CBO implies Obama regulation shoveled $8 billion to insurers

The Congressional Budget Office issued a report this week revising its February projections of the cost of the Affordable Care Act.  Although there is much to discuss regarding the report, I want to focus here on its troubling discussion of “Risk Corridors.”  That’s the part of the law under which the federal government reimburses insurers selling policies on the new Exchanges for sizable fractions of their losses. It also taxes insurers if they happen to make money selling policies on the new Exchanges. Between February and April, the CBO estimated cost of Risk Corridors jumped $8 billion.  In February, Risk Corridors were predicted to make the government a net of $8 billion over the three years of the program. Now, Risk Corridors are expected to net the government nothing. The CBO claims that this jump was caused by regulations issued by the Obama administration in March that drove up the cost of the program.

There’s a second explanation, however, for the $8 billion change between February and April that’s possibly more troubling. This past February I wrote a blog entry with a lot of math explaining that the CBO prior analysis of the Risk Corridors provision was baffling and rested on extremely dubious and factually unsupported assumptions about the profitability of insurers selling on the Exchanges.  That error, if it was one, was particularly salient because it ended up forestalling growing efforts within Congress to repeal Risk Corridors as an unwarranted “bailout” of the insurance industry.  Could it be that with the repeal threat gone, CBO is now using the “noise” created by an Obamacare regulation as cover for rectifying the unduly optimistic assumptions it made back in February regarding Risk Corridors? That would be very troubling, because while math errors merely challenge the CBO’s competence, the alternative behavior about which I am speculating here goes to something more important: the CBO’s integrity.

The CBO explanation means the Obama administration shoveled $8 billion to insurers through a regulatory “tweak”

The official explanation from the CBO on its change of $8 billion in the cost of Risk Corridors is as follows:

“In March 2014, the Department of Health and Human Services issued a final regulation stating that its implementation of the risk corridor program will result in equal payments to and from the government, and thus will have no net budgetary effect.  CBO believes that the Administration has sufficient flexibility to ensure that payments to insurers will approximately equal payments from insurers to the federal government and thus that the program will have no net budgetary effect over the three years of its operation. (Previously, CBO had estimated that the risk corridor program would yield net budgetary savings of $8 billion).”

So, if the CBO is to be believed, the change isn’t due to any earlier error, but due to an administration regulation promulgated by the Obama administration that has resulted in a net of $8 billion more going to insurers.  That’s a big change for several reasons. First, it means that the regulatory changes instituted by the Obama administration cost the federal government $8 billion.  All of that money went to the insurance industry.  And so, in March of 2014, without much fanfare, the Obama administration would in effect have written a check to the insurance industry for $8 billion.  That payment would only have been motivated by one thing: a desire to keep insurers pacified and in the Exchanges after having deprived them of perhaps their most healthy potential insureds by a prior administrative ruling  – in violation of the ACA — that insurers could keep selling non-compliant policies.  The $8 billion would thus have been “damages” paid by the taxpayer in order to permit the President to honor his campaign promise that if you liked your insurance plan you could keep it.

In short, if you believe the CBO, a regulation for which statutory support will be extremely hard to find, resulted in the government shoveling $8 billion to insurers, basically to pacify them for the losses they suffered as a result of further regulatory changes of dubious legality.  The Obama administration can not afford to have its signature program enter a death spiral as a result of regulatory actions that, while mollifying those who otherwise would have lost their health insurance coverage, caused insurers to lose more money in the Exchanges. And, again, the Obama administration did so in a clever way that made it difficult for anyone to have legal standing to challenge them.  So far as I can discern, no insurer will be worse off as a result of the March 2014 regulatory changes. The real victims are taxpayers with diffuse interests and, of course, the Rule of Law.  

The CBO math is still baffling

A second reason the change by the CBO is big comes from a look at the math.  As I said in my February 2014 post calling the CBO February report “baffling,” consider the implications of asserting that the insurers would make so much money on the Exchanges that they would, on net owe the federal government $8 billion. If you do the math, it means that the CBO assumed that, over the course of three years, insurers would be earning about 8 cents on every dollar they earned via policies sold on the Exchanges.   I just ran the numbers again and came up with a very similar conclusion: the earlier estimate could only be true if insurers were supposed to make a hefty 8% or greater return on premiums. That estimate of 8 cents on the dollar was really peculiar at the time because enrollment — let alone actually paying customers — was running seriously behind projections and the number of “young invincibles” was particularly low.  Low overall insurance purchases and particularly low rates of purchases by the people who were most needed in the Exchanges caused many people to believe back in February that insurers would hardly make hefty profits and pay money to the government under Risk Corridors.  Instead, they thought insurers would fare poorly and probably have to be subsidized (or “bailed out”) by the government.

The effect of the February CBO pronouncement was to dampen enthusiasm for a bill proposed by Senator Marco Rubio that would have repealed the Risk Corridors provision as a bailout to the insurance industry.  If, after all, the federal government was, on balance, making money on Risk Corridors, it was hard to see it as a “bailout” to the insurance industry. Whether intended or not, the political effect of the February CBO announcement was to pull the rug out from one justification for repeal of Risk Corridors.

But is it even plausible to believe that the regulatory change made by the Obama administration in March without the approval of Congress could cause such a large change in the Risk Corridors program? I have done the math again and the answer is no.  I do not see how it is possible to get $8 billion out of the regulatory tweak that was made. Again, the calculations are baffling.

Here’s how we know.  The $8 billion the CBO thought back in February the government would make off of Risk Corridors represents about 4% of the premiums insurers on the Exchanges would take in during that time period. One can use that and other information from the CBO to reverse out a distribution for  “allowable costs” (basically claims expenses) We can thus make a respectable estimate of how many insurers would make money on the Exchanges, how many would lose, and how much these insurers would gain and lose. I describe the gory process in my post from February.  Call this distribution the CBO Insurer Profitability Distribution.  Then assume the government tweaks, as it did, two regulatory parameters used in the computation of Risk Corridor payments, changing something called a profit margin floor from 0.03 to 0.05 and changing an “administrative cost cap” from 0.2 to 0.22. If one then takes the CBO Insurer Profitability Distribution and computes how much the government would now make on Risk Corridors does one emerge with the CBO’s new prediction that Risk Corridors will produce no net revenue? No! One gets that the Risk Corridors program now generates about 2.8% of premiums for the government. In other words, the reduction in Risk Corridor revenue resulting from the administrative tweak is only 1/3 of what the government claims.

The easier way to reach the CBO’s April’s conclusion is to assume that the gain of $8 billion resulted from two phenomena: (1) the regulatory tweak mentioned by the CBO and discussed above, but (2) a recognition that the CBO Insurer Probability Distribution the CBO had used in February was, as I have said, wrong.  If, for example, one assumes that insurer claims were about 6% higher than the CBO estimated in February, the regulatory tweaks combined with higher insurer claims expenses indeed generate an $8 billion shift in the amount of revenue the government would make on Risk Corridors.

For those interested in the details, I link here to a Mathematica notebook showing the computations; I try to avoid black boxes.

Conclusion

So, what are we to make of this apparent discrepancy between the CBO’s explanation of its change in estimates and the actual effects of the regulatory changes it asserts to be the cause ?  It could, I suppose, be my mistake.  I have been careful and consider myself pretty knowledgable in this area, but I will hardly claim to be mathematically infallible. The problem is that the for ordinary Americans (like me), the CBO is a black box. It is not subject to the Freedom of Information Act and it does not publish enough of its methodology for even experts in the field to figure out what it is doing.  That, I would submit, is a real problem for the democratic process, where the fate of legislation depends essentially on trust rather than the Reagan doctrine of “trust but verify” (doveryai no proveryai, in the original Russian).

It could also, however, be a coverup for a mistake (or worse) back in February. There is, after all, an alternative explanation of the change in estimate. It was unrealistic all along for the CBO to think that insurers in the Exchange were going to make money on balance. That’s what I suggested in my February 2014 post.  So, rather than admit that the it had been guilty of unwarranted optimism, the CBO simply used a new distribution of likely claims expenses, came up with a different answer, and used the March 2014 regulatory changes as a smokescreen.

I will confess, however, that I am very uncomfortable with conspiracy theories or with theories that are premised on people acting in bad faith.  Nonetheless, I would not find it impossible to believe that a culture could emerge in a politically sensitive agency that was reluctant to expose forcefully the consequences of government programs that proved far more expensive and far less successful than forecast originally.  It would be a culture in which good news, or optimistic speculation, was uncritically embraced. What I challenge the CBO to do, therefore, not only with the Risk Corridors analysis, which is but the tip of a very big iceberg, but with the entirety of its ACA analysis, is to open it up for scrutiny.  When government policy is essentially set on the basis of models that are not subject to peer review or public scrutiny, there is a great chance for error and, frankly, for manipulation. Government by black box breeds suspicion.

Postscript: Is the tweak legal?

I have said before and I say again that the regulatory tweak that the CBO now says will cost the federal government $8 billion is extremely dubious.  It’s an extremely sneaky way of sending money to the insurance industry, resting, as it does, on arcane manipulations of mathematical formulae. And I have serious doubts that the changes are authorized by Congress.The submission of the original regulations in March, 2013 says that essentially all commenters agreed that a 3% margin for profit was appropriate.  No commenters indicated at that time that insurers were entitled to a higher imputed rate of return on capital.  No one said anything about 5%. Back in March of 2013, HHS thought 3% was the right number. There has been no fundamental change in the capital markets since that time.  The only thing that has changed is that the Obama administration has made the pool of insureds making purchases in the Exchanges less healthy on average. The regulatory “tweak” moving the profit margin from 3% to 5% is thus not consistent with the original goal of Congress for the Risk Corridors program, but is simply a way of compensating insurers for another regulatory change.

The change in the administrative cost cap from 20% to 22% that will likewise result in higher payments to insurers is likewise dubious.  The reason 20% was suggested in the original July 2011 proposal and chosen in the March 2013 regulations was to maintain parity with regulations governing the “Medical Loss Ratio” codified at 42 U.S.C. § 300gg-18 as part of the ACA. The idea, which was apparently supported by commenters on the original rules, was that if insurers — even small group and individual insurers — could not claim more than 20% administrative costs without owing rebates pursuant to section 10101(f) of the ACA then they should not be able to claim more than 20% administrative costs under the Risk Corridors provision.  Makes sense!  But, again, nothing has changed.  There is no indication that anything President Obama did that raised the administrative costs of running a health insurance plan on the Exchanges.  There is no indication that any factor in the real world (such as the cost of computers or paper) increased the administrative costs of running a health insurance plan on the Exchanges.  The limits for the Medical Loss Ratio computation have not changed.  There is no better reason now then there was a year ago to let the cap on administrative costs be higher for Risk Corridors than it is for Medical Loss Ratio.  And, yet, it is now 22% instead of 20%.  The only reason it has changed is to provide a vehicle for shoveling money to insurers.

Again, unless one thinks that the goal of keeping insurers in the Exchange is so overwhelming as to permit the Executive Branch to do anything, it is difficult to see a conventional, lawful justification for the regulatory change that results, according to the CBO, in $8 billion of compensation to the insurance industry. And I say that believing fully well that many of the Obama administration’s other regulatory changes — also of dubious legality — such as expanding the hardship exemption and permitting insurers to sell policies off the Exchanges that contain prohibited provisions have significantly hurt insurers selling policies on the Exchanges. Two wrongs do not make a right.

Technical Appendix

The following graphic shows the relationship between the Risk Corridor Ratio and the net receipts of the government for each premium dollar. As one can see, the higher the Risk Corridors Ratio, the less money the government receives or, in some instances, the more money the government pays out.

RiskCorridorsRatioToHHSNetReceipts

The following graphic compares the relationship between claims costs (“allowable costs”) incurred by an insurer as a percentage of premiums and the Risk Corridors Ratio. It does so for two sets of regulatory parameters.  It first uses the regulatory parameters that were in place prior to March of 2014 (3% profit margin and 20% administrative cost cap).  It next using the new regulatory parameters (5% profit margin and 22% administrative cost cap). As one can see, the regulatory changes increased the Risk Corridors Ratio for all levels of allowed costs and thus decreased the amount the government would receive from insurers (or increased the amount the government would pay to insurers).

AllowableCostsToRiskCorridorsRatio

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New prescription data is troubling for Exchange pricing stability

Much has been made of the enrollment data in the Exchanges — pronounced “a success” by the Obama administration — and of the demographics of enrollments in the Exchanges — distributed enough towards the older end to be troubling.  We don’t yet have the key data, however: what are the actual claims being filed by those newly insured on the Exchanges relative to what was expected.  If the medical claims are higher than expected, that is likely to raise the costs of the Affordable Care Act this year and in the future.  This year, high claims will increase “Risk Corridor payments” made by the federal government to losing insurers. Next year. it will place pressure on gross premiums charged by insurers or possibly force some insurers to withdraw from the marketplace.  The result will be increased amounts paid by insureds, increased premium tax credit payments made by the government, and increased payments made by the government to address cost sharing reductions. It will also shrink the number of insureds below what it would have been had claims costs and, derivatively, premiums remained as expected.

