The impact of the ACA on young Americans

“Young Americans,” the classic David Bowie song repeats these lyrics:

“We live for just these twenty years
Do we have to die for the fifty more?
All night
He wants the young American.”

I know I show my age by citing a Bowie song, but he was an icon of my generation.  And I liked his music (and still do).  The lyrics have more meaning for me today as the Democrat’s nominating convention winds down.  I see them as reflective of our government’s view of young Americans:  “You’re only young once (and for a very short time) and then you die.  We’d better get as much out of them while we can because the dying process begins all too soon.” 

The cornerstone of the Affordable Care Act is the individual mandate, declared constitutional not by the commerce power of the federal government, but because it is viewed (at least by one person) as a tax.  Why do we need a mandate in the first place?  Now that coverage is available, won’t everyone want to have it?  Not by a long shot and let me explain why. 

Before implementation of the act, approximately one-half of all uninsured people in the US were between the ages of 18 and 34.  Now several million under the age of 26 are receiving coverage through their parents’ policies.  Will the rest purchase insurance when the ACA is fully implemented?  First, understand that about one-third are offered insurance through their jobs but refuse to participate because of it costs too much.  Their share (averaging 25% of the total premium) is too much.  Second, they’re young and healthy and don’t think they need it.  Has anything changed? 

These are people who on average have about $800 in annual medical expenses.  Ignoring administrative costs and profit, the actuarially-fair premium would be $800 (about $67 per month).  A 75/25 split between employer and employee would result in a net monthly premium of about $16.  This result would require homogeneous risk pooling with only adults age 18-34 in the pool. 

In contrast, people 35-64 years old spend on average 6 times the amount of those 18-34, or about $4,800.  The same homogeneous risk pooling will require they pay their own way and not rely on younger Americans to subsidize them.  Thus, their annual premium is $4,800 (or $400 per month).  A similar agreement with their employer would result in a worker share of the premium of around $100 per month, roughly 6 times that of their younger co-workers. 

How does the Affordable Care Act affect this result?  Well, the ACA only allows a premium differential of 3 to 1.  Let’s see what this does to premiums.  According to the 2010 US Census, there are approximately 2 times as many people in the older age category.  Assuming that the risk pool has twice the number of 35-64 year olds and 18-34 year olds and that the older group’s premium is only 3 times the younger group, the annual premium for the young American will be $1,480 and that of the older co-worker will be $4,440. 

The 3:1 ratio in premiums results in the younger group paying 85% more than the actuarially-fair premium so the older group can pay about 8% less.  Remember in my last post I noted that Jonathan Gruber failed to take adverse selection into consideration in his predictions on the ACA’s impact on premiums?  How does adverse selection affect my example?  I’ll tell you how.  Young people won’t buy the insurance.  There will be fewer in the pool to subsidize their older co-workers and premiums will rise for everyone. 

If half of the young refuse to purchase insurance, the premium will rise another 4% to $1,540 for young people and to $4,620 for everyone else.  In economists’ lingo, this is the beginning of the death spiral.  More young Americans will drop out and premiums will rise for everyone.  Soon 35-44 year olds will resent paying the same premiums that 45-64 year olds pay and demand separate pooling.  If they don’t get what they want, they too will drop out of the pool and premiums will continue to rise.  Soon insurance for the older group costs more than $4,800 and even those with chronic medical conditions will consider the prospects of dropping insurance.  Drop the insurance, pay the penalty, and re-enroll when you need medical care.  The structure of the act encourages this type of gaming. 

Our problem is that “we live for just these twenty years,” the time of our lives when we do not have much money.  There are demands on our money other than the purchase of insurance.  And the last thing we want to do is subsidize a bunch of older, sick co-workers who make more money than we do.  Even though we too will one day be old and sick.  But as Scarlett O’Hara said: “I can’t think about that right now.  If I do, I’ll go crazy.  I’ll think about that tomorrow.”