What, me buy insurance?

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What a difference a bad year makes. Executives at UnitedHealth Group initially voiced optimism about their prospects on the Affordable Care Act's insurance exchanges. The nation's largest health insurer foresaw a big role for individual plans in its business model.

But after evaluating early claims by enrollees who turned out to be sicker and more costly than expected, UnitedHealth hedged. It raised premiums and cut some plan designs, even as it maintained an upbeat tone for investors and the public.

“We continue to expect exchanges to develop and mature over time into a strong, viable growth market for us,” Dave Wichmann, UnitedHealth's second-in-command, said last October.

Then, just one month later, UnitedHealth upended everyone's expectations about the future of the exchanges when it confirmed it had lost $1 billion on its ACA plans and threatened to pull out altogether. Last month, UnitedHealth began giving notice it will exit most of the marketplaces, although it will remain in a “handful” for next year.

Although some of UnitedHealth's wounds were self-inflicted, other insurers are also struggling to manage their high-cost exchange population. Many are boosting premiums significantly. Experts predict the average rates for next year's ACA plans, which insurers are proposing now, could rise by double digits.

Rising rates are not solely the result of the uninsured who bought health plans on the exchanges having a tremendous pent-up demand for healthcare services. Many insurers also underpriced their plans to gain a larger share of the new market. The Congressional Budget Office found premiums in 2014 were 15% lower than expected.

The most significant factor behind next year's sharply rising prices, experts say, is that millions of “young invincibles,” who represent a large segment of the uninsured pool, have so far not signed up for Obamacare.

“We saw very little of the young and healthy,” said Sherri Huff, a consultant and former chief financial officer of Common Ground Healthcare Cooperative in Wisconsin, one of the insurance co-ops funded by ACA loans.

Indeed, only 28% of exchange members in 2014 were in the coveted 18-34 age range, and that percentage stayed level for 2016. It's below the 40% level many actuaries say is needed to create a more stable rate environment. The insurance industry has a name for that condition, which Obamacare was designed to fight. It's called adverse selection. And so far, the ACA's medicine isn't working.

Here's how adverse selection undermines the individual insurance market. The ACA allowed anyone to buy coverage on the exchanges, even if they had pre-existing medical conditions. The sickest among the uninsured—people with previously untreated chronic health conditions who use a lot of healthcare—generally chose plans with higher monthly premiums to gain access to broader provider networks and more generous coverage.

The few younger and healthier people who bought plans chose ones with lower premiums, since they don't visit the doctor very often and were willing to accept the risk of paying high deductibles for those occasional visits. They were also willing to put up with narrower networks. But there is a needed mix of those two groups—which are found in a typical employer-based plan—to moderate premiums.

Policymakers and economists anticipated that predicament and built provisions into the law to help mitigate insurers' risk from adverse selection. Those provisions included the individual mandate with a tax penalty for failing to buy a plan, and special payments to insurers who wound up with a disproportionate share of sicker beneficiaries. But during the first three-plus years of operations, those measures, especially the tax penalty, haven't performed as expected. Many young, healthy enrollees are avoiding the subsidized markets. Insurers and policymakers now are weighing what needs be done to attract that premium-stabilizing demographic.

At its core, adverse selection is an imbalance of information. Aside from emergencies, people can reasonably predict how much healthcare they will use during a year. Older people with cancer or heart disease know they will use a lot more services than able-bodied young adults at the outset of their working lives.

The key from an actuarial view is making sure sick people don't inundate the market, which would drive up premiums, and deter healthy people from enrolling as a result. But insurers no longer have that information upfront, because the ACA restricted medical underwriting and set limits on what insurers could charge older people purchasing policies.

Before 2014, health insurers could charge enrollees more based on their medical history. They could even deny coverage if someone had a pre-existing health condition. Preventing discrimination based on health status has been one of the law's most popular provisions and is favored by most Americans.

However, taking all enrollees requires younger, healthier and wealthier people to pay the healthcare costs of older and sicker patients. It's a core requirement if the country's fragmented health insurance marketplace—where every employer forms a group no matter what the demographics of its workers, and every individual or family without coverage is thrown into the same pool—is going to work.

Adverse selection reared its ugly head from the start. The colossal technological failures of the federal HealthCare.gov site and some state ACA exchanges during the initial open enrollment resulted in only 106,000 people selecting a plan in the first month.

“Who do you think was willing to wait three to five hours or try three or four days to get on? They were probably the people who needed medical care the most,” Roy Goldman, a former chief actuary at Humana, said of the botched rollout. Approximately 6.3 million Americans had signed up and fully paid their ACA premiums by the end of 2014.

For 2016, following the law's third open enrollment, there are currently 12.7 million exchange members, which, while lower than initial projections, is still a hefty total. Most observers agree the exchanges are not in danger of immediate collapse.

“Whenever the market expands, that's a good sign you're getting closer to an average mix of people,” said Jason Siegel, an actuary at Wakely Consulting Group and a fellow with the Society of Actuaries.