Some evidence on claims costs is beginning to trickle in, however.  Express Scripts, a large Pharmacy Benefit Management company that, so far as I know, has no axe to grind either in favor or opposition to the ACA, has published a report indicating that, at least so far, costs per member on the Exchanges are 35% higher than they are for commercial policies off the Exchanges. The study is based on a national sample of more than 650,000 pharmacy claims (423,000 covered lives) for the first two months of 2014 for patients enrolled in an Exchange policy with with pharmacy benefit coverage administered by Express Scripts. The analysis compared these pharmacy claims to those from commercial health plans, with pharmacy coverage administered by Express Scripts, during the same time period.

Express Script's highlighted findings

Express Script’s highlighted findings

The key Express Scripts result — a 35% increase in claims costs — is significant for two reasons.  According to data from the government’s own Actuarial Value Calculator, pharmaceutical expenses comprise about 21% of total healthcare expenses.  Having to pay 35% more for such expenses is thus significant in and of itself.  But peer-reviewed scholarly research such as that summarized and extended here indicates that  pharmaceutical claims  correlate positively with overall healthcare expenses.  The higher pharmaceutical claims may just be the tip of the iceberg.  Although these medical claims are often slower to be processed, Express Scripts has provided a disturbing leading indicator.

Before anyone pushes the panic button, however, there are less distressing possibilities.  Everyone expected that those without prior health insurance or with lousy prior health insurance would result in a surge of claims to insurers for previously untreated conditions. One hopes insurers anticipated this surge in their pricing.  If the surge is only transient as patients get various conditions under control, unanticipated extra costs on insurers will be addressed through Risk Corridor payments for this year and will not result in insurers revising their actuarial models of the risks posed by insuring on the Exchanges in an environment where most conventional underwriting methods are prohibited.

And, if one looks at the conditions that are apparently contributing to the high use of pharmaceuticals, a different spin can be placed on matters.  The Express Scripts reports a higher use of anti-HIV/AIDS drugs, including expensive ones such as Atripla,  among the Exchange population than among commercial insurers.  So, it may be that the existence of subsidized coverage in the Exchanges is proving a vehicle for bringing hope and treatment to individuals with HIV or AIDS who previously were falling through the cracks (or being treated by other programs). The counter-spin, however, is that the fact that HIV treatment is a worthy end may be served does not mean that a general insurance scheme is the right way to address untreated HIV  or AIDS.  A coarsely rated and somewhat voluntary insurance scheme is a problematic vehicle for providing access to care to groups that include high-expense individuals, such as many with HIV or AIDS.  The high and disproportionate prevalence of high expense individuals in a common pool contributes to the risk that the system will enter an adverse selection death spiral.

So, let me sound a notion of caution here.  Just as the “enrollment” of 7 million people is not grounds for proclaiming the ACA a “success” or here to stay in any sort of stable way, an early datum about one component of claims is not grounds to proclaim the ACA a failure or to say with certainty that ACA insurance policies are likely to undergo massive premium increases.  Still, since insurers will likely need to be making pricing decisions for 2015 in the coming months, and not after all the data is in early data can be important.  The latest information from Express Scripts should be worrisome indeed.

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Stop reporting enrollment and start reporting policies in force

In theory, open enrollment ends tonight. No longer can individuals without any excuse whatsoever wait to purchase health insurance policies on the Exchanges that will be in effect during 2014.   I very much expect we will hear numbers over the next few days such as 6.5 million or 7 million bandied about as “enrollment figures.” Many supporters of the ideas behind the original ACA who have managed to tolerate its metamorphosis over the past year will herald those numbers as signs of success.  And, indeed, those numbers are considerably better than many had feared.  I, for one, am prepared to confess that I may have been too pessimistic in the past about first year enrollment in the ACA. My pessimism is all the more glaring because the enrollment numbers are apparently coming notwithstanding the Obama administration’s decision to tie its hands behind its back by creating a new opportunity to evade the individual mandate via an undocumented “hardship exemption” and to delay making a  purchase decision based on “honor system” claims of difficulties in accessing healthcare.gov or state enrollment systems.

That said, however, these enrollment figures are essentially irrelevant.  Those who persist in touting them as signs of success reveal themselves more as Obamacare fanboys than as credible advocates or serous scholars.  The aggregate enrollment figures are irrelevant for two reasons and of lesser value for another. In short, my predictions may have been on the low side, but the numbers that will be coming out tonight absolutely do not vindicate those who assured us that Obamacare would end up being just fine. Reciprocal honesty would be nice.

Nothing economically or legally in the ACA turns on “enrollment”

1. “Enrollment” is, as many have noted, simply checking boxes on a web site.  It is not the same thing as actually having a policy in force, of being covered by an insurer who will pay medical bills in the event the “insured” becomes sick. In terms of the real health of Americans, access to expensive medical care, enrollment numbers are as meaningful to the success of the ACA as knowing the number of individuals outfitting their fantasy Corvette Stingray on Chevrolet’s“build your own” web site is to the success of GM. The former is a leading indicator of interest in plans on the Exchanges just as the latter is a possible leading indicator for purchasing a snazzy car. But that, really, is all.  Responsible journalists and bloggers should stop bleating “enrollment” merely because it is the only number the Executive branch dispenses.

Friends of the Obama administration gain credibility and actually help their President by insisting that the Obama administration release the number of policies in force  This is so because there are only two and a half conclusions that can be drawn from silence: either the Obama administration has the number and is refusing to provide it or it just doesn’t have the number.  Not releasing a number or decent approximation is contrary to the transparency values that the Obama administration espouses.  My FOIA request on the topic is, like many others, I suspect, unanswered. Not having the number is perhaps even worse.  I have read much of the ACA and its regulations and I can not think of a single economic or legal matter that turns on the number of people who have “enrolled” in plans on the Exchange.  Insurers get paid, tax credits are advanced, and a whole host of other important financial and legal consequences depend instead  on the number of people who, for any given month, actually have coverage, have a policy in force.  I say “two and a half” conclusions because there is a variant of not having the information that is sometimes advanced — not having precise enough information to release.  But this is about as flimsy as it gets.  Governments release approximate numbers all the time.  I believe Americans are sophisticated to understand the word “about” and the concept of a “good faith estimate.” Any lack of precision down to a single individual does not excuse a failure to release relevant information. I am confident that the public would be well served by having a policies in force number that was accurate even to just two or three significant digits.

The difference between enrollment and purchase is not trivial. Suppose the fall off between enrollment and purchase is, as some have suggested, 20%.  And suppose further, as again some have said, that 3% of  the remaining policyholders don’t pay each month.  The graph below shows the fraction of policyholders persisting over 12 months.  The blue line shows the time series and the yellow dotted line shows the average level of policies in force. As one can see, by the end of 9 months, only 65% of the initial level of policies remain in force. The annual average is about 70% of the starting amount. Moreover, the healthy are the most likely to stop paying; those who are sick are most likely to persist in their policies. Thus, if 6.5 million enrollees start out, only 4.2 million will be left with policies at the end of 9 months and the average number of purchasers over the year will be 4.6 million.

stop_reporting_enrollment_nb_3

Even if just 10% decline to pay their first month’s bill, only 70% of the policies remain in force at 9 months (see figure below on left); the annual average is about 79%. At 20% initial decay and 5% monthly decay thereafter, only about 55% remain after nine months; the annual average is 65% (see figure below on right).  And some, of course, have suggested the fall off between enrollment and retention of a policy is actually worse.

stop_reporting_enrollment_nb_1stop_reporting_enrollment_nb_3

Note: it is possible that some of the losses due to non-payment will be offset by those purchasing policies via “special enrollment.”  These individuals, however, may be particularly high risk.

2. The state-by-state totals matter a lot; aggregate purchases matter little

Aggregate purchases or, worse yet, aggregate enrollment is largely irrelevant to the success of the ACA.  There are at least 51 markets for individual policies.  The fact that California may have exceeded expectations in terms of purchases does nothing to help Texas, Louisiana, Arizona and other states where enrollment has been low.  Insurers in states where enrollment is low or the demographics are particularly problematic — few young people, lots of middle age women — will not be compensated for their losses by the fact that enrollments are better in California, New York and Connecticut.  Even if it is the same parent company that makes money in one jurisdiction, that will not deter the subsidiaries in losing jurisdictions from either withdrawing or raising premiums. There will still be immense pressure on insurers in the less successful states to either drop out entirely — something the make-it-up-as-you-go-along implementation of Obamacare  fosters — or to raise prices substantially.

As I said in a story broadcast on National Public Radio and as the New York Times admits, we need to stop thinking about the ACA as a single narrative and start to think about it as multiple complex narratives.  Indeed, it’s probably more like 175 or more narratives (the number of issuers in all federal plans) because not only will the experience vary between states, they will also vary by insurer.  An insurer who charged a very low premium in a given state and attracted a good deal of business may react very differently next year in pricing policies than an insurer even in the same state who charged a high price and got less.

3. Experience matters most

But the life of the Affordable Care Act will not be enrollment or even purchases, it will be experience.  Did insurers set prices realistically or did they underestimate the medical problems and demand for services of enrollees?   Does the fact that many of the purchasers on the Exchange actually had policies already actually help insurers because many of those purchasers would have undergone at least some recent medical underwriting? Are the networks that have been created by insurers so narrow that they will lead to unsatisfactory medical care or will they in fact keep prices low? Will insurers regard uncertainty in the political environment  – like not knowing whether Obama will extend the inchoate hardship exemption into next year when, otherwise, the individual mandate/tax/penalty more than doubles — result in at least some insurers pulling out of the market? Will the diminishing reinsurance available to insurers writing in the Exchanges have the effect I predicted of increasing prices by about 7%?

Conclusion

Tonight, March 31, is a milestone for the ACA, but it is hardly the end of the challenge. We’ll see lots more important data start to dribble in over the next few months, including, critically, information on premiums insurers hope to charge in 2015. In the interim, though, could everyone please start to focus on statistics and data that matters rather than proxies such as “enrollment.”  Use of enrollment rather than policies in force may at one time have been a necessary evil. But persisting in doing so is a practice that is no longer useful other than as a vehicle for spreading political propaganda.

My suggestion, only slightly tongue in cheek, is that, just as the IRS imputes some awful income to you if you don’t file a tax return, journalists and bloggers start reporting appallingly low purchase numbers until the Obama administration releases the actual data. I’ll start:

“Tonight’s disclosure by the Obama administration that about 4.5 million individuals will have coverage via Exchanges under the Affordable Care Act during 2014 means that some big states such as New York and California have done reasonably well in making it likely that their insurance markets will be stable. It also means, however, that Exchanges could be under great stress in a number of states, most notably Texas.”

 

Addendum

4/7/2014

My rough estimate of the rate of decline in Obamacare enrollment appears to be vindicated by an article appearing here in Kaiser News titled  “Why Some Don’t Pay Their Obamacare Premium: It’s Not What You Think.”  Kaiser reports that Covered California, the Exchange for the nation’s largest state, has produced a report projecting a significant drop in the number of enrollees throughout the year:

According to the report between 53 and 58 percent of Covered California enrollees are expected to stay in a Covered California plan for 12 months. This analysis is consistent with a Kaiser Family Foundation study published earlier this year. It found that of people who enrolled in an individual insurance plan in 2010, years before the health law fully kicked in, only about 48 percent were still in the individual market two years later. (Kaiser Health News is an editorially independent program of the foundation.)

But most of these people dropping ACA Exchange coverage won’t become uninsured, the report says.  Instead, they will go on to the state’s expanded Medicaid program or find better/cheaper coverage elsewhere. It’s not clear from the Kaiser article or the Covered California report whether they expect those moving out of the Exchanges to be healthier than average.  In any event, though, the report further establishes why touting “enrollment” is ridiculous.

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Reinsurance reduction will add 7% to gross premiums for 2015

That’s in addition to whatever increases are caused by medical inflation and adverse selection

 

As we draw to what was originally to be the close of the 2014 regular open enrollment period for policies sold on Exchanges under the Affordable Care Act and as the evidence comes in on the actual numbers and demographics of purchasers, it’s time to start thinking about 2015. In this post, I’m not going to speculate today about the effects of the expanding the “hardship exemption” from the individual mandate on insurers’ experience in 2014, the effect of the “Honor System” in extending the time in which individuals can purchase coverage on the Exchange without medical underwriting, or on the effects of any of the other the myriad changes in the law that have been promulgated by the Executive Branch since Congress passed the ACA in 2010. Instead, I want to focus on the effect of statutory changes in the government-created reinsurance program on likely premiums in 2015.

First, a refresher. One of the ideas behind Obamacare was to lure people into the Exchanges with carrots and sticks.  The most frequently discussed carrots were advanced premium tax credits that reduced the effective price of insurance for many individuals and, for many of those receiving the premium tax credits, contracts with extra benefits (cost-sharing reductions) for which the purchasers do not have to pay. Not only, however, are Exchange policies subsidized by reducing the price to the consumer but also by reducing the cost the insurer faces in paying claims.  A key mechanism for this latter reduction for the first three years of the program is free “reinsurance” provided to all insurers for slices of their claims. Of course, the reinsurance isn’t really free; there’s a $63 per insured life tax levied on other health insurance policies in order to make policies on the Exchange more attractive, a transfer whose justice will not be considered today.

The reinsurance works in 2014 by having the government reimburse insurers for 80% of the amount of any insureds claim between $45,000 and $250,000. Thus, if an insured had claims of $105,000, the government rather than the insurer would pay for $48,000 of the claim while the insurer itself would pay for the remaining $57,000.  If an insured had claims of $30,000, the insurer would pay the whole bill.  And if an insured had claims of, say, $300,000, the government would cover more than half — $164,000 — while the insurer itself would pay the remaining $136,000.

