CLASS is the Next Huge Taxpayer Bailout

COMMENTARY Health Care Reform

CLASS is the Next Huge Taxpayer Bailout

Jul 26th, 2010 3 min read

Senior Fellow, Manhattan Institute

Are you ready for the next massive taxpayer bailout?

Many of the same lawmakers who infuriated taxpayers by bailing out Wall Street, the auto companies, and Fannie Mae and Freddie Mac recently created a new program virtually guaranteed to require bailouts.

And unlike those one-time bailouts, this one will become an annual taxpayer expense.

The Community Living Assistance Services and Supports (CLASS) Act is a new long-term care insurance program. The concept had floated around Washington for years before Congress inserted it into the Obamacare health law — most likely to provide a $70 billion piggybank that could be raided to cover up Obamacare's initial deficits. Yet this ticking entitlement time bomb could cost future taxpayers trillions of dollars.

Here's how it works:

CLASS is a voluntary long-term health care insurance program. Enrollment is open to all working adults, regardless of health status. Benefit eligibility requires first paying premiums for five years.

CLASS is supposedly self-funded, and the secretary of health and human services is empowered to adjust premium and benefit levels to guarantee 75 years of solvency without costing taxpayers a dime. Like Social Security, CLASS is funded on a pay-as-you-go basis, meaning current premiums will fund current beneficiaries.

But there is one complication: CLASS administrators are forbidden from basing individual premiums on any health-risk factors other than age. Unhealthy individuals who will likely require more benefits must be charged the same premiums as healthy individuals who will likely require fewer benefits.

And therein lies the seeds of bankruptcy.

Consider a basic example of three 45-year-olds of varying health deciding whether to enroll in the program. Based on their expected long-term care needs, their individual willingness to pay for this insurance comes to $100, $500 and $900 per month.

In order to maintain solvency without risk-based pricing, CLASS would be required to charge all three people the same $500 premium. The healthiest person (willing to pay just $100) would consider this a bad deal and decline participation. At that point, premiums for the remaining two individuals would have to rise to $700 to keep the program solvent. This would cause the moderately healthy person (willing to pay $500) to also drop out, leaving only the unhealthiest person and a $900 premium.

Health economists call this an "adverse-selection death spiral," and it would likely end in program bankruptcy.

For this reason, the Congressional Budget Office, the chief actuary for the Medicare program, and the American Academy of Actuaries have all acknowledged that CLASS is unsustainable.

In fact, Senate Budget Committee Chairman Kent Conrad, North Dakota Democrat, calls CLASS "a Ponzi scheme of the first order, the kind of thing that Bernie Madoff would have been proud of."

But the bankruptcy and bailouts won't happen overnight. CLASS is scheduled to begin enrolling participants as early as Jan. 1. Because benefits require five years of premiums, the first benefits won't be paid until 2016. Consequently, the program is estimated to run a $70 billion surplus through 2020, which will be raided to cover Obamacare's deficits.

Of course, those $70 billion in excess premiums were supposed to finance future benefits, not be spent elsewhere. So when the baby boomers' benefits push CLASS into deficit in the 2020s, Congress will have to repay the $70 billion (plus interest) to CLASS with new taxes or borrowing. So much for not costing the taxpayers a dime.

The bailouts won't stop there. Given the likely adverse-selection death spiral described above, even that $70 billion bailout will shore up the program's soaring deficits for only a few years.

Congress will then face three options:

It could let CLASS go bankrupt to reflect the promise that taxpayers be shielded from its costs. In reality, Congress is highly unlikely to create an insurance program, collect premiums, and then not pay out the promised benefits.

Or, Congress could make participation compulsory for all adults. This solves the adverse-selection death spiral by forcing the healthy individuals to remain in the program and pay the high premiums necessary to subsidize unhealthy individuals. However, forcing everyone to pay an expensive premium for a benefit that few want would be enormously unpopular, not to mention unaffordable for low-income individuals.

That leaves a third option: Large, permanent taxpayer bailouts to keep premiums low and pay out all benefits. These bailouts would continue as long as anyone who has ever paid into the program is alive and eligible for benefits. The long-term cost could reach into the trillions of dollars.

The only way to avoid program bankruptcy or (more likely) decades of taxpayer bailouts is to repeal the program — preferably before it begins enrolling participants and collecting premiums. After that date, paring back a social-insurance program that people have paid into will be much more difficult.

Nonsensically, repealing CLASS would violate the "pay as you go" law against expanding budget deficits. This is because "pay-go" focuses only on the 10-year $70 billion "cost" of repeal, and ignores the trillions of dollars that would be saved thereafter. If the true spirit of pay-go is to prevent deficit spending, then Congress should set aside the pay-go law and repeal this debt-ridden entitlement.

Brian Riedl is Grover M. Hermann Fellow in Federal Budgetary Affairs at the Heritage Foundation.

First appeared in The Washington Times

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