The Two Million Scenario: What if the Affordable Care Act enrolls a lot fewer people in the Exchanges than predicted?

People can be blinded by dreams in many spheres
People can be blinded by dreams in many spheres

Many people who remain basically positive about the Affordable Care Act are viewing the enrollment statistics like the football fan whose team is 2-6 and who point out that the team could win 7 out of its 8 remaining games and still probably make the playoffs.  Yes, getting off to a really bad start doesn’t preclude a happy ending. Success may still be mathematically possible. But unless there’s good reason to think that the fundamental factors such as poor coaching,  poor game plans or unexpected injuries that have led to the bad start no longer apply, the more reasonable prediction is that things will continue more or less as they have.

It’s time to start thinking realistically about what happens if a core component of the Affordable Care Act, subsidized, non-underwritten health insurance available from private insurers, essentially fails to provide many with better access to medical care. This might not happen in every state — there might be a few whose Exchanges can be deemed “successful” — but it is looking more and more to me as if we are heading for enrollments in many states well, well short of that on which the arguments for the ACA were significantly premised. Indeed, some supporters of the ACA have started moving the goal posts, revising history to say that the real goal of the Act wasn’t to reduce the number of uninsureds but to have an actuarially sound pool. (So the purpose of the Act was to help insurance companies stay afloat?) And it hardly helps enrollment when President Obama urges his allies to hold back enrollment efforts so the insurance marketplace does not collapse this coming week under a crush of new users even after he earlier assured the nation  was supposed to be working much better by this time.

For purposes of this blog entry, I’m going to assume that enrollment in the Exchanges ends up being about 2 million for 2014 instead of the projected 7 million.  I can’t rigorously justify that number — but, of course, neither could the pundit who is now saying 4 million. And, if I had time and space I’d prefer to do this analysis under a variety of scenarios, but, for now, the 2 million figure feels about right. And if I were betting on which side of the 2 million we will fall, it would be the lower side. What are the consequences? I can’t address all of them in a single blog entry — and trying to predict matters past 2014 gets very treacherous — but here are some.

And, for those of you who don’t want to read further, here’s the headline:

Insurance sold through Exchanges without medical underwriting — a central promise of the Affordable Care Act — is likely to implode in a significant number of states by 2015 while limping along in several others but providing little net desired decrease in the number of people without quality health insurance.  The silver lining in this failure will be that the program will likely cost less than projected due to fewer number of people receiving subsidies, although this reduction will be partly offset by higher-than-projected subsidies to the insurance industry. Expect significant pressure to grow among supporters of the Affordable Care Act to use these net savings to increase the subsidies available to people buying coverage through the Exchanges and to lure insurers in the problem states back into the Exchanges.

1. The number of people without private health insurance may actually grow

This is so because, if 2 million obtain insurance through the Exchanges but more people (3.5 million is a prevailing estimate from sources ranging from Forbes to Jonathan Gruber) lose their current individual health insurance, that’s a net decrease in the number of insured.  And if we add in the loss of 100,000 or so people from the Pre-Existing Condition Insurance Plan that likewise is terminated or those who heretofore were in various state high risk pools, there is a serious risk that the Affordable Care Act will have decreased the number with private health insurance.

In fairness, I have not taken Medicaid expansion into account. Some may see it as unfair to count just the number of people with private health insurance rather than the number with access to health care through private insurance or public schemes such as Medicaid. And, indeed, in those states in which Medicaid has been expanded — one can’t blame President Obama too much if other states choose not to participate — enrollment has outpaced enrollment in private plans at about a 4-to-1 ratio. This suggests, by the way, that people are willing to use a web site, even some clunky ones, to sign up for health care if they think the price is right.