Sample of the data embedded in the Excel spreadsheet for The Actuarial Value Calculator

Sample of the data embedded in the Excel spreadsheet for The Actuarial Value Calculator

One can use information contained in the government’s own “Actuarial Value Calculator” to estimate the effect of this reinsurance on Exchange premiums.  (I’ve placed a graphic above this paragraph showing some of the information in the Calculator.)  Based on my computations using Mathematica and done in connection with a recent academic conference, the reinsurance should lower the price of an Bronze policy by about $450 (11%), a Silver policy by $531 (11%), a Gold policy by $545 (11%) and a Platinum policy by $616 (10%).

The parameters of the reinsurance policy will change in 2015.  HHS currently says that instead of “attaching” at $45,000, reinsurance will only kick in if an individual’s claims exceed $70,000. And instead of reimbursing the insurer 80% of the slice between the attachment point and the $250,000 limit, the government will now reimburse just 50% of the slice. The table below shows the results of this change in reinsurance on the expected value of the reinsurance policy. If one assumes that medical inflation will be 4%, the value of the reinsurance will range from $192 for Bronze policies to $243 for Platinum policies. These computations are all again done using Mathematica based on data provided by the government itself in its Actuarial Value Calculator.

Value of reinsurance subsidy in 2015 for varying rates of medical inflation

Value of reinsurance subsidy in 2015 for varying rates of medical inflation

Insurers will need to compensate for the diminished reinsurance by raising prices.  How much?  The table below shows the answer: somewhere between 7 and 8% depending on the type of policy being sold and the rate of medical inflation.

Increase in premiums for 2015 just to cover reduction in reinsurance subsidies

Increase in premiums for 2015 just to cover reduction in reinsurance subsidies

If one adds regular medical inflation to the increases induced by reduced subsidization, here’s a picture of what we get. To obtain a single result for each rate of medical inflation, I’m going to weight the metal tiers according to their rough proportions in the market as last measured.

Projected premium increases for 2015 with reinsurance subsidy reductions taken into account for varying rates of medical inflation

Projected premium increases for 2015 with reinsurance subsidy reductions taken into account for varying rates of medical inflation

The results of combining ordinary medical inflation with reinsurance reductions are a bit scary.  While most people seem to believe the ACA system can survive premium increases of 6% or 8%, what we see is that even if medical inflation is kept to 4%, the results of combining medical inflation with subsidy reduction is a 12% hike.  And, if insurers are nervous about pricing in 2015 due to higher than expected claims experience in the early parts of 2014 or the persistence of problematic demographics such that they expect ordinary claims inflation of 10%, then we start getting into premium increases of about 18%.

Is there a workaround?

It is fair to say that the Obama administration has not been reluctant to change implementation of the Affordable Care Act in response to changing circumstances.  And, I suspect that if the Obama administration starts getting hints that insurers selling on the Exchanges are either thinking of pulling out of the Exchanges or of raising premiums significantly, one of the ways it will respond is by altering the parameters of the reinsurance program.  The attachment point, limit and reimbursement rate are all matters as to which the Obama administration has regulatory flexibility.  Indeed, it changed the 2014 reinsurance parameters favorably for insurers late into the process. And, of course, by providing a lower attachment point, higher reimbursement rate and/or a higher limit, the government can increase the effective subsidy created by the free reinsurance and thereby reduce pressure on insurers to raise premiums.

If, for example, the Obama administration were to go to, say, a 65% reimbursement rate rather than a 50% rate for 2015 and were to go to a $60,000 attachment point rather than a $70,000 one, a 4% increase in medical inflation might result in a lesser 9% increase in premiums rather than 12%.  And even a 10% increase would result in a lesser 14% increase in premiums rather than an 18% one.

The problem with this “fix,” however is that it costs money.  And, by statute, the government is supposed to spend $4 billion less on the reinsurance program on claims for 2015 than it spent on claims for 2014.  That’s why HHS reduced the reinsurance parameters for 2015 in the first place.

I can foresee two ways around this limitation.  The first is for the Obama administration to engage in creative math and find a theory under which the projected cost of its reinsurance program aligns with statutory requirements.  While cynics may be fond of my projection of this response, there is a serious question as to the extent that principled actuaries in the Executive branch will permit this “methodology” to be used. The second possibility is for the Obama administration to stockpile funds from 2014  and use them to pay reinsurance in 2015.  Section 1341(b)(4)(A) of the ACA appears to make this possible.  This scheme only works, however, if the government actually has money left over from its 2014 reinsurance pool.  And, while lower than expected enrollments in the Exchanges increase the probability that there will be money remaining, that potential surplus could well be eaten away if claims for 2014 are higher than expected.

A result of improper conceptualization

Amidst all the technical detail, it’s worth thinking about how this could have happened. How could the architects of the ACA, who were acutely aware of the risks of an adverse selection death spiral, create a system in which there were built in pressures to increase premiums? I think the answer comes in examining the rhetoric of the reinsurance program.  It was not articulated as a subsidy but rather as a way of reducing the risk of entering the Exchanges. See here, here and here for examples.   If adverse selection or moral hazard drove claims costs up, the government would significantly insulate insurers from that risk by providing reinsurance. This, along with Risk Corridors in the first three years of the program, and Risk Adjustment thereafter, was supposed to provide insurers with comfort as they deliberated whether to enter an untested market for health insurance in which most of their conventional underwriting mechanisms were prohibited. And, indeed, the Transitional Reinsurance program does reduce risk. Based on my computations, it reduces the standard deviation of losses for Bronze policies from $16,403 to $11,430 and for Platinum policies from $17,215 to $11,598.

If one conceptualizes the transitional reinsurance program merely as a risk reduction policy, it makes sense to phase it out as insurer experience with the purchasing pools in the ACA.  Insurers gain confidence in how to price their policies.  But what appears to have been forgotten in that calculation is that these reinsurance subsidies also save insurers lots of money.  And insurers will need to respond to the phasing out of these substantial subsidies by raising premiums.  Whether that tunnel vision in conceptualization contributes to an implosion of the ACA, at least in some states, remains to be seen.

 

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Does competition in the Exchanges result in lower premiums?

One of the touted benefits of the Affordable Care Act was that, by fostering transparency, there would be greater competition in the health insurance market and that premiums would go down as a result.  We now have data to help see whether competition within the various Exchanges has succeeded in reducing prices. This post, based on a scholarly talk I recently gave at the University of San Diego’s Workshop on Computation, Mathematics and Law, will suggest that the effect, if there is one, is small and subtle.  It looks as if having just one seller of a product within a county may lead to somewhat higher prices, but the effect may not be robust. The methodology used here is a first cut. Whether other methodologies might tease out a larger relationship remains to be seen.

Note to ACA Death Spiral Fans: The USD conference mentioned above is one reason for the infrequent posts as of late.  It’s been a busy period. Sorry. There’s A LOT to write about.  Keeping track of Obamacare is at least a full time job.

Data

The data for this project comes mostly from good old healthcare.gov, which, if one forages around a bit, actually contains a user-friendly database exportable in various standard formats such as CSV and JSON describing all 78,392 plans currently being sold in 2,512 counties via the federal Exchange. Each plan is described by 128 fields, including the metal tier of the plan, the name of the issuer of the plan, the type of plan (PPO, HMO, POS, EPO), the monthly gross premiums of the standard plan for various family types, the deductibles and cost sharing arrangements of the standard plan, and the deductibles and cost sharing arrangements of the variants of the plan that feature cost sharing reductions as described in 42 U.S.C. § 18071. The remaining data comes from the United States census.

Methodology

The idea here is to consider each county of the United States as a market for health insurance and to find, for each county, the number of issuers selling plans on the Exchange, a representative measure of the price being charged by each issuer, and, therefore, a representative measure of the price charged within each county.  If competition resulted in lower prices, one would expect to see — all other things being equal, which of course they are not — an inverse relationship between the number of issuers and the representative price charged within each county.  We can also see, however, whether any such correlation is either spurious as a result of factors that correlate with both the number of issuers and the premiums charged or whether a stronger correlation might appear if other factors were controlled for. Here, the one other factor I took account of was county population density, the idea being that insurers might be less eager to enter counties in which the population density was low and that prices might be higher in such areas due to transportation costs.

Visualizing the Results

The “Distribution Chart” below shows a typical result from this data exploration.  Here is the distribution of representative monthly premiums charged a couple in which the members are both 40 years old for a Silver PPO plan.  The plot is broken down by the number of issuers within the count.  If the insurer sells more than one Silver PPO plan within a county — which sometimes occurs — I take the median price for that insurer.  And to determine the county price, I take the median price for all of the issuers.

Distribution Chart (basic)

Distribution Chart (basic)

The Distribution Chart works by using a dot to represent each gross monthly premium broken down by number of issuers. It  applies different background colors that depend on the number of issuers within the county and shades each part of the background according to the density of premiums at that price level.  Darker shades represent higher density.

We can run the same analysis for different purchasers, different metal levels, different types of plans and using different measures to move from issuer prices within a county to a single representative issuer price and to move from representative issuer prices to a representative county price.  Here, for example, is the Distribution Chart for gold PPO plans purchased by couples age 40 with two children in which I use the minimum price offered by the issuer within each county and then use the 25th percentile price of those minimum prices to come up with a representative county price.

Distribution Chart for Gold PPOs (Coupled +2 children, Age 40), minimum by issuer, 25th quantile to derive county price

Distribution Chart for Gold PPOs (Coupled +2 children, Age 40), minimum by issuer, 25th quantile to derive county price

We can also aggregate matters. Here is the Distribution Chart for all Bronze plans of all types (HMO, PPO, POS, EPO) in which I take the median of multiple plans issued by a single issuer and then take the median value of all issuers to derive a county price. I do this for a single adult, age 30.

All bronze plans

All bronze plans

Here’s an analysis examining all types of Bronze plans but using a variant of the visualization.  The individual dots are suppressed and we now have little histograms for situations in which there is 1 issuer through 8 issuers.

Histogram density visualization of all bronze plans

Histogram density visualization of all bronze plans

 

Eyeball Analysis

When I eyeball this data and many more permutations that I have produced, I at least do not see any dramatic and widespread relationship between the number of issuers within a county and the representative gross premium being charged.  For some combination of parameters, one occasionally sees higher prices when there is only one issuer in the county, but generally the picture, at least the naked eye is quite blurry. The one thing I can say with some certainty is that the family-type of the purchaser — individual, couple, family with children — does not appear to affect matters. Premiums appear quite uniformly scaled across these groups.

What I do consistently is, as noted here and here, that there are many counties in which there is only one issuer of a particular level and type of plan. For Silver PPO plans, for example, in which one wants a medium level of cost sharing but wants at least some freedom in selecting a provider, of the 2,512 counties, 20% of the counties have no issuers with such a plan while another 36.6% have only one such issuer.  Only 13% of the counties have three or more issuers of these plans. The pie chart below shows the distribution of issuers.

Distribution of Silver PPO issuers

Distribution of Silver PPO issuers

Or, suppose one simply wants a bronze plan of any sort. What we see is that 16.2% of the counties apparently have no such plan, 27.9% have only one issuer and 31% have 2.  Thus, only about one third of the counties have 3 or more choices for a simple bronze plan.  The pie chart below shows the result.

Distribution of bronze issuers

Distribution of bronze issuers

Statistical Analysis

Sometimes the human eye and the human brain, magnificent as those organs are, do not see patterns that in fact emerge when studied through the lens of statistics or machine learning. Modern computers and statistical activities make it easy to go beyond eyeballing data. What I have done, therefore is to merge representative premium data with data on the population density of each county and see if any statistically significant relationship emerges between the number of issuers within each county and the county representative price.

I want to start with the simplest model: a linear relationship between the number of issuers and the county representative premium.  I will do the analysis at first for my baseline Silver PPO purchased by a couple age 40 where I use the median price of the issuer if they sell more than one Silver PPO within the county and the median price of issuers .  The graphic below shows the results.  There is a statistically significant relationship between the number of issuers and the premium.  For each additional issuer, the gross premium goes down by about $16.  The model overall, however, accounts for only 2.1% of the variation in representative county prices, meaning, roughly speaking, that 98% of the variation in premiums is correlated with factors other than the number of issuers.

Linear regression of county representative price on number of issuers

Linear regression of county representative price on number of issuers

The problem with leaping from this finding to an attempted vindication of claims about the virtues of the ACA is that the result, even weak as it is, depends a bit on specification of the model.  This gets a little technical, but unless one assumes a priori that there is some good reason to think that the relationship between number of issuers and price is in fact a linear one, restricting the regression to a simple linear model is potentially misleading.  Here, for example, I regress the same data on n (the number of issuers), n-squared and the log of n.  All of the coefficients in front of the various terms are still significant, but if one looks at the picture one gets a much more complex story.  It appears that having one issuer does lead to high prices and that having two issuers may minimize the number of prices. As one increases the number of prices beyond two prices go up again until we peak at four issuers.  This model explains almost 9% of the variance in pricing, which is considerably better than the simplest linear model but still not very good.  Clearly, pricing is determined by much more than the number of issuers within a county.

