Will health reform cause the next bailout?

Will health-care reform cause America’s next great financial disaster?

Over the past 30 days, health-insurance companies have announced shocking premium increases, headlined by a 39 percent increase for many Anthem/BlueCross policyholders in California. President Obama has slammed the insurance companies and redoubled his call for a new federal agency to roll back "excessive" rate increases.

But what’s an "excessive" increase?

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The New York Times reported this week on the gathering unease of state insurance regulators.

State officials worry that they would be left to police the solvency of health-insurance companies while federal officials pressured insurers to reduce premiums, as Mr. Obama has done in recent days.

"You can’t separate the underlying solvency of companies from the rates they charge," said Sean Dilweg, the insurance commissioner in Wisconsin.

What happens if we disregard Commissioner Dilweg’s warning? If the federal government pushes rates down at the same time that structural forces in health-care economics push costs up?

The answer, very conceivably, is the same thing that happened in the 2000s, when the federal government pushed mortgage lenders to lend more freely to less-creditworthy borrowers, resulting in a combination of rising liabilities (for banks then, insurers now) and declining revenue from customers who can’t afford to pay. Eventually — bang! The system crashes.

It’s important to understand why insurance premiums are suddenly jumping — and no, it’s not because insurers have suddenly become "greedy." Here’s a clue: Notice that the sharpest premium increases are being imposed in California and the Southwest, ground zero of the financial crisis, mortgage foreclosures, and recession?

What’s happening is this:

So long as workers receive health coverage through their employers, the cost of insurance remains invisible to them. When workers lose their jobs, however, they suddenly see the bill. Federal COBRA law enables the unemployed to continue their health coverage after they lose their jobs, but they must pay for it directly. For California families, the average monthly cost of these benefits is more than $1,100, according to the Kaiser Family Foundation. That’s monthly, not yearly.

The Obama stimulus plan offered a 65 percent subsidy to qualifying COBRA recipients, and that subsidy has been extended into 2010. But even subsidized, the monthly cost of COBRA benefits is $388 per California family. Rather than pay almost $5,000 per year for health insurance they likely will not need, many young and healthy Californians are understandably opting to go uncovered.

Result: The insurance companies’ customer bases are growing older, sicker — and more expensive. Consequently, insurers must now cover approximately the same volume of claims, but do so out of the shrunken revenue that results from fewer premiums. As the youngest and healthiest customers exit the marketplace, insurers load more and more costs onto those customers who remain, driving even more customers — and revenue — away.

Given these pressures, what would happen if a federal agency now intervened to ban or reduce an insurance rate increase? If the insurer cannot recover the cost of care from its shrunken customer base, from whom will it recover that cost?

In the original Obama plan, pressure on insurance companies was a feature, not a bug. If private insurance plunged into this kind of death spiral — with rising costs leading to more customer defections leading to more cost rises ... and more defections — well, great! People who abandoned private insurance would be swept into the "public option," a government-run insurance company — which is where President Obama’s team wanted them in the end anyway.

But now the public option has been removed from health reform. So there’s nowhere for people to go if they are left exposed by the insolvency of the insurer to whom they have paid their premiums.

The Obama plan tries to address this problem by requiring Americans to buy insurance or pay a fine. But the fine is cheap and insurance is expensive. It may become economically rational for young Americans to pay the fine to the government rather than a premium to an insurer — especially since the Obama plan guarantees that they can buy insurance later, if they get sick.

These economic paradoxes will push the industry closer to failure. But if the Obama plan is enacted, the insurance companies cannot be allowed to fail — not because they are "too big to fail," but because they will have become "too important to fail." The same overly aggressive government regulation that threatens to bankrupt them also implicates the government in their fate.

Which means that at the same time that the Obama administration is demonizing the insurance industry, it is setting the table for the next big government bailout — of the insurance industry.