The rejoinder to the argument that we should consider Medicaid, however, is that an awful lot of political energy and an awful lot of monetary investment has been predicated on healthcare reform benefiting more than just the poor but the middle class too. If it turns out the middle class has, net, been hurt by the 2014 features of Affordable Care Act or has paid a large investment for the 2014 features of a law that, net, does provide little marginal benefit, it’s fair to criticize the 2014 features of the Act for their architectural shortcomings. And, yes, I know all about staying on your parents’ policy until you are 26 and limitations on rescissions, but none of those pre-2014 “achievements” should count in assessing the 2014 record.

2. The number of people with quality health insurance may stay about the same

Yes, there will be people who formerly had no health insurance or who had rotten health insurance who, thanks to the 2014 aspects of the ACA, now have health insurance that covers more.  There are many news accounts from pro-ACA forces providing evidence of this. Here’s one (although all the “success stories” are likely to have high medical claims); here’s another (notice again that the successes are likely to have high medical claims).

But it may well be that for every such success story apparently to be catalogued by paid grants from the government, there is another who had health insurance tailored to their needs (such as policies for the 50 and over set that did not cover maternity expenses) who now find themselves priced out of the health insurance market with its Essential Health Benefits requirement (section 1302 of the ACA). Here’s a website inviting people to post their cancellation notices.  Here are some anecdotes relating such problems (although one always have to be very careful about exaggerations in this arena; see here for a discussion of a particular case by Consumer Reports).  Here’s another.

On balance, though, it’s quite believable that, many of the gains due to subsidization may be offset due to government offering only products that have more “features” than many people are willing to pay for.  To analogize, consider a law that prohibited people from owning either a clunker car (defined somehow) or a car without four-wheel drive. The theory behind the law was that clunkers were unsafe and that four-wheel drive is sometimes useful: even if you don’t need it right now, you might need it or have needed it at some point.  Fair enough. But such a law might not actually increase the number of people driving quality cars that fit their needs. Some people just can’t afford a new car.  And others, who could afford a respectable car without four wheel drive and didn’t think they needed it right then (urban Floridians, for example), might simply decide not to get a car rather than use scarce marginal dollars for cars with features they don’t need. While such a result need not occur — it depends on all sorts of factors — my sense is that this is where we are heading with the Affordable Care Act and its fairly demanding and undifferentiated requirements for coverage in policies sold on the Exchanges.

3.  Federal mandate tax payments may be a little bit bigger than expected for 2014

The Congressional Budget Office estimates this spring that the United States Treasury would receive about 2 billion dollars as a result of the individual mandate tax (26 U.S.C. § 5000A). That figure was premised, however, on a belief that 7 million people would enroll in the Exchanges.  If only 2 million people get insurance through the Exchange that’s roughly 5 million fewer than anticipated who will not. There thus could be as many as 5 million more people who will have to pay the individual mandate (26 U.S.C. §5000A) and could lead to something like another $500 million in revenue next year.

Before we spend the money of 5 million more Americans who might have to pay extra in tax, however,  we need to we need to subtract off two categories of people.  (1) We should subtract off those who acquire faux-grandfathered policies created by President Obama’s recent turnabout to let people who like their (potentially cruddy) coverage keep it under some circumstances and not have to pay the individual mandate.  (2) We should subtract off the small number of people who were projected to purchase policies on the Exchange but, because of poverty or otherwise, would not have had to pay the mandate tax had they failed to do so.

So, let’s say on balance that 3 million fewer people than projected pay the tax under 26 U.S.C. 5000A. It’s hard to know exactly what sort of tax revenue would be involved, but it is likely in excess of $285 million per year because each such person would have been responsible for at least a $95 per person penalty. (I know, I know, there are lots of complications because the penalty is difficult to enforce and because you only have to pay half for children, but then there are complications the other way in that $95 is a floor and one may have to pay 1% of household income). Why don’t we use round numbers, though, and say that the government might get about $300 million more in tax revenue for 2014 (although they may not get the money until 2015) due to lower-than-projected enrollments in the Exchanges.

