Is the Affordable Care Act Failing? (AET, ANTM)

"Providing affordable, high-quality health care options to consumers is not possible without a balanced risk pool," Aetna Inc. (AET) Chairman and CEO Mark T. Bertolini stated in a press release announcing the company's withdrawal from several Affordable Care Act individual insurance exchanges Monday, dealing yet another blow to President Obama's signature healthcare reform. In a trend that has heartened the ACA's critics and set the administration scrambling to find fixes, insurers are tumbling out of the exchanges mandated by the 2010 law.  

Aetna, which announced it would cut its participation from 778 counties to 242 for the 2017 plan year, is just the latest in a string of similar announcements. The company cited pre-tax losses of more than $430 million on individual products since the exchanges' inception in January 2014, as well as the precedent set by the "more than 40 payers of various sizes" that have also pulled back from the marketplaces.

Among these is UnitedHealth Group Inc. (UNH), which announced it would exit all but a "handful" of states during its first-quarter earnings call in April. The company said it had lost $475 million on the exchanges in 2015; it simultaneously upped its 2016 loss estimates from $525 million to $650 million. Shortly afterward Humana Inc. (HUM) warned that it might also leave some states, meaning that three of the country's "Big Five" insurers are drawing away from the exchanges. All have said they're losing money on them.

This wasn't always the case. Even as Humana and UnitedHealth were sounding the retreat this spring, Aetna was still gung-ho. While acknowledging losses of 3% to 4% on individual Obamacare coverage, the company said it planned to remain in the 15 states where it operated exchanges and would even consider expanding. So what changed?

The answer, as so often with the ACA, is complicated by politics. Aetna had been preparing a merger with Humana, which the Department of Justice sued to block on anti-trust grounds in July – simultaneously taking the same action on another pending Big Five merger between Anthem Inc. (ANTM) and Cigna Corp. (CI). When, just weeks after the DoJ's action, Aetna announced its pullback, Massachusetts Senator Elizabeth Warren, a Democrat, cried foul: "The health of the American people should not be used as bargaining chips to force the government to bend to one giant company's will," she wrote on Facebook.

The Huffington Post reported Wednesday that the company indeed "threatened" – in that outlet's wording, with the Wall Street Journal opting for "warned" – to withdraw from some states if the merger was not allowed to proceed. A company spokesperson told the Huffington Post that the exchanges "showed a significant deterioration. That deterioration, and not the DOJ challenge to our Humana transaction, is ultimately what drove us to announce the narrowing of our public exchange presence for the 2017 plan year." He added that the letter was a response to a written request for information from the DoJ, according to Reuters. To muddy the picture even further, the website Balloon Juice pointed out on Wednesday that the company earned a 3.9% ($6.4 million) profit in Pennsylvania, one of the states it plans to leave, in 2015.

Anthem CEO Joseph Swedish echoed Aetna's sentiment during the company's second-quarter earnings call in July, telling analysts that a combined Anthem and Cigna could expand to nine additional states, if the DoJ permitted the merger with Cigna. Anthem has not announced a pullback from the exchanges.

Whatever the other factors at play, the challenges facing insurers in the exchange system are real. People signing up on Obamacare exchanges are older and sicker than its architects anticipated. Incentives for the healthy and wealthy to participate have not worked as planned, and measures intended to limit insurers' losses in the marketplaces have fallen victim to political wrangling. 

The main challenge facing the insurers is the fundamental of their industry: the problem of what's termed "adverse selection." People who are more likely to need expensive healthcare – the old, sick and accident-prone – are unsurprisingly more likely to purchase health insurance. Prior to Obamacare, companies were allowed to discriminate against these consumers, rejecting those with pre-existing conditions, for example. Since they can no longer do so under the new law, one would expect them to be flooded with expensive customers. Payouts would accordingly rise, driving up premiums and making insurance unaffordable for just about everyone.

That is more or less the scenario, often called a "death spiral," that Aetna's CEO described Monday: "Fifty-five percent of our individual on-exchange membership is new in 2016, and in the second quarter we saw individuals in need of high-cost care represent an even larger share of our on-exchange population. This population dynamic, coupled with the current inadequate risk-adjustment mechanism, results in substantial upward pressure on premiums and creates significant sustainability concerns."

The law's architects foresaw this problem, and their solution was the controversial "individual mandate," the requirement that just about everyone – those facing financial hardship and certain religious groups exempted – buy health insurance. Younger and healthier people would have to sign up, subsidizing the higher-cost policy-holders. As they aged and caring for them grew more expensive, a new generation of subsidizers would come up behind them.

