CREDIT: AP Photo/Kenneth Lambert, File
On Tuesday, while most court-watchers were fixated on the high profile Hobby Lobby litigation, a panel of three judges just a few miles away heard a much more sweeping attempt to destroy the Affordable Care Act. Should this lawsuit succeed, however, much more will fall than a single contentious law. If it succeeds, it could completely destroy much of the health insurance market and throw millions of Americans’ health care into chaos — and at least one judge who heard the case, Judge Raymond Randolph, appears poised to make this chaos a reality. (Lest there be any doubt, the lawsuit is rooted in a flawed legal theory. To learn why, read this piece — or, better, read a federal trial judge’s decision rejecting the plaintiffs’ legal theory.)
The Affordable Care Act gives states a choice to either set up their own health insurance exchange or to allow the federal government to do it for them. The theory of this lawsuit, named Halbig v. Sebelius, is that the residents of the 34 states with federally-run exchanges are not eligible for subsidies to help them pay for insurance. On Monday, we reported that “an estimated 6.5 million fewer people will obtain health coverage by 2016, and many of those who do obtain it will have to pay much more to do so” if the courts strip them of the subsidies they are entitled to under Obamacare.
The reality, however, could be much worse. If the courts strip health care consumers in these 34 states of these insurance subsidies, the result is likely to be a phenomenon known as an “adverse selection death spiral” — a chain reaction where higher premiums drive consumers from the insurance market, which leads to higher premiums, which drives even more people from the insurance market.
To understand why, it’s important to first understand how insurance companies think. Insurers are more or less in the business of making predictions. Their job is to predict how much money they are likely to have to pay to their customers in any given year, and then charge a premium that is large enough to cover all of those claims plus a little extra money so that the company can make a profit. So for example, if a health insurance company serves 100 patients, and those patients’ medical bills are likely to total $1 million per year, then the insurer might charge each of those patients an annual premium of $10,300. That way, the insurer will have enough income to cover their customer’s costs, plus about $30,000 left over as profit. (In reality, insurers also have to cover their administrative costs, so premiums would be somewhat higher).
Now imagine the same scenario, but with one difference. In the real world, health costs are not spread evenly though all of an insurance company’s customers. Some have chronic illnesses that lead to predictable costs, others have sudden medical emergencies, and still others may be healthy and seek no medical care for an entire year. So let’s imagine that the hypothetical insurer described above has 20 customers that are in perfect health and who never, ever ask their insurer to pay for medical care. Now imagine that these customers decide that they would rather spend their insurance premiums on something else, so they drop out of the insurance pool. Now the insurer still has to cover $1 million worth of claims, but they only have 80 customers who can help them cover their costs, so premiums would have to go up to $12,875 per year.
This phenomenon, where healthy people drop their insurance (or do not obtain it in the first place), while sick people remain insured to cover their higher medical bills, is known as “adverse selection.” An adverse selection death spiral happens when the higher premiums caused by healthy people dropping out of the market lead to even more people dropping out, which leads to higher premiums, which leads to more people dropping out — and so on and so forth until the entire market collapses.
Which brings us back to Halbig and Judge Randolph’s reckless views. If the courts cut off subsidies to millions of insurance customers, that’s going to make the out of pocket costs paid by those customers much more expensive. A family of four in Dallas, for example, that earns $50,000 a year would see their premiums nearly triple if judges take their subsidies away. Those kinds of premium spikes will cause a whole bunch of healthy people to leave the insurance market — potentially setting off a death spiral. Indeed, as a brief filed by several economists in the Halbig case explains, the resulting premium spikes would render insurance “unaffordable for more than 99 percent of the families and individuals eligible for subsidies under the current IRS rule.”
As previously explained, Judge Randolph, a George H.W. Bush appointee, left little doubt at Tuesday’s hearing that he would trigger this death spiral and let the consequences be damned. A second judge, Carter-appointee Harry Edwards indicated that he would not repeal the subsidies. That leaves Judge Thomas Griffith, a George W. Bush-appointee, as the only member of the panel who seemed uncertain.
If Griffith votes with Edwards, he will allow the Affordable Care Act to move forward as it was intended — as the economist’s brief explains, the only way to accept Randolph’s theory of the case is if you believe that “Congress sought to legislate into existence a massive new social program that it understood would immediately fail.” Should Griffith side with Randolph, by contrast, he will be voting to do a whole lot more than undermine Obamacare — he will be voting to completely collapse the individual insurance market in many states.