4. Before the federal government subsidizes them, insurers in the Exchange will lose billions

4. Before consideration of various subsidies (a/k/a bailouts) of the insurance industry created by the Affordable Care Act, insurers could lose $2 billion as a result of having gambled that the Exchanges would be successful.  Here’s how I get that figure. No one knows for sure but, if the experience under the PCIP plan is any guide, when about 1/3 of the projected number of people apply to a plan that is not medically underwritten, expenses per person can be more than double that originally expected.  Even if we assume that experience under the PCIP is not fully applicable, given an enrollment 1/3 of that projected, it would shock me if covered claims were not at least 125% of that expected. If so, on balance that means that losses per insured could total roughly $1,000. If we multiply $1,000 per insured by 2 million insureds, we get about $2 billion. If the Exchanges lose money at the same rate as the PCIP, insurer losses could be upwards of  $7 billion. Again, I make no pretense of precision here. I am simply trying to get a sense of the order of magnitude.

5. The federal government will subsidize insurers more than expected but insurers will still lose money

The Affordable Care Act creates several methods heralded as protecting insurers writing in the Exchanges from claims that were greater than they expected.  One such method, Risk Corridors under section 1342 of the ACA, could end up helping insurers in the Exchanges significantly. But, if, as discussed here, enrollment in the Exchanges for 2014 is 2 million persons, the cost of helping the insurance industry in this fashion will be another $500 million for 2014. Risk Corridors, which have recently been aptly analogized to synthetic collateralized debt obligations (CDOs), requires the government to reimburse insurers for up to 80% of any losses they suffer on the Exchanges.  It also imposes what amounts to a special tax (again of up to 80%) on profits that insurers may make on the Exchanges. The system was supposed to be budget neutral but, as I and others have observed, will in fact require the federal government to pay money in the event that insurer losses on the Exchange outweigh insurer gains. The basis for my $500 million computation is set forth extensively in a prior blog entry. It will only be more if, as discussed in another prior blog entry, the Obama administration modifies Risk Corridors to indemnify insurers for additional losses they suffer as a result of President Obama’s decision to let those with recently cancelled medically underwritten health insurance policies stay out of the Exchanges.

If claims are, as I have suggested 25% higher as a result of enrollment of 2 million, insurers will lose, after Risk Corridors are taken into account, about 9% on their policies. It would thus not surprise me to see insurers put in for at least a 9 or 10% increase on their policies for 2015 simply as a result of enrollment in the pools being smaller than expected.

The relatively modest 9% figure masks a far more significant problem, however.  It is just a national average. Consider states such as Texas in which only 2,991 out of the 774,662 projected have enrolled thus far.  If, say, Texas ends up enrolling “only” increasing its enrollment by a factor of 16 and gets to 50,000 enrollees, I would not be surprised to see claims be double of what was projected.  Even with Risk Corridors, insurers could still lose about 24% on their policies. A compensating 24% gross premium increase, even if experienced only by that portion of the insurance market paying gross premiums, could well be enough to set off an adverse selection death spiral.

Footnote: For reasons I have addressed in an earlier blog entry, one of those methods, transitional reinsurance under section 1341 of the ACA is best thought of as a premium subsidy that induces insurers to write in the Exchanges. Because the government’s payment obligations are capped, however, the provision is unlikely to help them significantly if the cost per insured ends up being particularly high throughout the nation.

6. The federal government might save $19 billion in premium subsidies

The Congressional Budget Office assumed that premium subsidies would be $26 billion in 2014, representing a payment of about $3,700 per projected enrollee.  If the distribution of policies purchased and the income levels of purchasers are as projected, but only 2 million people apply, that would reduce subsidy payments down to $7.5 billion.  And if the policies sold in 2014 cost a little less than projected, that might further reduce subsidy payments.  I think it would be fair, then, to estimate that low enrollment could save the federal government something like $19 billion in premium subsidies in 2014. This savings coupled with heightened tax revenue under 26 U.S.C. §5000A — could we round it to $20 billion — would be more than enough to cover insurer losses resulting from the pool being smaller and less healthy than projected.

