Three Steps To Achieving More Affordable Health Insurance In The Individual Market

In the ongoing debate over the Affordable Care Act (ACA), consensus seems to have formed on one major point: The law failed to deliver affordable coverage through the individual health insurance market for people who don’t qualify for premium subsidies. Republicans have long argued that the ACA led to higher, often unaffordable premiums for millions of Americans. In March of this year, Democrats in Congress took action to temporarily address this affordability problem during the pandemic by including a provision to expand premium tax credits through 2022 in the American Rescue Plan Act (ARPA). President Joe Biden’s American Families Plan now proposes to make this policy permanent.   

Supporters of expanding the ACA’s premium subsidies maintain that this will be an efficient way to cover more people. Yet, the ACA—in particular the ACA’s premium subsidy structure—has resulted in costlier health insurance premiums. Instead of building on ACA policies that led to costlier health insurance premiums, as Biden proposes, we need to find a better way to ensure a stable insurance market that extends affordability to all income levels. In this post, I explain how ACA policies inflated premiums while failing to provide an efficient way to expand coverage, and I propose three steps to create a more affordable, competitive, and efficient individual market for people of all incomes.

ACA Policies Made Individual Market Premiums Unaffordable  

Immediately after the ACA’s main regulations took effect in 2014, the price of individual market insurance premiums began to grow out of reach for many middle-income people who do not qualify for federal subsidies. In 2013, people paid an average of $242 a month for a plan on the individual health insurance market. The average monthly premium then rose to $352 in 2014—a 45 percent increase. By 2018, premiums had jumped to $588—a 143 percent increase from 2013.

Older, moderate-income consumers who make slightly too much to qualify for premium subsidies were hit hardest by these premium spikes. According to a Centers for Medicare and Medicaid Services (CMS) report examining affordability issues, in 2020 the annual premium for the lowest-cost silver plan in counties located in states (except Alaska and Hawaii) using HealthCare.gov on average equaled 25.8 percent of income ($12,886) for a 60-year-old making $50,000 and reached 35.3 percent of income ($17,651) in the highest-cost quintile of counties. This is well above the maximum contribution amount—9.83 percent of household income—for people who qualified for ACA subsidies last year, and it clearly is not affordable.

As the CMS report on affordability explains, “[t]his increase in premiums is primarily due to the implementation of the ACA’s insurance reforms in 2014, including decisions on how to implement these requirements.” The report highlights the major ACA regulations that caused higher premiums, including the closure of state high-risk pools, premium rating requirements, health benefit mandates, health insurance taxes, and the exchange user fee. Implementation decisions leading to higher premiums include the allowance of “transitional” policies (also known as grandmothered plans) that don’t meet ACA requirements, the lack of eligibility verifications for exchange special enrollment periods, and decisions that led to initial failures and glitches on the exchanges. In addition, the report notes how “the structure of the premium tax credit also encourages premium inflation.”

The ACA’s Subsidy Structure Inflates Premiums

The inflationary nature of the ACA’s premium subsidy structure may be one of the most overlooked problems with the law. Basic economics holds that government subsidies inflate prices, but the ACA’s subsidy structure aggravates this already inflationary posture. This is because the value of the ACA’s premium tax credit is tightly linked to the price of insurance premiums and, therefore, the subsidy tends to rise lock-step with the increase in premiums. 

More specifically, the premium subsidy is linked to the price of the second lowest-cost silver plan—also called the benchmark plan—and covers the portion of the benchmark plan premium that exceeds a certain percentage of income. This percentage is set on a sliding scale of income to provide more generous subsidies to people with lower incomes and creates a maximum amount of household income any eligible individual must contribute toward a benchmark premium. Thus, the federal subsidy generally pays the full portion of a benchmark premium above this maximum contribution amount. As the maximum contribution amount is largely fixed from year to year, any annual increase in premium is fully funded by an increase in the premium subsidy. 

Because the government generally pays the full cost of any premium increase, there’s little pressure on insurance companies to keep premiums down for subsidized people. The main pressure for insurers to keep premiums down comes from unsubsidized people in the market who pay the full freight, but this pressure is dropping as the unsubsidized portion of the market shrinks. Between 2016 and 2019, the unsubsidized portion of the individual market dropped by 2.8 million people—reducing the proportion of the unsubsidized in the market from 43 percent to 29 percent. 

Despite the obvious inflationary nature of the ACA subsidy structure, there is scant research on this topic. A recent paper by Sonia Jaffe and Mark Shepard may be the first to estimate the inflationary impact of price-linked subsidies in the context of the ACA. Using pre-ACA data from the 2011 Massachusetts health insurance market, they estimate that price-linked subsidies increase premiums by 6 percent. They also show the price distortion is larger when fewer insurers are competing in the market, with the distortion ranging up to 12 percent in various simulations.

