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Sticker Shock

When it comes to health care reform, many Americans are still asking: What’s in it for me? They should put that question to Californians who have individual insurance coverage from Anthem Blue Cross--and just learned their premiums will be going up by almost 40 percent this year.

Beneficiaries started learning about the rate hikes last week, according to the Los Angeles Times, which first reported the story. The premiums will, I’m sure, cause real hardship for many people.

This is not, to be clear, just another story of medical care getting more expensive because of technology, over-treatment, monopoly pricing, or any of the other familiar drivers of system-wide costs. Yes, health care costs in this country are rising, faster than any of us would like. But inflation--that is, the increase from year to year--rarely exceeds 12 percent. And Wellpoint, Anthem’s parent company, reports that its medical expenses rose by only around 9 percent this year. Obviously, something else is going on.

In a statement, Anthem explained that a big part of the problem was the down economy--and the effect it was having on people’s decision to buy insurance. As budgets get tighter and people look to cut back on expenses, some people will decide to drop insurance. And, overall, they will tend to be people in better health, since they are most willing to risk going without coverage. The whole point of insurance is to pool risk, so that premiums from healthy people (who make up most of the population) cover the expenses of unhealthy people (who constitute a small fraction of the population). When healthy people start dropping coverage, rates for the unhealthy go up, to the point where they become unaffordable.

As Karen Tumulty notes, that's a pretty good argument for some sort of universal health care system, in which everybody has to maintain coverage. The idea that insurance premiums would rise more quickly at precisely the moment when more people are struggling financially is positively perverse.

But, most likely, a slow economy isn't the only culprit here. It appears, based on press accounts, that not all Anthem beneficiaries are seeing such huge rate increases. Only some are. If so, there's more to this story.

(Warning: The rest of this item is pretty wonky.)

When insurance companies sell coverage in the individual market--that is, when they offer polices to people one-on-one, rather than through employers--they don’t typically put everybody’s premiums into one big pot. Instead, they usually break up their business into different “blocks.” A block could be everybody living in a particular area, everybody fitting a certain demographic profile, or everybody buying a particular type of policy, just to use a few examples. And after enough people are in a block, the insurer will often “close” it, meaning they don’t add new beneficiaries to that particular group.

Insurers will set the premiums in each block based on their projection of what kinds of medical bills people in the block are going to incur. And so, for example, a block that has a a lot of young, healthy men will probably have really cheap premiums--since, on the whole, young, healthy men tend not to have very high medical expenses.

(Young, healthy women are another story. They have the actuarially unfortunate habit of getting pregnant and having babies.)

Over time, the blocks evolve. And, inevitably, some of those young, healthy men will develop medical problems. They’ll get injuries or develop life-threatening illnesses--the type that require extended hospitalizations, long stints in rehabilitation, and all sorts of prescriptions. Rates in the group will start to go up.

At that point, people in the block will seek better deals. And the healthy ones will find such deals quickly. But the ones with the medical problems won't have such an easy time. If they shop around, they're likely to find only policies that provide way too little coverage or cost way too much. Whether they stick with their existing coverage or decide to switch, they're going to end up paying a lot more for their medical care.

Policy wonks call this the adverse selection death spiral. And the key thing to remember is that it happens all the time, even when the economy is strong. It is inevitable, given the way the individual market works, although insurers can make it better or worse depending upon how aggressively they want to pursue profits.

An insurer might, for example, raise rates for a particularly high-cost block more severely than its expenses actually require, in the hopes that expensive-to-treat beneficiaries will eventually flee for other carriers. There's no way to know if that's what's happening here, at least given the information now available. (When contacted by TNR, Wellpoint sent its prepared statement and declined to answer further questions.) But it's a question worth exploring, given that Wellpoint made $2.7 billion in just the final quarter of 2009.* 

In any event, piecemeal reforms can't really stop this from happening. As it is, the law prevents insurers from raising rates (or canceling coverage) only on individuals with high medical expenses. That's why insurers end up raising rates for entire blocks as costs go up. The favorite conservative answer--high-risk pools--don't offer much relief, either. They tend to be underfunded, which generally translates as less coverage for higher prices. They may be better than nothing, particularly for people who don't have coverage already, but they're not a real solution.

No, the best way to avoid adverse selection, as I've argued many times, is to create one giant insurance pool--in which everybody, healthy and sick, gets coverage at the same rates. And, roughly speaking, that's what the Democratic health care bills would do, by creating insurance exchanges through which all individuals in a given state would buy coverage.

In these exchanges, insurers couldn't charge different rates based on medical risk; they'd have to cover a defined set of benefits and would have to spend most of their revenue on actual patient care. The government would require (almost) everybody to get insurance--and then offer subsidies, so that (almost) everybody could comply with the requirement. Projections suggest most people in the individual market would end up paying less for their coverage than they would otherwise, while getting stronger, more reliable benefits.

It's not the most elegant solution or, to be sure, a perfect one. (A single-payer system would be even better, in my humble opinion.) But it's good enough, certainly. Just ask the people of Massachusetts, where such a system is up and running--and rather popular, as well.

Of course, only a relatively small portion of Americans carry individual insurance coverage. The majority of people with private coverage get it through their employers, where such stark rate increases are rare. But, without reform, it's entirely possible--some would say likely--that more and more employers will be dropping coverage, leaving more and more individuals to buy it on their own. That's why the California Anthem story should get everybody's attention.

*Answers on this question may be forthcoming. HHS Secretary Kathleen Sebelius sent Anthem a scathing letter, noting the company's large profits and seeking an explanation for the rate hike, while Representatives Henry Waxman and Bart Stupak are hauling Braly into hearings before the House Energy and Commerce Chairman.

Update: I fleshed out the explanation of why an insurer might raise rates on expensive blocks of customers, plus I smoothed out the prose in a few places.