The Bottom Line

I suspect my conclusion will make absolutist ideologues on the left and right equally uncomfortable.  What I am wondering is if the Affordable Care Act might not die in 2015 with a giant imploding bang but rather limp on with a whimper. On balance, what we may well see if only 2 million enroll in Exchanges pursuant to the Affordable Care Act is a system that fails to function in some states and remains fragile and expensive elsewhere. On the one hand, it will be an expensive system because of the enormous overhead incurred in creating a highly regulated industry that provides assistance to a relatively small number of people. On the other hand, precisely because it will be helping far fewer people than projected, it might well cost significantly less  than anticipated. I would expect this departure from what was projected to lead to two sorts of pressures:

(1) There will be a claim from ACA supporters that we can use the savings to increase subsidies or the domain of the subsidies beyond the 400% of Federal Poverty Line cutoff  and thereby reduce the adverse selection problem that will already be manifesting itself.

(2) There will be a claim from ACA detractors that all of this confirms that, apart from ideological considerations, the bill is an expensive turkey and that, if  the only way to save it is to impose more and more regulation and spend more and more money, it ought simply to be repealed.

Complicating factors


There are many factors that could result in the estimates provided in this entry being quite wrong.  I do not want to fall into the same trap as others who have ventured into this field and claim that there are not very large error bars around all of these numbers.  And I do not believe the system is necessarily linear. It may be that small changes have cascading effects. Here are several reasons my estimates might be wrong.

1. The rules change in 2015. There are at least three significant rule changes in 2015.

a. The tax under 26 U.S.C. 5000A for not having government-approved health insurance increases significantly, going from the greater of $95 per person or 1% of household income to the greater $295 per person or 2% of household income. Insurers may therefore assume that enrollment will be greater in 2015 than in 2014.  Some people will be pushed over the edge by the higher tax rate into purchasing health insurance. If so, insurers may feel less pressure to increase prices because they believe their experience in 2014 will not be repeated in 2015.

b. The employer mandate will presumably not be delayed again by executive order which may have two offsetting events: employers reducing the number of full time employees thereby adding more to the Exchanges or employers maintaining health insurance thereby reducing the potential pool for the Exchanges.

c. As discussed in an earlier blog entry, there will be a decline in transitional reinsurance now provided free to insurers in the Exchange which, in and of itself, will put significant pressure on premiums


Finally, this is a field where events just frequently overtake predictions.  All of these predictions go out the window, for example:

a. if there is a major security breach in the government computer systems and people’s personal information is disclosed;

b. continues to seriously malfunction during the critical pre-December 23 sign up period

c. if the yet-to-be-built payment system for insurers does not function and people become dissatisfied as a result;

d. if people find, as some are projecting (here and here), that the set of medical providers available in the Exchange policies is drastically reduced over what they expected; and

e. there is a major sea change in legislative power in Washington.

f. other





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Proposed cuts in transitional reinsurance could increase Exchange premiums 7-8% in 2015

Late last week, HHS released its 255-page HHS Notice of Benefit and Payment Parameters for 2015. Buried away in this technical documents are at least two interesting matters.

  1. HHS is planning to cut reinsurance payments to insurers participating in its Exchanges in a way that, in and of itself, could increase gross premiums 7-8% in 2015 and increase the risk of further adverse selection
  2. HHS has validated the claims of insurers that President Obama’s recent about-face on the ability of insurers to renew certain policies not providing Essential Health Benefits could destabilize the insurance market.  The Notice proposes changing the way insurers calculate their profits and losses so that the amount of payments made by government to insurers in the Exchange would increase. It claims, however, that it does not know how much this will cost.
The HHS Notice for 2015
The HHS Notice for 2015

Less reinsurance

Under the system in place for 2014, if insurers in an Exchange have to pay between $45,000 and $250,000 on one of their insureds, the government picks up 80% of that loss (assuming the $63 per insured life it taxes various other health insurance plans is sufficient to pay that amount). But in 2015, the money that goes into this transitional reinsurance pool (section 1341 of the ACA, 42 U.S.C. sec. 18061) declines by a third from $12 billion to $8 billion and the head tax correspondingly declines from $63 to $44. As a result, HHS proposes to now pick up only 50% of the tab for losses between $70,000 and $250,000. Thus, losses between $45,000 and the new $70,000 attachment point will now fall entirely on insurers without federal help and insurers will have to pay 30% more on losses between $70,000 and $250,000.

