The health insurance marketplaces created by the Affordable Care Act (ACA) could unravel because its enrollees strategically drop in and out of coverage, Stanford scholars write in a new working paper released June 4 by the National Bureau of Economic Research.

The end result could be a complete unraveling of the market, said Petra Persson , an assistant professor of economics in the Stanford School of Humanities and Sciences.

“If you have too many people who drop out after a few months of coverage, you might end up in a situation where insurers don’t want to offer any insurance at all in the market,” said Persson, who co-authored the paper with Stanford Graduate School of Business assistant professors Rebecca Diamond and Timothy McQuade and NYU Stern’s Michael J. Dickstein. Persson and Diamond are also fellows at the Stanford Institute for Economic Policy Research .

The ACA, also known as Obamacare, passed in March 2010 with the goal of making health insurance more accessible. It established a competitive marketplace where individuals could shop for federal and state-level health care plans. Over 2014 and 2015 – the first two years of the program – the share of Americans covered by individually purchased health insurance rose by 50 and 75 percent, respectively.

Health care consumption surged, especially in low-income households and families with young children. But, as the researchers discovered, so did attrition: Dropout was sharpest after just one month of coverage. And only half of all new enrollees committed a full year to an insurance program.

Health care consumption and attrition

To analyze enrollment and attrition, the researchers studied 104,233 households that purchased health insurance in California either before or after the ACA came into effect.

The researchers examined spending habits and income sources for possible explanations of why people might have discontinued health care coverage. For example, did they drop out because they could no longer afford it, because of a job loss or other large expense?

The researchers found that this was the case before the ACA came into effect. Pre-ACA, people often dropped out early because they experienced a loss of income, like unemployment. But post-ACA, the loss of income was much less important in explaining early dropout.

“These findings indicate that the ACA limited the risk of being forced to drop insurance coverage due to unexpected liquidity shocks,” said Persson.

If income shocks can’t account for dropout, then what can?

The researchers found that some people strategically drop coverage after they have used the health care services they need.

“Our analysis shows that many consumers are strategically signing up for insurance to help defray the costs of non-chronic, potentially discretionary, health care needs and then dropping coverage once they have satisfied these needs,” said Diamond.

“The regulatory structure of the ACA law potentially incentivizes exactly this behavior,” the researchers wrote, noting that because the ACA prevents insurers from discriminating against applicants, they cannot legally reject applicants who strategically dropped coverage the previous year.

The fallout of dropouts

This behavior makes it difficult for insurers to set prices, said Persson.

When people consume a year’s worth of health care in only a three-month period – and only pay a portion of the annual premium – it can be incredibly expensive for insurers. They can only guess what fraction of policyholders will end up dropping out mid-year.

The researchers discovered a counterintuitive response from insurers: Health care plans that experienced more dropouts reduced their premium prices the following year.

“Insurers are trying to increase the demand from the pool of consumers who don’t drop out,” said Diamond, observing that these are the people who are more price sensitive to the cost of an annual plan. “People who drop out are going to be less sensitive to the price set by the plan. They are always going to be willing to pay a higher monthly premium because they know they are not going to pay the full annual amount.”

While lowered annual premiums may seem like a beneficial result for committed health care consumers, the presence of dropouts undermines the stability of the market, the researchers said. As a result, insurers may be unwilling to offer plans in the individual market, they said.

Next steps

The ACA has been especially effective in providing lower-income households with health care coverage through a market that previously had largely served more affluent households, said Persson.

But for ACA to continue being effective, enrollees must stay enrolled, Persson added.

While the ACA originally came with penalties for ceasing coverage early, the researchers said it was not enough. It was still cheaper for new enrollees to pay the fine for dropping out mid-year than paying a full year of annual premiums, the researchers found in their cost analysis.

The recent removal of the individual mandate will likely increase the midyear dropout rate, said Diamond. “More dropout will raise financial pressure on insurers, increasing the possibility that the market unravels completely.”