The mandate survived heated political opposition and tough legal challenges, but now appears to be failing on its own merits. A report on ACA-compliant individual plans offered by Blue Cross Blue Shield (including non-exchange plans) found that those who enrolled after the law went into effect were more likely to suffer from conditions such as diabetes and HIV.

They also used medical services more often, including emergency rooms, and filled more prescriptions. The problem has only gotten worse as the reform has matured: In the first quarter of 2014, when the law went into effect, BCBS spent an average of $436 per newly-insured individual per month. By the third quarter of 2015, that figure had risen to $569. 

Rural areas are particularly challenging for insurers under Obamacare. Blue Cross Blue Shield of Arizona said in June that it would stay in some rural counties because it "couldn't overlook that several counties would have no options or very limited access if we didn't find a way to stay in the market." Still, at least one county in the state, Pinal, may have no insurers on its exchange in 2017, following Aetna's withdrawal. Rural individuals are more likely to smoke, abuse alcohol and drugs, be overweight and lack access to healthy foods, according to the Rural Health Information Hub, a project supported by the Department of Health and Services.

Why have the exchanges failed to attract the "young invincibles" they need to balance the risk pool? One explanation is that the penalty for violating the individual mandate hasn't been expensive enough to motivate young people to sign up. The penalty for 2015 was 2% of total household adjusted gross income, or $325 per adult ($162.50 per child), up to $975. For 2016 the penalty is 2.5%, or $695 per adult ($375.50 per child), up to $2,085. The flat fees will be adjusted for inflation in 2017 and after.

Wealthy customers have also found Obamacare options unattractive, since they tend either to have access to higher-quality alternatives through their or a spouse's employer, or to be able to afford better alternatives on their own. According to data from the consulting firm Avalere, reported by the Wall Street Journal, 81% of those enrolled in exchanges earn incomes between 100% and 150% of the federal poverty line, with just 2% earning over 400%. While the purpose of the exchanges is to make coverage more "affordable," the high proportion of poor customers – who tend to suffer from more health problems – squeezes insurers.

The quote often attributed to Otto von Bismarck is true: Laws are like sausages – it's best not to see them being made. The Affordable Care Act began with a bit of political legerdemain: Since the Senate is not allowed to originate revenue bills, it took an unrelated housing-tax bill, dumped its contents and wrote its health-reform proposals in its place. The messiness and wrangling only accelerated from there.  

Obamacare theoretically has three safeguards in place to keep insurers from losing out: Reinsurance insures providers who get stuck with particularly costly enrollments; it has worked well enough, but ends after this year. Risk adjustment involves payments from insurers with low-cost customers to those with high-cost ones; it has met with criticism that it favors larger insurers. 

The third, risk corridors, was intended to subsidize plans that suffer cost overruns. But Republicans, led by Florida Senator Marco Rubio, threw a wrench in the risk corridors program, barring the administration from spending on a "bailout," as Rubio called it, and depriving insurers of $2.5 billion – nearly 88% of expected payments last year. By attacking a tweak to the reform, Rubio may have succeeded in exacerbating the problems with a law his party could not vote down or repeal.

When UnitedHealth announced in April that it would leave the Georgia, Arkansas and April exchanges – a prelude to the later announcement that it would leave all but a "handful" – a spokesperson for the Department of Health and Human Services said the exchange system "should be judged by the choices it offers consumers, not the decisions of any one issuer. That data shows that the future of the marketplace remains strong." 

Now that two other major insurers have announced pullbacks, the administration is not so sanguine. According to the New York Times, it is trying to convince young people to sign up on the exchanges, sending letters directly to those who were charged penalties last year. It is also seeking out satisfied Obamacare users to provide testimonials on TV, radio and social media. Kevin Griffis, assistant secretary for public affairs at the Department of Health and Human Services, also pointed out that "the marketplace continues to grow and there are companies making money."

A more radical change will have to wait for a future administration. The "public option," a government-run alternative to private options on the exchanges, had been pushed by Obama since 2007, when his primary opponents also favored it. He downplayed the need for one as wrangling over the health law heated up in Congress, and the option was scrapped from the final version of the Affordable Care Act. Hillary Clinton still favors it, however, and she may push for its adoption if she becomes president. And new companies may join the mix of choices. The program is still evolving.

Whether these approaches will be enough to save the exchange system, which opponents say is economically unworkable at its core, remains to be seen. With many Republicans, including GOP nominee Donald Trump, on record as favoring a repeal of the entire program, November will be key in what happens next.