This reduction in free reinsurance provided by the taxpayers will almost certainly result in increased premiums for insureds. My estimate is that the average premium hike induced by this reduction in reinsurance is likely to be about 7-8%.

Here’s how I did this computation. I took loss distributions contained in the government’s “Actuarial Value Calculator.” That’s the Excel spreadsheet the government (and insurers) use to figure out what metal tier, if any, their policy falls into. I then performed the following steps.  You can verify what I have done in the Computable Document Format (CDF) document I have placed on Dropbox. You can view the document using the free CDF player or using Mathematica

Step 1.  I determined the expected value of claims under those loss distributions with reinsurance parameters set at the 2014 rates.  I get four results, one for each metal tier: {3630.52, 4223.87, 4468.95, 5556.06}. I then do exactly the same computation but use the 2015 reinsurance parameters. I get four results, one for each metal tier: {3906.67, 4550.95, 4807.06, 5948.53}.

Step 2. I multiply each result by the actuarial value of the associated metal tier to approximate the size of the premium needed to support the expected level of the claims. I get {2178.31, 2956.71, 3575.16, 5000.46} for the 2014 reinsurance parameters and {2344., 3185.67, 3845.65, 5353.68} for the 2015 reinsurance parameters.

Step 3. I then simply compute the percent increase in the needed 2015 premiums over the needed 2014 premiums and get {0.0760631, 0.077436, 0.0756584, 0.0706371}

If losses are, as I suspect they will be, greater than those assumed in the actuarial value calculator — because the pool is going to be drawn for a variety of reasons from a riskier group than originally anticipated —  the diminution in reinsurance is yet more significant and, standing by itself, could add more than 7-8% to the gross premiums charged in the Exchanges.

Whether the increase in gross premiums is about 7-8% or whether it is higher, it creates a heightened risk for an adverse selection problem.  This is so because, although subsidies insulate many people in the Exchanges from increases in gross premiums — net premiums are pegged to income rather than gross premiums for them — it will affect the significant number (estimated by HHS to be about 18% (4/22)) who are expected to purchase policies inside the Exchanges without subsidies.  The higher premiums go, however, the more we would expect to see the healthy drop out and find substitutes for the non-underwritten policies sold in the Exchanges. (If premiums are low enough, adverse selection is not a problem: insurance is a good deal for everyone and healthy and sick purchase it alike. See, e.g., Medicare Part B, which is very heavily subsidized and does not suffer seriously from adverse selection.)

Note to experts. Some of you might think I erred in saying that the 2014 reinsurance attachment point is $45,000 and not $60,000. But the 2015 notice says on page 11 that it will retroactively reduce the attachment point to $45,000.

HHS Validates Insurer Fears About Obama Reversal and the Destabilization of Insurance Markets

Many individuals, including me, have claimed that President Obama’s recent decision to permit insurers to “uncancel” certain individual plans that do not contain Essential Health Benefits could destabilize insurance markets. The Notice of Benefit and Payment Parameters just released appears to validate that assertion. Stripped of bureaucratese, the HHS document basically says that insurers are right to be disconcerted by the President’s about face.

For those who enjoy bureaucratese, however, or who properly want to validate my own conclusions about the document, here’s what it actually says.

On November 14, 2013, the Federal government announced a policy under which it will not consider certain non-grandfathered health insurance coverage in the individual or small group market renewed between January 1, 2014, and October 1, 2014, under certain conditions to be out of compliance with specified 2014 market rules, and requested that States adopt a similar non-enforcement policy.