Pricing model based on linear, quadratic and logarithmic term

Pricing model based on linear, quadratic and logarithmic term

The observed pattern when this more complex regression model is used appears roughly to persist for all metal types of HMOs and PPOs except platinum PPOs where we see the price increase as the number of issuers within a county increases.  The family type of the purchaser appears not to affect the general shape of the relationship.  I am never able to explain more than about 12% of the variance in premium pricing when I use just the number of issuers within the county as my single explanatory variable.

I have some sense that the population density of a county might have an effect on pricing. Perhaps lower density counties are more expensive.  Or, it could be the case that higher density counties, which may have fancier equipment, are more expensive.  The regression below shows a simple linear regression using two variables: number of issuers within the county and population density of the county. As one can see, the results are little changed.  Both variables have effects that are statistically significant but small. As one goes from 1 to 2 issuers, the price drops by about $17 per month.  As one goes from a county in which the population density is 4.3 (which would put it in the 10th percentile) to a county in which the population density is 491 (which would put it in the 90th percentile), the price goes up by $7 per month. The model still does not explain much (adjusted R-squared <0.03).  Here are the results in more detail.

Linear regression using number of issuers in county and population density

Linear regression using number of issuers in county and population density

Again, I can use a more complex specification.  Below I show the results of using linear, quadratic and logarithmic terms for both number of issuers and population density.  What we see is a complex picture in which having just one issuer appears to persist in causing somewhat higher prices and in which population density plays a small role.  But we are still able to explain less than 10% in the variation of premiums.  Again, whatever is going on in premium pricing models, is a lot more complex.

Linear, quadratic and logarithmic terms for number of issuers and population density

Linear, quadratic and logarithmic terms for number of issuers and population density

A Foray into Machine Learning

I also attempted to see whether a computer could find a formula that predicted county representative gross premiums any better than my statistical models when given free rein to do so.  To do this, I loaded the data into a program called Eureqa from Nutonian .com, which basically uses “genetic programming” to find models that predict well. The basic idea is to treat mathematical formulae kind of like strands of genetic material and permit mathematical formulae that perform better to evolve via mutation and “sex” to produce what may be yet formulae.  Sometimes it produces amazing results and — well — sometimes it does not.  Either way, however, genetic programming and other methods of machine learning are a useful complement to traditional techniques. They help one  check whether the apparent incapacity of traditional methods such as regression are an artifact of limited specifications or the result of unavoidable noise in the data.

In this case, Eureka basically found little. It found some functional forms a human might not come up with such as the one below, which appeared to predict decently, but in fact did not do any better than the models I developed by hand.  The foray into machine learning suggests, then, that the limited ability of our our statistical models to predict well is not the result of a failure to specify the model correctly but rather the result of noise in the data and unobserved variables.

Formula discovered by genetic programming

Thoughts

Unfortunately, perhaps, the results shown here are not the sort one writes home about or that get on the front page of either scholarly publications or news reports.  They are kind of “meh” results. Maybe market concentration has an effect, but, at least as revealed by the data here it is small. So, why might this be?

1. Perhaps the number of insurers in the Exchange is not as relevant anymore as might be thought. Given the availability of individual policies off the Exchange in some states, the number of individual polices within the Exchange may not be as important.  I don’t have the data on off-Exchange policies and neither, so far as I know, does anyone else.

2. Maybe pricing is determined more by the identity of the insurer than the number of insurers.  Suppose, for example — and I do not say this is true — that Blue Cross made different assumptions about adverse selection and moral hazard with the purchasing population than did, say, United Healthcare. Markets that Blue Cross entered aggressively might thus have lower representative county prices than markets in which they did not.  Or suppose that Blue Cross was able to use market power and/or superior skill to create narrower networks that nonetheless satisfied regulators.  This might account for markets in which Blue Cross was present exhibiting lower prices.  Or suppose that Humana was more willing to take a loss the first year in order to supposedly lock in business than was Blue Cross.  This too might explain lower pricing.  This suggests another experiment in which one looks at pricing as a contest and seeing how each of the competitors fared against each other.

3. Maybe consumers are very sophisticated such that “Silver PPO plans” are  not comparable.  If consumers, for example, value the precise package of benefits and providers offered by, say, Blue Cross in a county as being quite different from the precise package of benefits and providers offered by, say, Humana, then we can’t just count issuers in determining the level of competition in a county.

4. Population density isn’t the right variable to include.  Maybe what we need is some measure of medical pricing by counties. Or maybe, as the Wall Street Journal suggested, we need to include some measure of income or income inequality.  Sadly, it may be that healthcare costs more in poorer counties, perhaps because the poor have more serious health problems.  At the moment I have not included those variables.  Future examinations of this area should probably do so insofar as the data permits.

Note

Ordinarily, it would be my practice to make the Mathematica notebooks used to conduct this analysis fully available.  I very much believe in transparency.  Unfortunately, this analysis was conducted using features in a beta version of Mathematica 10 and I have signed a non-disclosure agreement with respect to that software.  While I received consent to show certain results from use of that software, I did not request or receive consent to show code.  Moreover, the code would not work on computers that do not have Mathematica 10.  I commit to releasing the code as soon as Mathematica 10 is out of beta.  I don’t think my NDA stops me from saying, however, that Mathematica 10 looks somewhere between absolutely spectacular and completely mind-blowing.

 

 

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How Virginia insurers got the federal government to pay for bariatric surgery under Obamacare

I’ve been doing some research into the effects of market concentration on health insurance premium pricing on the health insurance Exchanges run by the federal government.  During the course of that research, I discovered what I first thought had to be a programming error on my part or a database error on the part of healthcare.gov: Silver and Gold plans that were costing individuals age 50 upwards of $2,000 per month.  Yes, per month!

It turns out, however, that these exorbitant prices are not errors. They represent a clever attempt by several insurers in Virginia — Optima Health, Coventry Health Care of Virginia, Inc., Innovation Health Insurance Company, and Aetna —  to get the federal government to pick up a substantial part of the tab for bariatric surgery. Here’s how it works.  The insurer offers the consumer a premium that is often $2,000 per month ($24,000 per year) more than it charges for other essentially identical plans. The bonus is that the insurer offers the consumer,  in addition to the usual benefits, bariatric surgery, which is otherwise subject to coverage restrictions in Virginia. Now, the only person who would rationally purchase such a policy is one who is pretty certain to undergo such surgery. And, as it happens, bariatric surgery (such as a gastric bypass) appears to cost between $20,000-$25,000. In effect, then, the insured prepays for the surgery via augmented premiums and perhaps piggybacks on the insurer’s bargaining power with surgeons to get a cheaper price.

So far, however, this does not seem like a compelling business model for insurance; at best it converts insurance into an elaborate financing scheme. But wait: if the insured has a relatively low income (and obesity correlates with poverty in modern America), under the cost sharing reductions provisions of the ACA (42 U.S.C. § 18071) the federal government now picks up much of the deductible and coinsurance that would otherwise be owed. Instead of there being, say, an $3,500 deductible and a $6,350 coinsurance limit, as there is under the Aetna Classic 3500 PD:MO policy offered in Virginia, if the person is poor enough (100-150% of federal poverty level), the deductible under the Aetna Classic 3500 PD: CSR 94% MO  is now $300 and the out-of-pocket limit is now $1,250. The federal government is thus likely to pay for $3,200 to $5,100 of the bariatric surgery that would otherwise come out of the patient’s pocket.

Is this legal under the ACA? I believe it may well be. I don’t see a violation of the “metal tiering” provisions of the ACA.  Under section 1302 of the ACA (42 U.S.C. § 18022), whether something qualifies as a Silver or Gold plan depends on the cost to the insurer of providing essential health benefits to a standard population, not on the cost to the insurer of providing its actual health benefits to the population it anticipates attracting.  That may not be a very good system, but is the one in the law; it is probably simpler than some alternatives. Moreover, section 1302(b)(5) of the ACA makes clear that a health plan may provide “benefits in excess of the essential health benefits described in [the ACA].” And, since some states apparent include bariatric surgery in their list of essential health benefits, it’s hard to say that Congress implicitly rejected paying for this procedure.

Footnote: I suppose there could be an issue as to whether this plan conforms to Virginia insurance regulations.  I’m not an expert on that, but my working assumption is that the Virginia regulatory apparatus has approved these plans.

Is what these insurers are doing appropriate?  That’s a tricky question. Basically what they are doing is the result of a decision by the Department of Health and Human Services relating to implementation of sections 1201 and 1302 of the ACA. HHS, instead of creating some uniform concept of Essential Health Benefits for those states that elected not to make their own decision, instead decided to try and mimic features of the “largest plan by enrollment in the largest product by enrollment in the State’s small group market.” 45 C.F.R. 156.100) That essentially made it a bit a matter of luck as to the circumstances under which bariatric surgery or other weight loss programs would be covered by plans permitted to be sold after 2013 on the individual market. It meant that in some states the risk of needing (or badly wanting) bariatric surgery would be spread among all those purchasing non-grandfathered plans after 2014 whereas in other states either the risk would not be transferred at all or would be transferred, as in Virginia, only at a high price. The map below created by the “Obesity Care Continuum” shows how the states differ.

 

Obesity treatment under state benchmark plans

Obesity treatment under state benchmark plans

And should bariatric surgery itself be covered?  It’s not an easy decision.  On the one hand, bariatric surgery frequently results in part from poor health choices made by the individual. Yes, there may be contributing factors such as access to healthy foods, genetics, access to safe methods of exercise, but, still, most people have a choice not to become obese.  And, if the condition is viewed as substantially the result of individual choice, the case for socializing and spreading the risk is weaker. On the other hand, there are plenty of risks that health insurance policies do pay for — both before and after the ACA — that likewise result substantially from personal choice.  They cover orthopedic surgery for (mostly wealthy) people who choose to ski. They cover smoking related conditions — albeit for an additional premiums which, if actually collected, would still probably be less than the actuarial risk of tobacco use. They cover treatment in at least some forms for the variety of conditions created by substance abuse (drugs, alcohol). They sometimes cover non-surgical costs to which obesity contributes even when those problems are partly the result of individual choices. And they covers the costs of treating sexually transmitted diseases even when those diseases might, in some instances, have been prevented by safer sexual practices. Untangling fault out of medical need is often a tricky proposition indeed.

So, perhaps these Virginia insurers are doing the public a service by evading/working around restrictions in the Obamacare package of essential benefits provided in some states that were unduly narrow.  Indeed, on this view, the problem is not that the federal government is subsidizing bariatric surgery, it is that individuals have to pay these enormous extra premiums for a risk that should be shared and that are shared in some states. It will be interesting to see what happens with these Virginia plans and whether what has started there extends to other states in which bariatric surgery is not presently considered an essential health benefit.

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Latest unlawful Obama administration “fix” may create standing for challenges

This past Thursday, the Obama administration issued its latest “fix” to the troubled roll out of the Affordable Care Act. The Center for Medicare & Medicaid Services issued a guidance that permits federal funds to go to insurers and insureds involved in sale of an individual health insurance outside of either a federally established or state-established Exchange. The premise of the guidance is that, in certain states such as Maryland, Massachusetts, Hawaii and Oregon, the complete dysfunctionality of the websites that were intended to determine eligibility for Obamacare subsidies may have led people to enroll in policies off the Exchanges; these purchasers, the guidance directs, should be treated the same as if the state Exchanges had made a timely determination and the individuals had enrolled in an Exchange policy. The guidance implements this concept by retroactively making such individuals eligible for premium tax credits the same as if they had purchased a policy on the Exchange and requires their insurers to readjudicate their claims both retroactively and for the remainder of the policy year as if they were eligible for the same cost sharing reductions that would have applied had they purchased a policy on the Exchange.

The Obama administration’s guidance calling for expenditures of taxpayer money plainly violates the Affordable Care Act. Unlike prior violations incurred in an effort to rescue the ACA from implementation and architectural infirmities, however, this one may actually hurt legal entities in a traceable and individualized fashion.  Some off-Exchange insurers may have standing to challenge the violation in court should they have the courage to pursue that option.

The illegality problem

Here’s why the Obama administration’s action is unlawful.

Premium Tax Credits

Under section 1401 of the ACA, which creates new section 36B of the Internal Revenue Code, the government may provide premium tax credits to the individual only for a “coverage month.”  The idea was that households with incomes less than 400% of the federal poverty level would ultimately see their federal income  taxes reduced to help compensate for the cost of purchasing health insurance.  But not any kind of health insurance purchase constitutes a “coverage month.”  Under section 36B(c)(2)(A), a coverage month is only one in which the taxpayer “is covered by a qualified health plan … that was enrolled in through an Exchange established by the State under section 1311 of the Patient Protection and Affordable Care Act.”  (emphasis mine) But the policies the Obama administration are now going to subsidize were not enrolled in through an Exchange established by a State (or the federal government); indeed, such is the entire “innovation” of this CMS guidance. And, thus, there is no statutory authorization for the federal government to be giving these taxpayers a credit.

Cost Sharing Reductions

Under section 1402 of the ACA (codified at 42 U.S.C. § 18071), the Secretary requires insurers to offer contracts with reduced cost sharing (deductibles, copays, out-of-pocket limits etc.) to individuals who purchase “Silver” plans. Purchasers are broken down into categories such that purchasers who fall into progressively lower income categories receive progressively more generous reductions. The program effectively converts “Silver” policies into “Silver-Plus”, “Gold Plus” and “Platinum Plus” policies. The government subsidizes insurers issuing these policies so that the cost sharing reductions should not cost them anything (providing the math is done properly). What the Obama administration is proposing is to extend these cost sharing reductions to insurance purchased off the Exchanges, at least where an application had been made to an Exchange.