The inflationary impact of the ACA’s price-linked subsidy is likely higher nationally than the 6 percent increase estimated for Massachusetts. First, compared to most states currently, the Massachusetts individual insurance Marketplace in 2011 was more competitive, with five insurers compared to an average of 3.5 available to HealthCare.gov enrollees in 2020. Second, the proportion of price-sensitive unsubsidized enrollees was also higher, as the state’s income cutoff for premium subsidies was lower than that established under the ACA—300 percent versus 400 percent of the federal poverty level—and due to the unique merger of the state’s individual and small-group markets (as people with small-group coverage did not qualify for subsidies). Third, given that trends in provider consolidation have continued and the Boston hospital market is among the least concentrated among US metros, the Massachusetts provider market in 2011 was likely less concentrated than most markets today. As Jaffe and Shepard note, providers with monopoly power can take advantage of price-linked subsidies and charge higher prices, leading to even higher premiums.

ACA Premium Subsidies Failed To Efficiently Cover More People

Enrollment and federal funding trends reveal the ACA’s failure to efficiently cover more people through the individual market. Efficiency generally means maximizing the amount of output from the amount of inputs. In the case of the ACA’s individual market subsidies, efficiency can be measured by dividing the additional federal spending on subsidies by the net increase in individual market enrollment.

When the law initially passed in 2010, the Congressional Budget Office (CBO) projected the individual market would, on net, cover 19 million more people in 2019 and federal spending on premium and cost-sharing subsidies would amount to $88 billion. That equates to about $4,600 per additional person covered. Those projections have proven to be substantially off the mark.

As shown in exhibit 1, enrollment in the individual market never came close to reaching the levels projected by the CBO. Exchange enrollment quickly reached 8.8 million in 2015 and has remained remarkably level at around 9.0 million ever since. Off-exchange enrollment has steadily declined, and this decline has reduced total individual market enrollment each year since its peak in 2015. 

Exhibit 1: Individual market enrollment, 2013 to 2019

Source: Author’s analysis of individual market enrollment based on CMS medical loss ratio (MLR) data, 2013–19, and effectuated enrollment data, 2014–19. MLR data reflect total covered lives as of December 31 each year. The analysis covers the entire individual market, including grandfathered and transitional/grandmothered plans. Exchange enrollment is sourced from CMS effectuated enrollment data (2014 to 2015 and 2016 to 2019) and reflects average monthly enrollment for the month of December each year. Off-exchange enrollment reflects the difference between individual market enrollment and exchange enrollment. Note: This analysis relies on enrollment reported in December of each year because it is the only reliable data source to compare national trends in on- and off-exchange enrollment dating back to the start of the ACA. However, due to enrollment attrition that tends to occur through the year, December enrollment does not fully reflect the annual enrollment experience.   

Exhibit 2 shows enrollment gains based on average monthly enrollment to compare the cost of annual federal spending on premium and cost-sharing subsidies to annual enrollment gains after the ACA’s main regulations took effect in 2014. By 2019, the gain in total individual market enrollment over 2013 had shrunk to 2.4 million from a peak of 6.7 million in 2015—far less than the 19 million additional enrollees the CBO had projected. This steady enrollment decline, combined with higher spending on premium subsidies, contributed to the trend of substantially higher spending per additional individual market enrollee gained. By 2019, spending per enrollee gained rose to more than $20,000. This clearly does not represent efficient federal spending for the outcome achieved.

Exhibit 2: Individual market enrollment gains compared to federal ACA spending on premium tax credits and cost-sharing reduction subsidies

Sources: Author’s analysis of CMS Medical Loss Ratio data and Office of Management and Budget, Budget of the US Government, Fiscal Year 2022, Historical Table 8.5. Note: Data reflect average monthly enrollment gains for entire year.

Impact Of The American Families Plan

In the American Families Plan, President Biden proposes to make the ARPA’s two-year expansion of premium subsidies permanent. This would mean the permanent expansion of enhanced subsidies for people with incomes between 100 percent and 400 percent of poverty—including access to fully subsidized premiums for people up to 150 percent of poverty—and the permanent extension of subsidies to people above 400 percent of poverty to cover the full cost of premiums above 8.5 percent of income. The Henry J. Kaiser Family Foundation estimates that under this proposal, the “vast majority (92%)” of people in the individual market would qualify for federal subsidies aimed at keeping premiums affordable. 

This expansion of premium subsidies would make the personal share of the premium far more affordable for a large portion of people above 400 percent of poverty, which will likely increase individual market enrollment. However, these enrollment gains will come at a substantial cost. Without any other policy changes, the Biden proposal addresses the affordability problem by simply increasing federal spending. In effect, this policy decision accepts the dysfunctional state of the current individual market as a given that either politically can’t be fixed or isn’t worth fixing. Therefore, the present high cost of the ACA’s regulatory and financing structure is baked into the proposal. Moreover, extending subsidies to more people would further inflate costs in the individual market by substantially reducing the small but still meaningful amount of price sensitive, unsubsidized people in the individual market. 