Issuers have set their 2014 premiums for individual and small group market plans by estimating the health risk of enrollees across all of their plans in the respective markets, in accordance with the single risk pool requirement at 45 CFR 156.80. These estimates assumed that individuals currently enrolled in the transitional plans described above would participate in the single risk pools applicable to all non-grandfathered individual and small group plans, respectively (or a merged risk pool, if required by the State). Individuals who elect to continue coverage in a transitional plan (forgoing premium tax credits and cost-sharing reductions that might be available through an Exchange plan, and the essential health benefits package offered by plans compliant with the 2014 market rules, and perhaps taking advantage of the underwritten premiums offered by the transitional plan) may have lower health risk, on average, than enrollees in individual and small group plans subject to the 2014 market rules.

If lower health risk individuals remain in a separate risk pool, the transitional policy could increase an issuer’s average expected claims cost for plans that comply with the 2014 market rules. Because issuers would have set premiums for QHPs in accordance with 45 CFR 156.80 based on a risk pool assumed to include the potentially lower health risk individuals that enroll in the transitional plans, an increase in expected claims costs could lead to unexpected losses.

So, the government wants help in figuring out what to do. One method it is contemplating involves technical adjustments to the Risk Corridors program in a way that would get insurers more money (pp. 101-105).  Although I will confess to considerable difficulty in understanding exactly what it is that HHS suggesting, the basic idea, as I understand it, would be to assume that those who, by virtue of the President’s about face, “uncancel” their policies would have had claims expenses equal to 80% of the average claims of the rest of the pool (page 103-04). HHS will then, on a state-by-state basis figure out what the position of the insurer would have been and try to adjust Risk Corridors such that the position of the insured after application of adjusted Risk Corridors is similar to that which it would have been in had these persons, who pay the same premium as the rest but who tend to have only 80% of the claims expenditures, enrolled in their plan.

It is not clear to me where the statutory authority to make this change comes from. Section 1342 of the ACA (42 U.S.C. 18062) does not define its key terms of “target amount” and “allowable costs” in a fashion that would appear to my eye to extend to hypothetical costs and hypothetical premiums. I will also confess to being unsure as to who would have standing to challenge this proposed give away of taxpayer money to the insurance industry.

What is clear to me, however, is the proposed reform, by necessity, will result in greater previously unbudgeted expenditures by the federal government. If we are really talking about making insurers whole and the people in question might have profited insurers something like $1,000 a person, the federal government appears to be suggesting a change in regulations that could cost it hundreds of millions of dollars.  The HHS Notice declines to put an exact figure on the cost of the change:

Because of the difficulty associated with predicting State enforcement of 2014 market rules and estimating the enrollment in transitional plans and in QHPs, we cannot estimate the magnitude of this impact on aggregate risk corridors payments and charges at this time.

HHS is probably correct in saying it is difficult to estimate the cost of the proposed changes to Risk Corridors.  I don’t think we have a good feel for how many people will return to the plans President Obama has carved out for special treatment.  It does look, however, as if a floor of a couple of hundred million dollars on the cost of the proposal would be quite reasonable. This, of course, could give some ammunition to those, such as Florida Senator Marco Rubio, who have called for repeal of the Risk Corridors provision as an insurance “bailout.” (For a discussion, look here, here and here)

Final Note

Yesterday, I said I hoped to provide a major post.  This actually is not the post I was speaking about. There’s still more news coming.  Maybe today or maybe while recovering from a turkey overdose tomorrow.

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5 articles worth reading from the past 24 hours

I’m in the middle of a major posting and my day job so I have not had the ability to post anything particularly insightful in the past 24 hours or so.  But others have been writing good stuff.   So here’s a compendium of Affordable Care Act / Adverse Selection stuff worth reading.  I’m hoping to have the big post out tomorrow or maybe late tonight.

An intelligent and balanced guide to discussing the Affordable Care Act at Thanksgiving from one of the best writers on the topic, Sarah Kliff.  I swear I know the people at the hypothetical Thanksgiving table she discusses. I bet you do too.