Again, the problem is that the statute does not authorize cost sharing reductions for all “qualified health plans” sold on or off an Exchange. Under section 1402(a), such payments are authorized only for an “eligible insured.”  And the definition of “eligible insured” is quite clear. Section 1402(b)(1) requires that an eligible insured “enroll in a qualified health plan in the silver level of coverage in the individual market offered through an Exchange …” (emphasis mine).  Again, that pesky “through an Exchange” language gets in the way of the administration’s goal.  The policies now being offered subsidization are precisely those not offered through an Exchange.” The payments to these insurers announced by the Obama administration are illegal. From a financial accountability standpoint, it is not much different than if the Obama administration just decided to give government money to those ineligible for Medicaid simply because it felt badly for some of them.

Why insurers may have standing to challenge the new regulations

The Obama administration has made a habit in its implementation of the Affordable Care Act to exploit the law of “standing.” This is the doctrine that usually denies individuals with generalized grievances about a law or its implementation from bringing suit. Standing usually requires, among other things, that the plaintiff in a legal action have suffered individualized injury from the statute. Thus, when the Obama administration simply declines to collect taxes (as with the refusal to enforce the employer mandate), it becomes challenging to find someone who can use the judicial system to overturn the action. A similar problem plagues efforts to challenge the Obama administration’s decision to permit insurers to continue to sell policies that do not conform to the requirements of the Affordable Care Act. It’s challenging to find an individual or business that is hurt in a particularized and traceable fashion.

With the latest lawless action, however, the Obama administration may have gone too far.  Insurers who sold off Exchange will be hurt by the cost sharing reductions.  The reason is “moral hazard.” The idea of moral hazard is that the more generous an insurance policy is the greater the frequency with which insureds encounter covered events. In the health insurance arena, people with lower co-pays and deductibles go to the doctor more.  Indeed, the major reason for co-pays and deductibles is precisely to induce insureds to be judicious in their use of expensive medical services.  Moral hazard is one of the major reasons that platinum policies cost more than bronze ones.

When cost sharing reductions imposed on off-Exchange insurers effectively convert their silver policies into silver-plus, gold-plus and platinum-plus policies, those insurers end up paying more in claims.  And, while insurers selling policies on the Exchanges could have taken the induced demand created by cost sharing reductions into account in pricing their policies, there may well be insurers who sold only off the Exchange who, of course, did not take this additional moral hazard into account. Those insurers never dreamed that the government would reduce the amount its insureds would owe in cost sharing. Such insurers should have a strong case for standing in bringing a declaratory judgments to challenge the new guidance or, perhaps, in refusing to honor the demand for cost sharing reductions. Such insurers will, of course, need to be willing to take the political heat that may come from taking on an Executive Branch that more than ever is regulating their products.

A practical problem with imposition of cost sharing reductions on off Exchange policies

There’s also a practical problem with retroactive imposition of cost sharing reductions on off-Exchange insurers.  The guidance issued last week does not seem to address it. There are a lot of ways of achieving cost sharing reductions.  Some insurers might choose to reduce a deductible for some benefits.  Other insurers might choose to reduce a different deductible.  Still others might choose to keep the deductible but reduce copays.  For this reason, insurers selling policies on the Exchanges needed to specify in advance how they were going to achieve cost sharing reductions for their policies. Hence the government’s “Actuarial Value Calculator.” But insurers selling policies off the Exchange may never have gone through such an exercise.  Since CMS is now going to tell these insurers to readjudicate claims once they find out the income level of their insureds, the insurers are somehow going to have to come up, retroactively, with a system of cost sharing reduction.  How the insurer chooses to do so will affect how much each insured gets rebated.

The demand for readjudication gives insurers a second basis for standing.  Claims adjudication is not free.  The insurer is now going to have to go back through claims and resolve them for a second time.  Programming computers to adjust claims on a new basis is not costless. Figuring out whether a given service qualifies for cost sharing reductions is not costless. Cutting checks is not costless. And, having an actuary figure out what forms of cost-sharing reductions actually qualify as appropriate under the ACA is hardly costless either.  In short, the CMS guidance places new and completely unanticipated burdens on insurers who may have chosen to sell off Exchange precisely to avoid some of the regulatory burden that comes with on-Exchange sales.

The possible abortion problem

The “fix” concocted by the Obama administration may also end up violating restrictions in the ACA on federal funds being used to fund elective abortions. I will admit this is a bit speculative, but here’s the issue.  The general problem is that the ACA is an extremely integrated federal statute in which various provisions were enacted on the assumption that the conditions set forth in other provisions would hold.  Once the administration starts lawlessly changing certain parts of the ACA, other sections of the act begin to unravel. With abortion, the problem is that section 1303 of the ACA  (42 U.S.C. § 18023) prohibits federal tax dollars from being used to pay insurers via advances on premium tax credits  to fund elective abortions. Nor may federal funds be used to reduce the amount of “cost sharing” (deductibles, copays) that certain poorer ACA policy purchasers would otherwise pay for services other than elective abortions. There’s an elaborate mechanism specified by the statute involving segregated accounts and allocations that keeps government out of the elective abortion business, almost as if the insured purchased two policies — one for elective abortion and one for everything else — only the latter of which was subsidized by the government.   As a result, to the extent that various plans sold on the Exchanges provided for elective abortions — and apparently plans in at least nine states do so — they were structured to avoid receipt of such payments through segregated accounts.

Policies sold off Exchange never anticipated being the recipient of federal taxpayer money via premium tax credits and cost sharing reductions.  To the extent they provided for elective abortion coverage — and probably some of them did — there would have been no reason to structure them with segregated accounts to avoid receipt of federal funds for abortion.  Thus, when the Obama administration now proposes paying these off-Exchange policies federal tax dollars, the mechanisms for addressing abortion will not exist. I suspect that insurers who chose to sell off Exchange will not be excited by the administrative costs of now establishing segregated accounts. And, of course, if these off-Exchange insurers are not required by the Obama administration to prevent use of federal funds to pay for elective abortions, expect a firestorm of protest from those who believe that the federal government should not be subsidizing elective abortion.

 Conclusion

One can be sympathetic to the plight of individuals in states such as Oregon, Maryland and others that wanted subsidized and community rated health insurance and, through no fault of their own, could not get it due to dreadful implementation of database systems that many states managed to accomplish with far fewer problems.  In a world of cooperation, it might have been possible for the Executive branch and Congress to work together to hold these individuals harmless for these failings while preserving political and legal accountability for government officials and contractors who collaborated in the various debacles. Instead, however, we have an illegitimate attempt to use the Executive pen to write around the problem and bail out those responsible for embarrassing state implementations of the ACA.

This fix is not only lawless, it is very sloppy.  It fails to prescribe a method by which the retroactive cost sharing reductions are to be done.  It imposes costs on insurers who may have traded the opportunities of selling on the Exchanges in favor of the comparative regulatory freedom that came with selling off the Exchanges. If the guidance is not clarified, it  may enable strategic behavior by those who purchased off the Exchange without suffering through a dysfunctional Exchange first; it may permit those people to apply for Exchange coverage now, reject it, but still obtain retroactive premium tax credits and cost sharing reductions for their off Exchange policies.  And the guidance as it stands fails to take into account sensitivities concerning elective abortion funding. And, of course, this spending of taxpayer money appears to be proposed via a “guidance” and not even a full fledged regulation promulgated with at least minimal process.

For proponents of the “flexibility” the Obama administration has shown in implementing the ACA in the face of a hostile Congress, however, the main sloppiness with the latest guidance is that it enables the judicial branch to rule on the pattern of unilateral Executive action that has characterized recent implementation of the ACA. Insurers off the Exchange will be hurt by the cost sharing reductions imposed by the guidance and by the administrative costs it creates. The question is, will any of them have the guts to sue.

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The ACA’s transitional reinsurance tax: the numbers are funny again

Most sellers of health insurance in the United States outside of health insurance Exchanges will be forced to add $63 per member on to premiums for 2014 to cover a new tax imposed by the Affordable Care Act on the sale of such policies. That tax revenue coupled with $2 billion out of the federal treasury will go to subsidize individual policies sold on the federal Exchanges, probably lowering their gross premiums by about $525 per person.  If, however, enrollment in the federal Exchanges remains considerably lower than projected and enrollment in non-grandfathered, non-Exchange plans does not compensate for the reduction, the revenue collected from the tax is likely to be in excess of that which needs to be paid to support the statutory subsidies.  The $63 per member tax, which has precipitated considerable protest, thus might end up being overly high. And if the Executive branch can exercise its discretion to delay or waive taxes for one part of the ACA based on alleged new developments, why not for another?

The Center for Medicare & Medicaid Services (CMS)  has many options for addressing the surplus.  It might choose to to use the surplus tax revenue either to cut similar taxes in the subsequent years of the program or to rebate the excessive tax back to health plans and others who paid it. CMS might, I suppose, inflame people from both ends of the ideological spectrum by gifting insurers with more generous reinsurance this year.  Or CMS might simply squirrel the surplus away to provide reinsurance after the normal sunset of the program in 2016. I suspect, however, that  CMS is likely to use the surplus to increase the generosity of reinsurance provided in subsequent years of the program such as next year. Doing so could mask problems of adverse selection that could otherwise result in large premium increases. Such a choice would not  necessarily be a bad thing: it just highlights yet again the expense of the ACA, the fragility of attempts prior to its passage to model its effects, and the problems with thinking about its interlocking web of provisions in a linear, reductionist manner.

Here’s a more detailed explanation.

The Affordable Care Act subsidizes both insurance purchases made on the individual Exchanges and  individual policies still sold off the Exchange that conform with various ACA rules.  Doing so lowers the price of insurance and decreases the systematic risk associated with selling policies in a new regulatory environment in which the population of insureds may have different (and worse) health profiles than those previously composing the insurance pool.  A key way that the ACA does this is through a program of “transitional reinsurance” provided free of charge to insurers willing to write policies in the individual market — so long as those policies haven’t been exempted from the requirements of the ACA by being “grandfathered.” The program is “transitional” because it is supposed to end after three years. One way of thinking about all this is that free reinsurance lowers both the mean and the standard deviation of the net claims distribution faced by eligible insurers.

Under section 1341 of the ACA and the regulations CMS has developed to implement it, the transitional reinsurance program is ultimately supposed to break even. If tax revenues that fund it are less than the expenditures it requires, CMS has provided in 45 C.F.R. § 153.230(d) that reinsurance payments are cut in that year in order to prevent a deficit. If tax revenues that fund the transitional reinsurance program are greater than the expenditures it requires, CMS has stated in 45 C.F.R. § 153.235(b) that the surplus will be spent in subsequent years of the program on reinsurance benefits.  The program also works with a one year lag: money is collected and paid in each year is for claims made the preceding year.

The Center for Medicare and Medicaid Services has funded the transitional reinsurance program this year by levying (with the help of its IRS friends)  a $63 per insured life tax on most (but not all) health insurance policies sold in the United States this year. (The payments are deductible for for-profit enterprises). CMS says it is planning an exception to the tax for self-funded plans that are also self-administered, a rule that, as shown in the graphic below, CMS previously said (correctly) it lacked statutory authority to issue and that will significantly benefit labor unions. This tax revenue, coupled with a required $2 billion from the United States Treasury, is estimated to yield $12 billion to be paid in 2015 for claims arising in 2014.  CMS will use the the money to provide a form of stop-loss reinsurance that attaches at $45,000 of claims per member and that provides 80% reimbursement for claims up to $250,000. In earlier versions of the regulation, the attachment point was a less generous $60,000.

Comparison of regulations: March 11, 2013 v. October 30, 2013

Comparison of regulations: March 11, 2013 v. October 30, 2013

How would you spend $12 billion?  Well, using the “continuance tables” (statistical claims distributions) contained in CMS’s “Actuarial Value Calculator,” one can show that the expected payments under the reinsurance system created by CMS for 2014 will range from about $433 per member for a bronze plan up to about $597 for a platinum plan. The weighted average expected payment will be about  about $525. The enhanced size of this subsidy, rather than other miracles of Obamacare, may explain in part, by the way, why premiums on the Exchanges came in somewhat lower than some had projected. If CMS is planning on spending about $12 billion on transitional reinsurance and it spends $525 per insured person, simple division shows that it takes about 23 million people who might trigger the reinsurance obligation in order to exhaust the fund.

The problem, however, is that, given recent developments, there are unlikely to be 23 million persons in 2014  (a) who might trigger the reinsurance obligation (“reinsurance triggering”) and (b) who are insured by reinsurance-eligible insurers (“reinsurance eligible”). You could just take my word on this point and skip to the end of this entry or, better yet, follow the accounting done here.

An accounting

Let me concede, temporarily and for the sake of discussion, that there will be 6 million people on average in 2014 who are paying premiums based on policies purchased in the individual Exchanges.  That’s hard to believe given (a) that the number with a month to go is probably about 3.2 million (President Obama’s alleged 4 million enrollment reduced by 20% shrinkage for nonpayment); (b) that the number of insured in the Exchanges would have to be 7 million post March for there to have been 6 million on average during all of 2014; and (c) Vice President Joe Biden’s augury that 5 million would be a “heck of a start.”  I will grumpily concede it nonetheless.

