that young people are indifferent about getting $1,000 today or $1,000 50 years from now. I challenge readers to find just one person who, when confronted with such a choice, would choose to take the payment 50 years from now instead of today. Most people—young or old—are not that patient. They would far prefer to have money today than to receive the comparable amount far in the future. Which is why banks, corporations and the U.S. government have to pay interest to people in order to induce them to put their money into bonds rather than spend it. Interest rates simply represent the time value of money. In a present value calculation, the discount rate is what is used to a future dollar into an amount comparable in value to today’s dollars.
Individuals Generally Have a High Rate of Time Preference (They Are Impatient). Many economists think U.S. society has a long-run discount rate (i.e., social rate of time preference) of 3% since that figure is comparable to the inflation-adjusted rate of return on long-term U.S. Treasury bills. But individual rates of time preference typically are much higher than societal rates, with double-digit rates not being at all uncommon in the vast literature that has sought to estimate their size. This makes sense because, for example, the U.S. government presumably has a lifespan longer than that of individuals. If someone is uncertain about living long enough to get their money back in 40 years, they will generally expect to be paid a higher interest rate than if survival were a certainty. Thus, from the standpoint of the average young adult adversely affected by Obamacare, I would argue that the figures using a 10% discount rate come much closer to the truth than do the figures using a 3% rate. And you can see from the chart that using that 10% rate, Obamacare is not a good lifetime deal even for people as old as 30 [and if I had used a much higher discount rate of say, 17%, Obamacare would turn out to be an even worse deal for young people]. For 18 year olds, Obamacare essentially is imposing a tax of 18.3% on the premiums they would otherwise pay under the more market-oriented reforms favored by many conservatives and Republicans.
These estimates are very conservative
I cannot emphasize enough how conservative my estimates are. I have ONLY accounted for for the “pure” effects of modified community rating–i.e., the fact that young people on average pay higher premiums while older people pay lower premiums. In calculating the increase in premiums required for young people to make this transfer work (i.e., for the number of extra premium dollars needed among young people as a group to exactly balance the amount of premium reductions given to older people) I have taken into account the first order impacts on how many people will demand health insurance (i.e., fewer young people and more older people will sign up for coverage under modified community rating than if insurers been allowed to fully price risk the way they do in auto, life and homeowners insurance). This meant I had to adjust the rates for the young even higher in order to provide enough additional premium reductions to finance the additional number of older people in the pool. However, I did NOT account for adverse selection at all: that is, I assumed that average spending by year of age among pool members remained the same. In reality, it would be the healthy young who would be most likely to drop out as premiums for that age group rose and the unhealthy old who would be most likely to join as premiums for that age group fell.
In short, I have bent over backwards to prove the claim of progressives and still found their hypothesis wanting. If I were an actuary capable of incorporating the adverse selection effects, the increase in lifetime premiums for the average young person would be considerably higher than shown in my chart. This is why the various estimates of rate shock estimated by Avik Roy (64-146% in California, for example) and others provide a much more accurate depiction of the premium increase for 18 year olds, for example, than the 35.4% figure I derived from my more limited calculations.
What’s so bad about modified community rating?
Modified community rating essentially is an excise tax on people who buy health insurance. Those who choose to go bare avoid the tax entirely, but for those who do buy coverage, the tax is highly discriminatory, imposing the highest burdens on those who are young. Can anyone name another tax that works this way? Imagine a state that tried to impose a sales tax in this fashion, where everyone would have to show an ID card and the amount of tax charged to 18 year olds would be 18% while those age 30 would only have to pay 5% and seniors would get a rebate!) How kooky is that? If we as a society have decided that some group needs help in paying for their health insurance, shouldn’t we make those subsidies visible for all to see instead of burying them in someone’s health insurance bill? Moreover, shouldn’t we be relying on taxes that are visible and fairly distributed rather than using “taxation by regulation” of health insurance? If older people need subsidies, why should young people (who are far from being the wealthiest in society) be disproportionately burdened with bankrolling what should be a social responsibility?
