Understanding ACA’s subsidies and their effect on premiums

As we move into April, health plans are working toward impending deadlines to complete rate filings for insurance products that will be available next year on state health exchanges. Last week we saw the release of two notable public analyses of premium impacts—a 50-state report from the Society of Actuaries, and a Milliman analysis for the California exchange, Covered California—and there are probably more estimates coming soon as the healthcare industry and the nation look to better understand the cost implications of the Patient Protection and Affordable Care Act (ACA).

Even though public debate has been wrestling with reform topics for three years now, there continues to be confusion over the interaction between insurance premiums and federal subsidies for lower-income individuals.

The common mistake here is that, while subsidies may reduce the amount that a lower-income individual has to pay directly for health insurance, they do not affect the actual premium. If a monthly premium for an individual policy in California is $450, a federal subsidy of $392.50 would reduce an individual’s cost to a manageable $57.50. But this is different from reducing the premium. The premium remains $450, with or without the subsidy. Here’s an illustration of this idea:

This distinction is important because premiums reflect the underlying cost of care. We cannot reduce premiums without reducing the underlying cost of care. Subsidies help make increasing premiums more affordable for lower-income consumers, but they do not actually reduce premiums. Someone still has to pay the full premium in order for the health plan to remain solvent. If the public is to better understand healthcare costs, it also needs to understand this distinction, because it is that underlying cost of care that is driving health insurance rates upward.

For a better sense of how the underlying cost of care affects premiums, read this paper. The Milliman Medical Index is also a useful reference in understanding this concept as are the videos in Milliman’s “Understanding Healthcare Costs” video series.