How many off-Exchange purchasers should we then add?  Here the numbers are slippery too.  I am indebted, however, to some careful work by the Kaiser Family Foundation on this point.  You can read it here. The highest estimate I have seen for the number of nonelderely persons covered by  a plan purchased directly from an insurer at any one time in a calendar year is 19 million.  But many of these 19 million will (a) not have insurance the entire year; (b) will have insurance that is secondary to other insurance and thus unlikely to accumulate the $45,000 attachment point in claims; and (c) will be in grandfathered policies not eligible for reinsurance and persisting through 2014 only by dint of President Obama’s magic waiver of the terms of the ACA.  When one looks at the situation at any given point in time — which is the proper basis for figuring out an average — it looks as if there might be 13-14 million who have some form of individual health insurance and 10-11 million who have primary health insurance coverage of the sort that might trigger a reinsurance obligation.

So, should I add 11 million to the 6 million and say that there are 17 million insureds that might trigger a reinsurance obligation?  No! That would ignore two substitution effects.  We know from various studies that a lot (perhaps 65% – 89%) of the people purchasing policies on the Exchanges simply swapped non-Exchange policies that would not be eligible for the other big federal subsidy — premium tax credits — for Exchange policies.  So, even if we assume, contrary to the evidence, that only half of the Exchange purchasers came from the ranks of the uninsured, that means there are really only 3 million new purchasers of policies eligible for reinsurance. Moreover, the 10-11 million figure isn’t right anymore either.  For 2014, individual insurers have to choose. They can stop selling their policy altogether, they can expand benefits to conform with the tougher requirements of the ACA and obtain a right to reinsurance or, at least in some instances, they may be able to grandfather their policy and avoid many ACA mandates but forfeit a right to reinsurance. I have not seen any good statistics on how many of the 11 million will persist into 2014, but I would be surprised if more than 80% did.  So, rather than 11 million, it seems to be the better upper bound on the number of extant non-Exchange, reinsurance eligible policies is 9 million.

It thus seems to me as if the better upper bound on  the number of policies that might trigger a reinsurance obligation is 12 million: 3 million genuinely new policies plus 9 million sold outside the Exchange but eligible for reinsurance. This means, however, that if CMS’s estimates of claims under the ACA are correct, a reasonable upper bound on reinsurance payments under section 1341 of the ACA are likely to be at most $6.3 billion ($525 x 12 million) rather than $12 billion.

Given all this, there are two aspects of CMS’ s behavior that are a bit puzzling.  Why is CMS not adjusting the reinsurance benefit for this year say to provide 100% coverage rather than 80% coverage and/or removing the $250,000 cap on claims triggering reinsurance? Or, given the belief of the President that he has discretion to waive taxes in light of changed circumstances, why is CMS not waiving, say, half of the taxes that would otherwise be owed.  (Not that I think this is constitutional).

The answer to the puzzler, I suspect, is either a cognitive failure or a very clever strategy. It is possible that it has not dawned on CMS that changing enrollment patterns means that it will not be able to exhaust the $12 billion it expects to receive pursuant to section 1341. More likely, however, someone at CMS has done the math and has been delighted to discover a slush fund that it can use the money to provide extra generous reinsurance next year and thus keep the price of premiums down.  How will we know? If we see an announcement from CMS in the next few months changing the parameters for the 2015 reinsurance plan to be considerably more generous, believe that it is the result of collecting “too much” in taxes in 2014. In the meantime, however, we have another example of ACA “details” that don’t seem to stand up under close scrutiny.

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A roadmap for legal attacks on the employer mandate delay

After going through notice and comment rulemaking, the Internal Revenue Service and the Department of the Treasury announced a “final rule” Monday that the employer mandate  tax contained in the Affordable Care Act (26 U.S.C. § 4980H) will not apply at all to large “bubble” employers with between 50 and 99 workers until after December 31, 2015, and that employers with 100 or more workers can avoid the § 4980H tax from December 31, 2014 to December 31, 2015, by offering compliant health insurance coverage to 70% of its employees. These provisions amend previous IRS rulings that the employer mandate tax would start for plan years beginning after December 31, 2014, and that a large employer would need to offer health insurance coverage to 95% of its employees before it would be exempt from the potentially steep taxes imposed by section 4980H.  Both the new final regulations and the earlier ones contradict the language of the Affordable Care Act, which states that the tax kicks in for plans beginning after December 31, 2013, and that an employer must offer health insurance coverage to “all” of its employees, not 95% and certainly not 70%, before it could escape this form of taxation.

In this blog entry, I want to accomplish three goals.  I want to educate on the legal issues created by the recent regulation.  I want to suggest both a conventional path to challenge the regulation and an unconventional path.  And, I want to advocate.  I want to implore the readers of this blog who are predisposed to think highly of President Obama to really question the precedent they let be set by permitting an Executive to refuse to collect a tax for years in circumstances where it is crystal clear that Congress has directed that it be done. There is a serious risk that future leaders may not share the same priorities as President Obama or themselves. Immunizing non-collection decisions from judicial correction will lead to collapse of government programs those sympathetic to our current President believe are worthy. It could also lead subsequent Congresses to refuse to enact government programs that make sense only if payment for them can not be subverted by a recalcitrant executive branch.   In short, the people who should be most disturbed about what the President has done are his many friends who support not just the now-gutted employer mandate but who believe that the federal government has a major role in, as with the ACA, redistributing wealth acquired through the market.  I would be very impressed if they mustered the courage to stand up to their friends.

A conventional path to challenge the employer mandate delay

Here are some plausible book moves in the legal chess game that likely lies ahead for the decision yesterday to modify the times and conditions under which the employer mandate will be enforced.

Standing

Opponents will hunt for a plaintiff.  As others have noted, due to a doctrine called “standing,” this will not be so easy. Under Supreme Court precedent, the plaintiff is going to have to show (a) that the failure to enforce the employer mandate caused the plaintiff’s employer not to provide health insurance, (b) that the employer would provide the requisite form of health insurance if the tax were being enforced, and (c) that the plaintiff has  actually been damaged by the failure of their employer to provide health insurance. If, for example, the employer says it is not sure what it would do if the tax were imposed, a case challenging the delay is likely to fail for lack of standing. Or if it could be shown that the failure of the employer to provide health insurance actually permitted the employee to purchase equally good and similarly priced health insurance on an individual Exchange, a case challenging the most recent IRS rules would likewise likely fail for lack of standing.

On the other hand, there may well be plaintiffs out there with standing to sue.  There are about 18,000 firms with more than 50 employees in the United States. While some might make decisions on whether to provide health insurance that would be unaffected by the tax, if even 5% would admit to being affected by the tax — whose whole point, after all, is precisely to cause the result plaintiff will need to show — that would represent a universe of 900 potential businesses that almost surely employ more than 50,000 employees. It takes only one employee with standing to bring suit in order to challenge the legality of the President’s latest actions.

The best plaintiff would be an employee of a large corporation that has not provided “minimum essential coverage” (a/k/a/ health insurance) but which says, without equivocation, that it would do so if the employer mandate were in place. It would be best if the insurance the employer would have provided would cost the employee less than alternatives made available on the individual Exchanges.  Perhaps, for example, the employee worked for an employer that had extraordinarily healthy employees — a large gymnasium chain filled with youthful, mostly male, low-health-cost physical trainers , for example —  and could thus provide even minimally acceptable coverage via self insurance for less than the amount the employee could obtain on an individual Exchange.

Violation of the Administrative Procedures Act

Plaintiff’s argument

Once the standing hurdle is overcome, expect a challenge based on violation of section 702 of the Administrative Procedures Act (5 U.S.C. § 702).  This law states: “A person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of a relevant statute, is entitled to judicial review thereof.”  The plaintiff will argue that Congress has spoken with crystal clarity on the issue of when section 4980H was supposed to take effect: it was supposed to take effect for plan years beginning after December 31, 2013.  There is nothing ambiguous about that date. There is nothing for the Supreme Court — let alone the Internal Revenue Service — to interpret.

Saying the year 2013 means the year 2015 is completely and totally absurd. The 2013 date chosen by Congress did not encompass the idea of “sometime in the kind of nearish future.” Congress balanced many factors, including the difficulty of complying with the statute and the desirability of having the employer mandate coordinate with many other provisions of the ACA that take effect starting in 2014.  Moreover, given the enormous costs of the ACA, even in the reduced form taken by original projections, the $10 billion per year in tax revenues the employer mandate was expected to generate, was another reason to call for adoption in 2013. Under these circumstances, Congress did not choose to give large employers 5 years and 9 months to figure out how to finance and acquire health insurance for their employees; Congress thought 3 years and 9 months of “transitional relief” was perfectly adequate. Congress did not want the goal of reducing the number of uninsureds subverted by letting employers off the hook or, perhaps, the burdens on the subsidized Exchanges exacerbated by large employers not pulling their weight.

The situation is no better, plaintiffs will argue, for the Obama administration’s decision in the regulations to distinguish amongst different sorts of large employers, letting employers with between 50 and 99 employers off the hook in the year 2015 while compelling at least some employers with more than 100 employees to provide health insurance in the same year. The statute carefully defined large employers in this context to mean more than 50 employees and deliberately chose 50 as the point at which to balance the importance of employer-provided insurance against the administrative and financial burdens of forced provision. Congress did not choose, for example, to stage imposition of the employer mandate first on the biggest of the large employers and a year or so later on the smaller within that group.

Finally, even if there was some basis for staging imposition of the mandate, plaintiffs will argue, the Obama regulations have butchered the provision of 4980H that calls for imposition of a large tax unless the employer offers insurance to all eligible employees. Conceivably the agency could stretch the “all” concept to 95% as it did before.  Perhaps 95% could be justified as a bright line proxy for the sort of honest mistakes that Congress would not have wanted to serve as a predicate for a hefty tax. But when the Executive branch goes from “all” to 70% it can not be said with a straight face that anyone is speaking about  providing a safety zone against honest mistakes.  Now we are talking an entirely different regulatory regime.  The Administrative Procedures Act does not give the Executive branch the power to legislate; and if it did so, the APA would itself be unconstitutional.

The Chevron Deference rebuttal

Expect the defendants to fight back with something known in the law as “Chevron deference.” This widely cited doctrine emerges from the observation that executive agencies actually have a lot of expertise in interpreting statutes in their area.  Therefore, it should be assumed that Congress would have wanted the agency to have considerable leeway in interpreting statutes. So long as the agency follows the right procedures in developing its rules, such as the “notice and comment” rulemaking that preceded the recent pronouncement on the employer mandate,  the rules developed by the agency are lawful and binding even if the court would itself not have interpreted the statute the way the agency does. The main caveat — and it is the big “Step 1″ in the Chevron process — is that the agency’s interpretation has to be a reasonable interpretation of the statute, a “permissible construction.”

But, the plaintiff will argue — and I believe with great success —  “Chevron deference” does not exist where the statute is really not subject to interpretation at all. As the Supreme Court said in Chevron, USA v. Natural Resources Defense Counsel, Inc., “If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress.” And it is hard to imagine anything clearer than “December 31, 2013.”  It is hard to imagine a construction of “all” — particularly in a context in which alternative taxes (4980H(b)) are placed on employers that offer compliant health insurance to at least some of their employees– that could mean 70%.  It is just not a reasonable construction.

“But wait,” I hear some judge asking.   “Are you saying that the IRS could not give a company a few extra weeks to get health insurance? Are you saying that the IRS could not give companies any leeway in obtaining health insurance and saying that if a single employee goes uninsured the company is subject to a $2,000 per employee (minus 30) tax?” No, not quite. As to the few weeks grace period, I do not believe the IRS can interpret the statute to permit such to occur automatically.  I understand giving a select company a few extra weeks if there were extraordinarily circumstances — a natural disaster, an unintentional failure of communications — but Congress (a) already gave the companies more than a three year grace period to get health insurance for their employees and (b) assesses the tax on a monthly basis, $166.67 per employee per month, so that the company would not in fact be hit with a $2,000 whammy.  And as to whether the IRS could give companies some leeway, again, if there were a factual showing that it would be easy for a company to mess up on a small percentage of employees and that some accommodation was necessary in a particular case, I do not believe some leniency would subvert the intent of Congress. But I see no evidence from the IRS that a 30% mistake zone is necessary; instead, this appears to be a way of simply mellowing out a tax regime that the Executive branch now believes (perhaps rightly) is too harsh without, however, asking Congress, who might actually agree were the case respectfully put to them, to assist with a modification of the statute.

The Prosecutorial Discretion rebuttal

The better argument the Obama administration will muster goes under the name “prosecutorial discretion.” The idea, buttressed by many case, including the 1985 Supreme Court decision in Heckler v. Chaney, is that the Executive branch needs lots of leeway in determining enforcement priorities and there is therefore a very strong presumption against judicial review of decisions not to prosecute and not to pursue agency enforcement actions. And while, to be sure, most of these cases arise where the government is less transparent about its enforcement priorities, surely the government should not be restricted in its otherwise existing discretion just because it sought notice and comment before deciding what to do and was transparent enough to publish the basis on which it would make decisions.

Here are some quotes from Chaney which the Obama administration’s attorneys  are likely to throw in the face of any potential challenger to its regulations.

