Tobacco Users Will Increase the Bill for Taxpayers

Premium Tax Credits How Tobacco Users Will Increase the Bill for Taxpayers
 
In 2014 the government’s premium tax program will begin for individuals and families with a household income of 400 percent of the federal poverty line or less.  An individual will be eligible if he/she makes $45,960 or less and a family of four will be eligible if they make $94,200 or less.  In addition to making 400 percent of the federal poverty line or less, to qualify for the premium tax credit program an individual or member of the family must not be eligible to participate in an affordable employer plan that provides minimum value or a government plan such as Medicare, Medicaid, or a veteran’s plan.
 
The value of an individual or family premium tax credit is the lesser of:
  1. The premiums for the qualified health plan that covers the individual or family, or
  2. Second lowest cost silver plan minus the individual’s (or family’s) household income x the individual’s (or family’s) applicable percentage
An individual’s (or family’s) applicable percentage is determined by comparing an individual’s (or family’s) household income to the federal poverty line.  The applicable percentage works on a nonlinear sliding scale starting at 2 percent for individuals (or families) with a household income of 100 percent of the federal poverty line and ending at 9.5 percent for individuals (or families) with a household income of 400 percent of the federal poverty line.  The premium tax credit can only be adjusted for a person’s age.  Importantly, the premium tax credit cannot be adjusted for a person’s tobacco use.
 
As a result of the second lowest cost silver plan being the starting point for the maximum value of the premium tax credit, its price in each individual State will be critical to the overall cost of the federal government’s premium tax credit program.  The proposed regulations limit an insurer’s ability to adjust premiums in the individual market to four factors:
  1. Whether the coverage covers an individual or family;
  2. The rating area where the individual or family resides;
  3. Age (limited to a 3 to 1 difference);
  4. Tobacco use (limited to a 1.5 to 1 difference)
States are free to limit an insurer’s ability to adjust premiums based on age and tobacco use or to prohibit the adjustment all together.  The rest of the paper explains why States prohibiting insurers from adjusting for tobacco use are adding to the overall cost of the Affordable Care Act.
 
The examples below illustrate whatever limits are placed on an insurer’s ability to adjust premiums will be made up for at the starting price of the premiums.  Consider the following oversimplified example.  Suppose an insurer estimates the cost of covering 10 individuals in a State will be $47,500.  The insurer wants to make a profit for covering the individuals so it will price the insurance to make the sum of the individuals’ premiums equal $50,000.  Seven of the 10 individuals are 21 years of age while the other three are 64 years of age.  There are two tobacco users in the group one who is 21 years of age and the other who is 64 years of age. 
 
If insurers are unable to make any adjustments for age or tobacco use, an approach the States of New York and Vermont have adopted, each individual would be charged $5,000 annually.  The formula to calculate this number is:
  • 10X = $50,000; X = $5,000
However, suppose the State allows insurers to charge a 64 year old three times as much as a 21 year old but restricts insurers from adjusting premiums based on tobacco use, an approach the States of California, New Jersey and Rhode Island have adopted.  Before the premiums are adjusted for age the premium would cost $3,125 annually.  In this case the individuals who are 21 years of age would be charged $3,125 annually and the individuals who are 64 years of age would be charged $9,375 annually.  The formula to calculate these numbers is:
  • 7X + 3(3X) = $50,000; X = $3,125 
Now suppose the State allows insurers to charge a 64 year old three times as much as a 21 year old and a tobacco user 1.5 times as much as a non-tobacco user, an approach the States of Delaware and Oregon have adopted.  Before the premiums are adjusted for age and tobacco use the premiums would be $2,778 annually.  The individuals who are 21 and do not use tobacco would be charged premiums of $2,778 annually.  The individual who is 21 and uses tobacco would be charged premiums of $4,167 annually.  The individuals who are 64 and do not use tobacco would be charged premiums of $8,334 annually.  Finally, the individual who is 64 and uses tobacco would be charged premiums of $12,501 annually.  The formula to calculate these numbers is:
  •  6X + 1.5X + 3(2X + 1.5X) = 50,000; X = $2,778
In each of the three examples the insurer receives $50,000.  The only difference is what portion each individual is paying based on whether the insurer is able to adjust premiums based on an individual’s age and tobacco use.  The examples below build on the examples above and illustrate how States not adopting a tobacco use premium adjustment will create a larger bill for taxpayers.
 
