Capitol Hill

Source: Architect of the Capitol Flickr.

The Supreme Court will weigh in on whether the Affordable Care Act, or ACA, as it is written authorizes the federal government to offer health insurance subsidies to consumers who buy insurance through the federal online marketplace.

Obamacare opponents argue that specific wording in the legislation allows subsidies only for states that set up their own health insurance exchange, not to states that piggybacked on the healthcare.gov exchange set up by the Department of Health and Human Services.

Lower court judges hearing cases challenging the legality of subsidies have come down on both sides of the issue, setting the stage for a showdown in the Supreme Court that could lead to higher monthly premium payments for millions of people and potentially a revenue shortfall for insurers such as UnitedHealth Group (NYSE:UNH), WellPoint (NYSE:ANTM), and Aetna (NYSE:AET).

First, a bit of background
Rather than deal with the cost and headaches of establishing their own health insurance marketplaces, 36 states instead have residents register for health insurance through the federal website
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Roughly 5 million of the 7 million people who signed up for health care insurance through exchanges did so via healthcare.gov marketplace, and about 90% of those 5 million Americans receive subsidies.

The ACA, though, specifically states that subsidies shall be available to people purchasing health insurance through exchanges "established by the state." To critics of the law, that means subsidies should not go to anyone who registered via healthcare.gov.

If the Supreme Court agrees, millions of people representing billions of dollars in insurance industry revenue might be forced to cancel their policies if subsidies vanish and premium payments jump.

What would be the impact be on insurers?
According to HHS, the average recipient's subsidy totals $264 per month, which brings that person's monthly premium payment down by 76% to just $82.

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That's a substantial savings, but many members still find it hard to make their payment. According to Humana (NYSE:HUM), roughly 75% to 80% of people who signed up for health insurance with the company through the exchanges have actually made payments.

Losing a significant number of customers who drop their insurance after the subsidy vanishes would challenge insurers, Companies participating in the exchanges use actuarial models to price plans based on the number of healthy and unhealthy people expected to sign up for coverage. If more healthy people decide the $346 monthly premium is too expensive, insurers might be left covering only the sickest of people, which would likely cause these companies' profitability to plummet.

The insurers most likely to feel such a pinch include WellPoint and Aetna, two of the most active participants in the exchanges last year. Exiting the third quarter, the number of people served by WellPoint via the healthcare exchanges totaled 751,000. The corresponding number at Aetna was just shy of 600,000.

Unsurprisingly, then, insurers are lobbying for subsidies to stay.

In March, the insurance industry's trade association, America's Health Insurance Plans, filed an amicus brief with the Supreme Court arguing that subsidies shouldn't disappear. In case lobbying efforts fail, insurers offering plans through the exchanges have also made sure that contracts include language that would allow them to walk away if the courts do away with subsidies.

It's not certain whether insurers would invoke that clause. It would likely depend on how willing states are to set up their own exchanges, and how quickly members can be transferred to them. Insurers might have some time to make a decision on walking away, as the ACA includes insurance industry protections that would make up for losses on those plans through 2016.

It's not clear how many states would launch their own exchange. So far, only 28 states have adopted Medicaid expansion under ACA, and the political divide over Obamacare might prove too wide a gap for many state legislatures to cross. If a similar scenario to Medicaid expansion plays out with the exchanges, the nation could end up with a very fragmented insurance system in which states with exchanges have significantly lower rates of uninsured and lower premium payments than states without exchanges.

Wait and see
Arguments from both sides should be presented to the high court in the spring; a decision would likely come next summer, ahead of the ACA's third open enrollment period. Since lower courts have come down along party lines, it wouldn't be to shocking to see the Supreme Court eventually determine the law does not provide for subsidies for healthcare.gov enrollees.
 If that's the case, it would cast a lot of doubt on the revenue stream for these big insurers; that means investors would be wise to keep a close eye on the situation, including any potential fixes that are being considered.

 

Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool recommends UnitedHealth Group and WellPoint. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.