  • “[A]n agency decision not to enforce often involves a complicated balancing of a number of factors which are peculiarly within its expertise. Thus, the agency must not only assess whether a violation has occurred, but whether agency resources are best spent on this violation or another, whether the agency is likely to succeed if it acts, whether the particular enforcement action requested best fits the agency’s overall policies, and, indeed, whether the agency has enough resources to undertake the action at all. An agency generally cannot act against each technical violation of the statute it is charged with enforcing. The agency is far better equipped than the courts to deal with the many variables involved.”
  • “In addition to these administrative concerns, we note that, when an agency refuses to act, it generally does not exercise its coercive power over an individual’s liberty or property rights, and thus does not infringe upon areas that courts often are called upon to protect.
  • “[A]n agency’s refusal to institute proceedings shares to some extent the characteristics of the decision of a prosecutor in the Executive Branch not to indict — a decision which has long been regarded as the special province of the Executive Branch, inasmuch as it is the Executive who is charged by the Constitution to “take Care that the Laws be faithfully executed.” U.S.Const., Art. II, § 3.”
  • “The danger that agencies may not carry out their delegated powers with sufficient vigor does not necessarily lead to the conclusion that courts are the most appropriate body to police this aspect of their performance.”

Sounds bad for our plaintiff!

There is, however, the noteworthy footnote 4 in Chaney that should give plaintiffs some hope. After all, Chaney articulates the doctrine of agency discretion as a strong presumption, not an irrebutable one. Here is what Justice Rehnquist said:

We do not have in this case a refusal by the agency to institute proceedings based solely on the belief that it lacks jurisdiction. Nor do we have a situation where it could justifiably be found that the agency has “consciously and expressly adopted a general policy” that is so extreme as to amount to an abdication of its statutory responsibilities.” See, e.g., Adams v. Richardson, 156 U.S.App.D.C. 267, 480 F.2d 1159 (197) (en banc). Although we express no opinion on whether such decisions would be unreviewable under § 701(a)(2), we note that, in those situations, the statute conferring authority on the agency might indicate that such decisions were not “committed to agency discretion.”

In other words, plaintiffs may be able to argue that this is not a case where the agency is in fact making enforcement decisions based on budgetary priorities or the probability of success. Few if any of the reasons behind the discretion doctrine exist here; the doctrine of discretion should not exist for its own sake precisely because it derogates from popular sovereignty exercised via Congress. There should be enough of a paper trail for the plaintiff to show persuasively that, the agency is making an enforcement decision based on a sense that the statute is unfair or unwise or, if someone has left a smoking-gun email around, pure political considerations.

The facts of Adams bear some resemblance to the facts here. Just as here there is a statute calling on the IRS to levy a tax starting in 2014, in Adams, there was a statute that directed certain federal agencies to terminate or refuse to grant assistance to public schools that were still segregated. Just as here the agency in charge (the IRS) is apparently going to refuse to pursue that tax in 2014 (and 2015) as a matter of policy, in Adams the federal agency in charge (Health, Education and Welfare) effectively adopted a policy of refusing to stop funding segregated public schools. The fact that there was general non-enforcement as a matter of policy distinguished the case, in the view of the Adams court, from conventional prosecutorial discretion.

The other hope for plaintiffs would be to use the extreme example of this case as a way of infusing contemporary doctrine on review of agency inaction with some thoughts from Justice Thurgood Marshall in his concurring opinion in Heckler v. Chaney. Marshall’s thoughts might have particular appeal to Justice Elena Kagan, for example, who, in addition to being fair minded, was one of Marshall’s clerks close to the time Chaney was decided.  Marshall, who perhaps unfortunately took an expansive view of the majority opinion in order to criticize it, and who appears to have drafted without noting its cautionary footnote 4, wrote several quotations that might prove helpful if introduced gently.

“[T]his ‘presumption of unreviewability’ is fundamentally at odds with rule-of-law principles firmly embedded in our jurisprudence, because it seeks to truncate an emerging line of judicial authority subjecting enforcement discretion to rational and principled constraint, and because, in the end, the presumption may well be indecipherable, one can only hope that it will come to be understood as a relic of a particular factual setting in which the full implications of such a presumption were neither confronted nor understood.”

“But surely it is a far cry from asserting that agencies must be given substantial leeway in allocating enforcement resources among valid alternatives to suggesting that agency enforcement decisions are presumptively unreviewable no matter what factor caused the agency to stay its hand.” (emphasis in original)

Moreover, conceivably traction might be gained in an attack on the employer mandate regulations by limiting the theory of the case to agency failure to enforce a regulation as opposed to decisions of prosecutors not to pursue criminal charges. As Justice Marshall wrote:

“A request that a nuclear plant be operated safely or that protection be provided against unsafe drugs is quite different from a request that an individual be put in jail or his property confiscated as punishment for past violations of the criminal law. Unlike traditional exercises of prosecutorial discretion, “the decision to enforce — or not to enforce — may itself result in significant burdens on a . . . statutory beneficiary.” (citing Marshall v. Jerrico, Inc., 446 U. S. 238446 U. S. 249 (1980)).

Nonetheless, plaintiffs will have to contend with the fact that (a) Thurgood Marshall’s ideas on prosecutorial and agency discretion were not shared by the remainder of the court and (b) the extreme conditions found in Adams have not been found in other cases in which such “footnote 4″ claims have been brought.  The presumption established by Heckler v. Chaney has clearly remained a very strong one.

A Tax Whistleblower action: An unconventional path for challenging the employer mandate delay

The greatest difficulty for those disturbed by the Obama administration’s regulatory subversion of its own law is the prosecutorial discretion argument discussed above. Almost everyone thinks there should be some degree of prosecutorial discretion and the case law strongly and pretty persuasively supports the idea that the judicial branch should at least seldom be able to force prosecutors or agencies to more forcefully enforce laws, particularly where Congress has the ability to coerce the Executive branch to do so through aggressive techniques such as appropriations or, I suppose, in the most egregious cases, impeachment.  The tension will be whether and under what circumstances the Executive branch under the rubric of “prosecutorial discretion” can completely subvert the language and intent of a statute through a refusal to collect a tax.

So, might there be another path for attacking the regulation, one either already in existence or one created by Congress?

IRS Form 211 (filled in)

IRS Form 211 (filled in)

Perhaps. There is a remedy on the books already that might at least make the Obama administration squirm. It would do so because it might make clear that what was going on was not an exercise in prosecutorial discretion at all, but rather an effort to rewrite the statute.  The idea is to for anyone at all to be a whistleblower  under 26 U.S.C. § 7623 and to advise the IRS via a Form 211 that a particular large employer, preferably one that had over 1030 employees and therefore could owe more than $2,000,000 in 4980H taxes, had failed to provide health insurance to its employees and had failed to pay any of the taxes created in section 4980H. The whistleblower does not need to show fraud to file a Form 211. The whistleblower merely needs to show that there has been an underpayment of tax. Of course, to protect against claims of bad faith, the Form 211 should disclose that the claimant knows that the employer is relying on IRS regulations as a defense but that the claimant asserts that those regulations are unlawful.

Now, I would not expect the IRS to then take a customary next step of pursuing the non-paying large employer for the 4980H taxes. I would not expect the IRS to provide any award to the whistleblower that would be available if the IRS had actually collected any money as a result of the Form 211 filing.  But it is this failure of the IRS to do anything or to pay anything that might trigger the right of the Form 211 claimant to bring a legal action in which the legality of the Obama administration’s delay of the employer mandate could be challenged. Section 7623(b)(4) of the Internal Revenue Code permits “any determination regarding an award” to be appealed to the Tax Court, which has jurisdiction over such appeals.

Again I would not expect the IRS to take such an appeal lying down.  The IRS will claim that it has complete discretion over whether to pursue a taxpayer brought to its attention under Form 211. A decision to the contrary could create the potential for massive, expensive litigation.  Moreover, the IRS will say, the appeal permitted by section 7623(b)(4) is one over the size of any award not over whether the IRS decides to proceed with any administrative or judicial action based on information contained in a Form 211.

These will be strong arguments. They may well persuade the Tax Court.  They may well persuade a Circuit Court of the United States to which an adverse decision of the Tax Court can be appealed. But what they will expose is that the IRS does not regard the regulatory changes it has made as merely ones of prosecutorial discretion — deciding where and how to expend its resources detecting underpayments. Here, that work has already been done for them. Instead, they constitute a substantive rule on the circumstances — none for 2014 and few for 2015 — under which a large employer that fails to provide health insurance should be liable for taxes that Congress demanded be paid under section 4980H.  Perhaps, therefore, the Tax Court, or, on appeal, an Article III appellate court or the Supreme Court might summon up the courage to  say, kind of like the suggestion in footnote 4 in Chaney, that, although the IRS may have broad discretion, it does not  have “discretion” to abdicate its statutory responsibilities. It can not fail to pursue obvious tax deficiencies brought to its attention by a third party when the only reason for so declining is an unlawful regulation promulgated by the IRS in a usurpation of legislative powers. Whatever one thinks of the merits of the employer mandate, such a decision, in my view, would be a healthy restoration in the balance of power among the federal branches of government.

One other note

It was suggested by a friend that Congress could overcome such exercises of prosecutorial discretion by an expanded use of  “qui tam” lawsuits. This remedy, which dates back to the 13th Century and has seen a resurgence over the past 20 years in the United States, allow a private citizen to bring a civil action in the name of the government and collect some of the money otherwise owed to the government.  Qui tam litigation is a broad and complex subject on which I do not pretend great expertise. But, as I understand it, qui tam lawsuits generally permit a private party to go forward only if the Executive branch either supports the private party’s efforts at supplemental enforcement of a regulatory norm or at least acquiesces to it.  Under 31 U.S.C. 3730(c)(2)(A) and case law interpreting one of the major branches of qui tam actions, the government can basically kill a qui tam lawsuit to which it objects even if the underlying claim is meritorious. It would therefore take a special qui tam statute that expressly squelched this veto power in order for such action by Congress to permit an attack on the delay of the employer mandate.  More fundamentally, however,  the probability of a gridlocked Congress enlarging qui tam rights to facilitate judicial overturning of the Obama administration’s delay of the employer mandate and doing so over a presidential veto is about zero.

Caution

I’m forging some new ground here and laying out arguments without weeks of legal research in order to get them on the table.  I am likely missing things or even, perchance, getting things wrong.  My hope, however, is that what I’ve written is intelligent and helpful enough to get others to discuss further and potentially take action on the serious legal issues involved when a President decides not to collect taxes that Congress has clearly demanded be paid.

Acknowledgement

This blog post benefited greatly from a conversation with Professor Sapna Kumar, an expert on administrative law.  I, of course, am responsible solely for any mistakes made herein and I have no idea what Professor Kumar — whose main focus is the intersection of administrative law and intellectual property — thinks about the Affordable Care Act or its implementation. So, if you don’t like the post or there is something wrong, don’t blame her.

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CBO projection of $8 billion from Risk Corridors is baffling

The Congressional Budget Office just issued a report that assumes the Affordable Care Act system of individual policies sold in Exchanges without medical underwriting can remain relatively stable. Tightly bound up with that assumption is its prediction about a controversial ACA program known as “Risk Corridors” that requires profitable insurers to pay the federal government up to 80% of profits they make on policies sold on the Exchanges but that also requires the federal government to pay insurers up to 80% of the losses they suffer from policies sold on the Exchanges.  The CBO now believes it has enough information to predict that Risk Corridors will actually make money — $ 8 billion over three years — for the government at the expense of insurers.

This CBO prediction of $8 billion in federal revenue, which has gained much publicity,  pulls the rug out from critics of the ACA such as Senator Marco Rubio who have introduced legislation that would repeal Risk Corridors as an insurance industry “bailout.” Such a blunting of Senator Rubio’s proposed repeal legislation is crucial in the ongoing battle over the ACA because repeal of Risk Corridors could  result in insurers (who just might not believe the CBO’s numbers) exiting the Exchanges for fear of having no government protection against losses resulting from unfavorable experiences in the new market the government has created. On the other hand, if the CBO is just getting its number wrong, Rubio’s case for repeal of Risk Corridors remains as strong (or problematic) as it ever was. The CBO projection is also important because Risk Corridors nets the government money if and only if the ACA works, insurers are able to make some profits, and a death spiral never takes hold. And this, as readers of this blog are aware, is a prediction about which many have serious doubts. 

Here’s the short version of the rest of this post.

I’ve done the math and I don’t see how the CBO is getting this $8 billion number unless it is assuming either very high enrollment in policies covered by Risk Corridors or very high rates of return made by insurers.  Or it made a mistake. I don’t think the CBO’s own numbers support very high enrollment in policies covered by Risk Corridors and I don’t believe either an emerging reality or the CBO’s own rhetoric justify assuming very high rates of return.  So I think the CBO ought to take a second look at its prediction. People should not yet make policy decisions based on the CBO estimate.

Reader, you now have a choice. I’m afraid that the next several paragraphs of this post become very technical. It’s kind of forensic mathematics in which one attempts to use statistics and numerical methods to deduce the circumstances under which something said could be true.  If that sounds dreadful, scary or tedious, I would not protest too loudly were you to skip ahead to the section titled “How could I be wrong?”  Before you leave, however, realize that what I am attempting to accomplish in the part you skip is a form of proof by contradiction. I prove that if what the CBO was saying were true, then insurers would have to be making 8% profit.  But nobody, including the CBO thinks they will make 8% profit, so the $8 billion number can’t be right.