Suppose all 10 individuals have a household income of $23,000 (200 percent of the federal poverty line).  The value of the premium tax credit would be:
  • Maximum premium tax credit = second lowest cost silver plan – 0.0625 x 23,000;
  • Maximum premium tax credit = second lowest cost silver plan – 1,438
The $1,438 is the maximum amount an individual can pay assuming the individual is not a tobacco user.  Remember the premium tax credit can only be adjusted for age and cannot be adjusted for tobacco use so a tobacco user with a household income of $23,000 could still pay more than $1,438 for insurance premiums in a year.
 
Assume in each of the three examples above that the variable X represents the second lowest cost silver plan prior to any premium adjustment.  When the State does not allow insurers to adjust premiums for age or tobacco use the maximum premium tax credit is:
  • Maximum Premium tax credit = 5,000 – 1,438 so $3,562 (total cost for 10 individuals is $35,620)
The maximum total cost of the premium tax credit program for the 10 individuals would be $35,620.
 
When the State allows insurers to adjust the premiums for age, but not for tobacco use the value of the maximum premium tax credit is:
  • Age 21 maximum premium tax credit = 3,125 – 1,438 so $1,687 (total cost for 7 individuals $11,809)
  • Age 64 maximum premium tax credit = 9,375 – 1,438 so $7,937 (total cost for 3 individuals $23,811)
The maximum total cost of the premium tax credit program for the 10 individuals would be $35,620.  As a result of the premium tax credits being allowed to adjust for age, the cost of the premium tax credit program is the exact same as the example of the State that does not allow insurers to adjust premiums for age or tobacco use. 

When the State allows insurers to adjust the premiums for age and tobacco use the maximum value of the premium tax credit would be less costly to taxpayers.  As a result of the insurer being able to adjust premiums for age and tobacco use, the second lowest cost silver plan in the State will be lower resulting in a lower maximum premium tax credit.  If the State in the hypothetical took this approach, the maximum premium tax credit would be:
  • Age 21 maximum premium tax credit = 2,778 – 1438 so $1,340 (total cost for 7 individuals $9,380)
  • Age 64 maximum premium tax credit = 8,334 – 1438 so $6,896 (total cost for 3 individuals $20,688)
The individuals who are 21 years old would receive a maximum premium tax credit of $1,340 regardless of tobacco use and the individuals who are 64 years old would receive a maximum premium tax credit of $6,896 regardless of tobacco use. However, the amount the individuals would pay in insurance premiums will be significantly different depending on whether the individual is a tobacco user.  After the premium tax credit is taken out the individuals who are 21 and do not use tobacco would be charged at most a premium of $1,438 annually.  After the premium tax credit is taken out the individual who is 21 and uses tobacco would be charged at most a premium of $2,827 annually.  After the premium tax credit is taken out the individuals who are 64 and do not use tobacco would be charged at most a premium of $1,438 annually.  Finally, after the premium tax credit is taken out the individual who is 64 and uses tobacco would be charged at most a premium of $5,605 annually.
 
As a result of the insurers being able to adjust premiums for tobacco use, taxpayers will only be obligated to pay at most $30,068 for the premium tax credit program to cover the 10 individuals.  This is a savings of $5,552 for the taxpayers compared to States that do not allow insurers to adjust premiums for tobacco use.  In States that do not allow insurers to adjust premiums for tobacco use, the extra $5,552 bill will be placed on taxpayers.
 
The States that are restricting insurers’ ability to adjust premiums based on tobacco use are placing an additional burden on taxpayers.  To make matters worse, the less education a person receives, the more likely a person is to be a smoker.  Additionally, numerous studies have shown that a person’s income is correlated to a person’s education.  By combining these two sets of data, it is clear the people eligible for the premium tax credit program will be heavily populated by tobacco users.  States that do not allow insurers to adjust premiums for tobacco use will be doing a disservice to taxpayers in every State as the taxpayers will ultimately be responsible for funding the premium tax credit program which will be significantly impacted by the States that restrict insurers from adjusting premium prices for tobacco use.  The government has better uses for its limited funds than to assist smokers continue their bad, costly habits.
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