Extending subsidies also could influence employer decisions—especially those of small employers not subject to the ACA’s employer mandate—to offer health insurance, which may further aggravate cost problems. To the extent that the American Families Plan leads to enrollment shifts from the group to the individual market to take advantage of higher subsidies, these policies could further reduce the price-sensitive portion of the insurance market and push premiums even higher. In a worst-case scenario, small-group markets in certain states may become unsustainable and certain large groups may opt to drop coverage and pay the employer mandate penalty to dump expensive, sick employees into the individual market. Unlike small groups, large groups can be rated based on the health status of their employees, and therefore may be subject to very high premiums that may incentivize them to drop coverage despite the mandate.

A More Efficient Way To Fix The Individual Market

While there is no easy fix to affordability problems in the individual market, I propose three policies that can help build a more functional, competitive market—a market offering individual health coverage that middle-income people can afford without direct subsidies. Importantly, these policies would address the root causes behind the high cost of health care rather than papering it over with taxpayer-funded subsidies that lead to higher federal deficits. These policies thus can help improve the entire health care system, not just the individual market.

• Fixed premium subsidies. A first step to improving the individual health insurance market is to shift from the current price-linked premium subsidy structure to a fixed subsidy. As Jaffe and Shepard explain, price-linked subsidies involve an inherent tradeoff—they sacrifice stronger price competition that keeps premiums lower for protection against price shocks that might make premiums less affordable if the subsidy were fixed. Yet, because ACA premiums are now rather predictable from year to year, there is little advantage to a price-linked subsidy. A well-designed fixed subsidy could adjust to predictable changes from year to year, including adjustments for inflation, to ensure affordability without weakening price competition among insurers. A fixed subsidy could be structured in various ways with adjustments for age or income or no demographic adjustment, as the late John McCain proposed when he ran for president in 2008.
• A federal reinsurance program. As a second step, the federal government should fund a reinsurance program to pay a portion of individual market claims that are disproportionately higher than claims in the group market. Due to the ACA’s regulatory and subsidy structure—in particular the law’s guaranteed availability and community rating regulations—the individual market now attracts people with relatively higher health risks than the group market and, as a result, costs more than it otherwise would. Many states have introduced reinsurance programs through state innovation waivers under the ACA that have successfully lowered premiums without undermining competition or efficiency. Unlike the ACA’s premium subsidy structure, which funds the full cost of premium increases, these state reinsurance programs subsidize a portion of claims—most ranging from 50 percent to 80 percent—thus helping to maintain insurers’ incentives to control costs. A nationwide reinsurance program structured to help equalize the cost of claims between the individual and group markets would likewise lower premiums and keep insurers motivated to control costs.
• Codification of individual coverage health reimbursement arrangements. Finally, federal law should explicitly authorize individual coverage health reimbursement arrangements (HRAs) in which employers can fund individual market premiums for employees with pre-tax dollars. If more employers offer individual coverage HRAs, the individual market will grow. This growth will draw more insurers to participate and result in a more competitive and affordable insurance market. Moreover, the risk pool will likely improve because enrollment growth would be tied to employment rather than health status, thus improving affordability even more. An improving risk pool more in line with the group market would eventually lessen the need for the reinsurance program. At some point, the proliferation of individual coverage HRAs could eliminate the need for reinsurance altogether if the individual market claims experience comes to mirror that of the group market.

The Internal Revenue Service has long recognized that individual premiums can be funded by employers with pre-tax dollars under the tax code, but there have also been questions and controversies over whether federal insurance requirements limit this practice. A change in federal regulation made individual coverage HRAs available on January 1, 2020. Explicitly codifying this policy in statute would provide helpful clarity and confidence to employers considering this option.

Summing Up

The vision behind these steps is a more competitive individual market with lower premiums that middle-income Americans can afford on their own without subsidies. The combination of fixed subsidies, a federal reinsurance program, and codification of individual-coverage HRAs will increase the proportion of unsubsidized people in the individual market. This change will help create a more functional, competitive market and, in turn, drive down the overall cost of care.

A transition to fixed subsidies under the first step will likely require more generous subsidies to account for the current affordability problems in the market. These subsidies will be built on a new foundation of active, price-sensitive consumers who drive insurer competition in the individual market, thus leading to lower premiums and better health coverage. As time goes by, lower premiums will reduce the need for subsidies. Instead of being yet another factor driving up the cost of care, the individual market will become a key part of the solution to bring down health costs for all Americans.