On the other hand, dear reader, if you liked the Numb3rs television show (including my minor contributions thereto) or math or detective work or just care a lot about the Affordable Care Act, the rest of this post is for you.  What I am about to discuss is not only exciting math, but also the soul of the Affordable Care Act — whether the individual Exchanges without medical underwriting can remain relatively stable.

Forensic mathematics in action

Conceptually, here’s the calculation one needs to do.  What we want to figure out is the distribution of insurer profits (measured as a ratio of expenses divided by premium revenues)  upon which the CBO must be relying. I assume the CBO is using a  member from the “Normal” or “Lognormal” family of distributions because those are typical models of financial returns and there is little reason to think that the distributions of insurer profits (expenses minus revenues) will materially depart from those assumptions.  To continue reading this post, you don’t have to know exactly what those distributions are except that they look for our purposes like the “bell curves” you have seen for many years.  I’ve placed a graphic below showing some normal (blue) and lognormal (red) distributions. Although it should not matter all that much, I’m going to use a lognormal distribution from here on in because the ratio of insurer expenses to premiums should never be negative and the lognormal distribution, unlike its normal cousin, never takes on negative values.

Examples of probability density functions for normal and lognormal distributions

Examples of probability density functions for normal and lognormal distributions

The problem is that there are an infinite number of lognormal distributions from which to choose.  How do we know which distribution the CBO is emulating in its computations?  How do we know just how positive the CBO assumes the individual Exchange market is going to be on average or how dispersed insurer profits are going to be? As it turns out, the complexity of the lognormal distribution can be characterized with just two “parameters” often labeled μ (mu, the mean of the distribution) and σ (sigma, the standard deviation of the distribution).  Once we have those two parameters (just two numbers), we can deduce everything we need about the entire distribution.

Now, to solve for two parameters, we often need two relationships. And, thoughtfully, the CBO has given us just enough information.  It has told us how much money in total it intends to raise from Risk Corridors ($8 billion) and the ratio (2:1) between money it collects from profitable insurers and the money it pays out to unprofitable insurers. These two facts help constrain the set of permissible combinations of Risk Corridor populations (the number of people purchasing policies in plans subject to the Risk Corridor program) and insurer profitability distributions. What I want to show is that it takes an extremely high Risk Corridor population in order to get rates of return that are not way larger than most people — including the CBO — think likely to occur.

I first want to calculate the amount of money insurers would pay to HHS under the Risk Corridors program if the total amount of premiums collected were $1. Some of the payments — those by highly profitable insurers  –  will be positive.  Those by highly unprofitable insurers will be negative. To do this I take the “expectation” of what I will call the “payment function” over a lognormal distribution characterized by having a mean of  μ and a standard deviation of  σ.  By payment function, I mean the relationship shown below and created by section 1342 of the ACA, 42 U.S.C. § 18062. This provision creates a formula for how much insurers pay the Secretary of HHS or the Secretary of HHS pays insurers depending on a proxy measure of the insurer’s profitability. The idea is to calculate a ratio of “allowable costs” (roughly expenses) to a “target amount” (roughly premiums).  If the ratio is significantly less than 1 (and outside a neutral “corridor”), the insurer makes money and pays the government a cut. If the result is significantly greater than 1 (and outside the neutral “corridor”), the insurer loses money and receives a “bailout”/”subsidy” from the government.  The program has been referred to with some justification as a kind of “derivative” of insurer profitability, the ultimate “Synthetic CDO.

The graphic below shows the relationship contained in the Risk Corridors provision of the ACA.  The blue line shows the net insurer payment (which could be negative) to the government as a function of this proxy measure of the insurer’s profitability. Ratios in the green zone represent profits for the insurer; ratios in the red zone represent losses. Results are stated as a fraction of  “the target amount,” which, as mentioned above, is, roughly speaking, premium revenue.

How much the insurer pays (positive) or receives (negative) under Risk Corridors as a function of  measurement of profitability

How much the insurer pays (positive) or receives (negative) under Risk Corridors as a function of a ratio-based measurement of profitability

When we do this computation, we get a ghastly (but closed form!) mathematical expression of which I set out just a part in small print below. (It won’t be on the exam). I’ll call this value the totalPaymentFactor. Just keep that variable in the back of your mind.

Excerpt of the formula for insurer total payout

Excerpt of the formula for insurer total payout

I next want to calculate the amount of payments profitable insurers will make to HHS. To do this, we truncate the lognormal distribution to include only situations where the ratio between premiums and expenses is greater than 1. Again, we get a pretty ghastly mathematical expression, a small excerpt of which is shown below. I will call it the expectedPositivePaymentFactor.

Formula for expected negative insurer payments under risk corridors over a truncated lognormal distribution

Formula for expected negative insurer payments under risk corridors over a truncated lognormal distribution

Finally, I want to calculate the amount of payments unprofitable insurers will receive from HHS. To do this, we truncate the lognormal distribution to include only situations where the ratio between premiums and expenses is less than 1. Again, we get a pretty ghastly mathematical expression, which, for those of you who can not get enough, I excerpt below. I will call it the expectedNegativePaymentFactor.

Formula for expected positive insurer payments under risk corridors over a truncated lognormal distribution

Formula for expected positive insurer payments under risk corridors over a truncated lognormal distribution

The CBO has told us in its recent report that the government will collect twice as much from profitable insurers (expectedPositivePaymentFactor) as it pays out to unprofitable ones (expectednegativePaymentFactor).  We can use numeric methods to find the set of μ, σ combinations for which that relationship exists.  The thick black line in the graphic below shows those combinations.

 

Black line shows combination of mu and sigma that result in the correct ratio of positive and negative insurer payouts under Risk Corridors

Black line shows combination of mu and sigma that result in the correct ratio of positive and negative insurer payouts under Risk Corridors

To determine which point on the black line above, which combination of the parameters μ, σ , is the actual distribution, we need to use our information about the totalPaymentFactor.  The idea is to realize that the totalPaymentFactor must be equal to the quotient of the CBO’s estimated $8 billion and the total premium collected by Risk Corridor plans over the next three years.  But we know that the total premium collected should be equal to the mean premium charged by the Exchanges multiplied by the number of people in Risk Corridor plans. Some math, discussed in the technical notes, suggests that the mean premium under the ACA is about $3,962. And the CBO accounts for 8 million people being in Risk Corridor plans in 2014, 15 million being in Risk Corridor plans in 2015 and 25 million being in Risk Corridor plans in 2016. This means that the total premiums collected by insurers under Risk Corridor plans over the next 3 years should be about $190.2 billion. And this in turn means that the totalPaymentFactor must be 0.042.

Ready?

It turns out that of all the infinite number of lognormal distributions there is only one that satisfies the requirements that (a) the government will collect twice as much from profitable insurers (expectedPositivePaymentFactor) as it pays out to unprofitable ones (expectednegativePaymentFactor) and (b) for which the totalPaymentFactor takes on a value of 0.042. It is a distribution in which the mean value is 0.923 and the standard deviation is 0.113.  I plot the distribution below. A dotted line marks the break even point for insurers.  Points to the left of the break even line correspond with profitable insurers; points to the right correspond with unprofitable insurers.

Lognormal distribution of insurer profitability consistent with CBO data

Lognormal distribution of insurer profitability consistent with CBO data

Here are some factoids about the uncovered distribution.  The  average insurer will have expenses that are 92.3% of premiums and the median insurer will have expenses that are only 91.6% of profits. In other words, they will be making 7.7 cent and  8.4 cents respectively on every dollar of premium they take in.  For reasons discussed below, this is a difficult figure to accept. It is particularly difficult in light of the pessimistic news that is emerging about things such as the age distribution of enrollees , reports from Deutsche Bank that one of the largest insurers in the Exchanges, Humana, expects to receive (not pay!) a lot of money under the Risk Corridors program, the hardly exuberant forecasts of other publicly traded insurers about the ACA, and the recent general downgrading of the insurance sector by Moody’s partly because of the ACA.

Implicit in my finding about the most likely distribution of profitability is an assertion by the CBO that 76% of insurers will be profitable under the ACA while 24% will be unprofitable. About 17% will be sufficiently unprofitable that they will receive subsidies (a/k/a bailouts) from the federal government and 9% will be sufficiently unprofitable that their marginal losses will be covered at 80%. Only 15% of insurers will be “inside” the risk corridor and neither pay nor receive under the program.

How could I be wrong?

I feel  confident that I’ve done the ” gory math part” of this blog post correctly. Mathematica, which is the software I’ve used to do the integral calculus and the numeric components involved just does not make mistakes.  I also feel pretty confident that I understand how the Risk Corridors program works under section 1342 of the ACA.  That’s kind of my day job. And so, readers who skipped down to this part, I do believe that if the CBO were right about the $8 billion, that could only happen if insurers were, on average, earning an implausible 8% in the Exchanges.

If I’m wrong, then, it is because, except for the little issue I will mention at the end, I have made bad assumptions about the total premiums insurers expect to collect over the next three years in policies covered by Risk Corridors. That error could come from two sources. I could have the mean premium per policy wrong or I could have the relevant enrollment wrong. Let’s look at each of these.

Could I be wrong about the mean premium?

I computed the mean premium in the computation above by using data collected by the Kaiser Family Foundation on the ratio of premiums by age under most insurance plans and the typical Silver plan premium for a 21 year old (non-smoker). I then used the original forecast about the age distribution of insureds to compute an expected premium.  I got $3,962.  And this number seems very much in line with earlier HHS estimates, which were that mean premiums would be $3,936. So, I think I have the mean premium correct.

Could I be wrong about the number of people in Risk Corridor plans?

I computed the number of people enrolled in policies covered by Risk Corridors by looking at the CBO’s own figures.  I’m not vouching that the CBO is right in its projections, but this is not the day to argue that point.  The CBO now says (Table B-3, p. 109) that individual enrollment in the Exchanges will be 6 million, 13 million and 22 million respectively over the next three years.   And it says that employment-based coverage purchased through Exchanges (which I assume are SHOP Exchanges) will be 2 million, 2 million and 3 million respectively.  So , by addition, that’s where the figures I used of 8 million,  15 million and 25 million come from.  I’m not aware of anyone else who would purchase a policy subject to Risk Corridors. Again, bottom line, I don’t think I’m doing anything wrong here.

The little issue at the end: Could ACA definitions be responsible for the incongruity?

The only other conceivable explanation of the divergence between the CBO figures and my analysis is that I am failing to take a subtlety of Risk Corridors into account.  Remember, careful readers, that sentence earlier up that started out: “The idea is to calculate a ratio of “allowable costs” (roughly expenses) to a “target amount” (roughly premiums).” I stuck in the “roughlies” because the “allowable costs” are not exactly expenses and the “target amount” is not exactly premiums. When you look at the statute and the regulations, you can see that both of these terms are tweaked: basically you subtract administrative costs from both values.  And you subtract reinsurance payments from expenses — but that makes sense because the insurer reduced premiums in anticipation of those reinsurance payments.

So, in the end, I don’t see why these subtleties should affect my analysis in any significant way. But I am not infallible. And I do pledge that if someone points out an error to me, I will dutifully assess it and report it.

Sensitivity Analysis

Out of an abundance of caution, however, I have rerun the numbers on the assumption that premium revenue from policies subject to Risk Corridors is 50% greater than my original estimate either because of an underestimate of per policy costs or a failure to understand that there is some additional group within Risk Corridors protection.  When I do that, though, I find that the ratio of expenses to premiums is 0.943, meaning that insurers are still earning a pretty substantial 5.6%.  Although that is more believable than the earlier figure of 7.7%, it is still pretty high. 

Conclusion

To be honest, it makes me very nervous to say that the CBO did its math wrong or, worse, to accuse it of bad faith.  These are intelligent, educated professionals and they have access to a lot more data and a lot more personnel than I do.  Here at acadeathspiral  it’s just me and my little computer along with some very powerful software.  On the other hand, it’s not as if the CBO hasn’t been wrong before. It assumed earlier that the government would reduce its deficit $70 billion over 10 years as a result of Title VIII of the ACA (the so-called CLASS Act on long term care insurance) when many independent sources believed — rightly as it turned out — that the now-repealed CLASS Act was obviously structured in a way that could never fly.  The CBO assumed in July 2012 that 9 million people would enroll in the Exchanges in 2014, a number that is now down to 6 million. And, while there are explanations for each of these changes, the bottom line is that CBO is fallible too.

So, if I might, I would strongly urge the CBO to double check its numbers and provide more information on the data it relied upon and the methodology it employed in getting to its results.  I’d ask Congress, which has ongoing oversight of the ACA, to insist that the Congressional Budget Office, which is exempt from Freedom of Information Act requests from ordinary citizens, provide further detail.  American healthcare is indeed too important to have policy decisions made on the basis of what could be some sort of mathematical error.

Really Technical Notes

  1. I’m using a reparameterized version of the lognormal distribution that permits direct inspection of its mean and standard deviation rather than the conventional one, which in my opinion is less informative.   The explanation for doing so and the formula for reparameterization is here.
  2. To compute the average premium, I took the premium ratios used by the Kaiser Family Foundation, calibrated it so that a 21 year old was paying the national average payment for a silver plan purchased by a 21 year old. I then computed the expected premium over the distribution of purchase ages originally assumed by those modeling the ACA.
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