But adverse selection still permeates many marketplaces, and claims—the medical losses—have been far greater than expected. A report from the Blue Cross and Blue Shield Association found enrollees who chose a Blues exchange plan in 2014 and 2015 had higher rates of hypertension, diabetes, hepatitis C and other chronic diseases, compared with people who already had an individual Blues plan.

At Arches Health Plan, the now-defunct co-op insurer in Utah, just 200 people—or 0.3% of its 63,000 members—accounted for 50% of its claims. By the end of January 2014, the first full month when ACA exchange coverage went live, the Common Ground co-op in Wisconsin had 19 people requesting transplants.

Insurers build their own mechanisms to guard against adverse selection, which consumer advocates argue border on discrimination. For example, many plans have tiered drug formularies that charge higher prices for specific medications.

“Why would anyone charge high copayments for generic HIV drugs? Those are probably some of the most effective products on the face of the planet, and yet you see high copays,” said Dana Goldman, a health economist at the University of Southern California. “The only reason is, (health insurers) don't want HIV-positive people in the plan.”

So why have the exchange-based individual insurance markets failed to attract the young invincibles they need? Bottom line: The ACA's numerous tools for combating adverse selection simply haven't worked yet.

And when they didn't, Republicans refused to fully fund the temporary risk corridors program that limits how much health plans could lose or gain on the new exchange population. They called this ultimate fail-safe mechanism an insurance industry bailout.

It's not as if the ACA's architects didn't anticipate the problem. A number of the ACA's new insurance regulations were designed to maximize sign-ups by the relatively healthy. Premium subsidies for the mostly low-income people attracted to the exchanges effectively lowered their out-of-pocket monthly costs. Risk-adjusted payments gave plans incentives to accept all comers.

The government required each plan to have a minimum essential benefit package that covered a range of popular and preventive services. The government even limited the open-enrollment period to prevent people from waiting until they got sick to buy coverage.

But the ultimate penalty in the ACA's repertoire was the individual mandate, which requires people to either have health coverage or pay a fine. Many consumers loathe the provision (but enjoy expanded insurance access), and the mandate has come under repeated political attack.

Doug Hough, a healthcare and behavioral economist at Johns Hopkins University, offered another reason for the ACA's shortcomings. He said buying coverage is a daunting, complicated task for many people. Insurers and policymakers need to connect with and educate more people, especially 27-year-olds leaving their parents' plan, Hough said. Many within that age group may have never had to use health insurance and know little about what it entails.

“It's one thing to buy a subscription to Pandora,” Hough said, referring to the popular music-streaming service. “But it's something else to figure out, 'I have to buy health insurance. Which plan am I going to buy?' ”

Hyperbolic discounting and regret bias also play a role, Hough added. Those behavioral-economics concepts suggest consumers will avoid making a choice if they fear it will be a bad one. It's a leap to give up their present no-consumption pattern in favor of something new and, in their eyes, unproven.

Many plans have restrictive provider networks and high annual deductibles, which may reinforce those positions.

The threat of penalties clearly hasn't been severe enough to persuade consumers to overcome those barriers. The penalties were relatively low in the first two years. But now those who forego health insurance for most of calendar year 2016 will have to pay either 2.5% of their annual household income, or a flat fee of $695 per adult and $347.50 per child, whichever is higher.

Some households could conceivably wind up paying more than $2,000 for skipping out on health insurance, which could wipe away all, or a sizable portion, of their tax refund. But that won't happen until they file their 2016 taxes next spring, which Hough said hides the impact. “If it's buried in your income taxes, it's not going to be as salient,” he said. “That isn't nearly as in-your-face as actually having to write a check for the penalty.”

Some academics have advocated for standardized benefit designs to simplify the purchasing process, and the CMS approved a set of uniform bronze, silver and gold options for 2017 federal exchange plans. However, insurers are not required to offer the plans, and large companies like Aetna have vehemently opposed standardized designs, arguing they will stifle their ability to create “innovative” plans.

USC's Goldman said offering uniform options “makes it easier for consumers to price shop, and it makes it harder for insurers to cherry-pick.”

The ACA's special-enrollment exemptions also encourage people to wait to buy coverage until they need it, plans say. Beth Roberts, senior vice president of enterprise sales and marketing at Harvard Pilgrim Health Care, said those who enroll outside of open enrollment incur more medical costs, and there's “not a lot of rigor with that process.” The CMS tightened special enrollments further this month.

Some improvements to the exchange risk pool will occur naturally. For instance, the so-called grandmothered plans—dating from when President Barack Obama told Americans that, “If you like your plan, you can keep your plan”—will be phased out by Dec. 31, 2017. Siegel said that will improve the risk pool as healthier consumers who clung to their transitional coverage shift to ACA-compliant exchange plans.

The market hiccups associated with adverse selection have been a rallying cry for those who support a single-payer system, which has been championed by Vermont Sen. Bernie Sanders on the presidential campaign trail. Goldman said he believes there are some problems with a single-payer system, but he said the elimination of adverse selection is its biggest advantage.

“It solves this problem, because everyone gets pooled,” he said.