People rationalize modified community rating on grounds that what goes around comes around. “Don’t worry kid. Someday you too will be old enough to enjoy premiums subsidized by youngsters your age. It all works out in the wash.” But it is now plainly evident that for typical young adults who have very reasonable time preferences, it does not all work out in the wash after all. Obamacare is a bad deal, plain and simple.
Instead of spending millions of hundreds of millions of taxpayer dollars to bankroll vacuous appeals (“make you feel like a winner.“ Seriously?) and trot out sports stars and Hollywood celebrities to fast-talk young people into signing up for Obamacare, how about instead using that money to educate them about the truth of how the health law treats them as a cash cow for older folks? Sadly, this administration can’t handle the truth since they know that once young people wake up and smell the coffee, it’s game over for Obamacare. Far better to stay the course with a mad scramble to put the law into place even though a) the bureaucrats responsible for implementing it are begging for more time; and b) haste will greatly inflate the risks of privacy violations on a wide scale.
At the risk of sounding like a broken record, is this really the best we can do? Perhaps we owe it to young adults to delay the entire law for a year so we can straighten out some of these problems. At minimum, it would give them an extra year to save up for the rate shock they will face on Day One of the exchanges. If young people knew as much about Obamacare’s adverse impact on them as they know about how to work their cell phones, this law would be in deep doo-doo. Sadly, this is the very demographic that is most ignorant about the freight train headed their way. Until and unless these same young adults get educated on the facts quickly and start urging their members of Congress for a one year delay, that train may be headed for a wreck.
 In 2014, the penalty for failure to obtain qualified health coverage will be $95 or 1% of income.
 Using Medical Expenditure Panel Survey (MEPS) data for 2010 (the latest figures available), I created 2 lifetime premium profiles for adults age 18-64. Using estimated actual average annual spending by age (inflated to include the administrative costs that would be typical for a health plan on the Exchanges), I calculated what premiums would be for every year of adult life prior to age 65 if insurance companies were permitted to simply use experience-rating (just as they do in auto, life, and homeowners insurance). I then created a parallel set of figures by adjusting these estimated premiums to take into account the Obamacare requirement that premiums for older people (defined in my analysis to be 64) could not be more than 3 times as high as premiums charged to younger people (defined in my analysis to be 18). This required systematically adjusting premiums upwards for young adults while systematically adjusting premiums downwards for older adults.
 Mark Pauly is the arguably the nation’s preeminent scholar on the inefficiencies and inequities created by community rating [Mark V. Pauly, The Welfare Economics of Community Rating, The Journal of Risk and Insurance Vol. 37, No. 3 (Sep., 1970), pp. 407-418; Herring, Bradley and Pauly, Mark V., The Effect of State Community Rating Regulations on Premiums and Coverage in the Individual Health Insurance Market (August 2006). NBER Working Paper No. w12504. Available at SSRN: http://ssrn.com/abstract=928067]. He and Patricia Danzon co-authored Responsible National Health Insurance two decades ago, a comprehensive health reform proposal that would have allowed health insurers to price risk and used fixed dollar tax credits that vary by health status to make such coverage affordable. Similarly, the remaining 8 health economists have co-authored a new health reform proposal with similar features [Best of Both Worlds: Uniting Universal Coverage and Personal Choice in Health Care, American Enterprise Institute, August 6, 2013].
 Frederick, Shane, George Loewenstein, and Ted O’Donoghue. 2002. “Time Discounting and Time Preference: A Critical Review.” Journal of Economic Literature, 40:351-401. On p. 385 is an extensive discussion of various empirical estimates of discount rates based on real-world behavior, with rates ranging from 11 to 17.5% being not that unusual.
 It’s actually much worse than my example. In my analysis, 18 year olds end up paying premiums that are 35.4% higher under Obamacare rules than if premiums were experience-rated, while 64 year olds would pay premiums that are 23.8% lower. Over a lifetime, the net increase in premiums is only 18.3% (since the premium reductions in later years offset the large premium increases in the early years), but extrapolating this example to sales taxes means that the day-to-day rate for 18 year olds would be 35% instead of only 18%.