Eligible to applying to enrolled by state
Eligible to applying to enrolled by state

Excellent visuals on enrollment in the Exchanges by states.   From this article in the Washington Post.

An Exchange website worse than  It’s possible. And it’s a sitting Duck for criticism.  Read about it here.

A dissection of New York Times columnist Paul Krugman’s statistical nonsense about the California enrollment numbers.  Krugman echoes the meme that where the websites are working, the young are signing up in the Exchanges.  James Taranto of the Wall Street Journal  joins my posts here and here in showing that the evidence does not support this point and exposes with some precision exactly Mr. Krugman’s path of sophistry.  Note to Mr. Krugman: there are other states with working websites. Have you looked at the enrollment picture there?

An article from KUOW providing anecdotal evidence that the substitution of subsidized Exchange policies for canceled private insurance may in many instances be welcomed by insureds — particularly those who have had high medical expenses.  If you ignore for a moment the tax costs of providing the subsidies — which is close to but not quite the equivalent of the macabre  “Other than that, Mrs. Lincoln, how did you like the play?” joke — the ACA has made some people better off.  The harder question is whether one gets much bang for the buck with the ACA.


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Colorado enrollment numbers look bad

According to a news report today from the Associated Press, the enrollment numbers in Colorado are about half of what the state had projected as its “worst case scenario” for enrollment in its Exchange.  The  6,001 Colorodoans who have enrolled thus far (and that is enrolled, not yet paid) is also way less than the 20,186 that had served as the midpoint projection for this time in the open enrollment season. Colorado officials apparently believed that 136,000 people would enroll by the end of 2014. Enrollment  thus far has apparently been complicated, however, by a requirement that  consumers seeking a subsidy on the exchange first find out if they qualify for Medicaid, which may require a 12-page application.

Three facts make the low Colorado numbers yet more troubling for those concerned either about a reduction in the number of uninsured individuals or about the prospects that those getting enrollment in the Exchanges for 2014 will shortly find themselves sucked into an adverse selection death spiral.

First, these low figures are coming in a state where the web site has, for the most part, been operating respectably (further details here) and not in a state dependent on

Second, it comes in a state where between 106,000 and 250,000 individual health insurance policies have been cancelled. I have an inquiry in but have not yet been able to find from published sources whether Colorado will permit insurers to reinstate those policies and under what conditions. [LATE BREAKING NEWS at 13:52 Houston time: Colorado insurance official says Colorado expects to announce a decision on this point later today or tomorrow (per email from Vincent Plymell, Communications Director at the Colorado Department of Regulatory Agencies, who courteously responded to my inquiry)]

Third, Colorado already had 1,227 people enrolled in the Federal Pre-Existing Condition Insurance Plan (PCIP). One would think those people, who tend to have high medical expenses and are willing to pay full freight for insurance, would have been among the earliest to sign up under the Colorado exchange with the potential for subsidized rates.  Thus, some of the 6,001 already enrolled may not represent a reduction in people without insurance to people with health insurance but merely a substitution from one federally created plan to another.

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Should California be happy or concerned by its early enrollment data?

The short answer: concerned but not panicked

As discussed yesterday on this blog and elsewhere in the media, Cover California, the state entity organizing enrollment there, has released data showing the age distribution of the group thus far enrolling in plans on its Exchanges.  Although I took a rather cautionary tone about the age distribution — fearing it could stimulate adverse selection — the head of Cover California and some influential media outlets generally favorable to the Affordable Care Act have been considerably more cheerful.  So, who’s right?  For reasons I will now show — and probably to no one’s surprise — me. (More or less).

To do this, we need to do some math.  It’s a more sophisticated variant of the back of the envelope computation I undertook earlier on this blog. The idea is to compute the mean profit of insurers in the Exchange as a function of the predicted versus the actual age distribution of the pool they insure.  Conceptually, that’s not too difficult. Here are the steps.

1. Compute the premium that equilibrates the “expectation” of premiums and costs for the predicted age distribution of the pool they insure. Call that the “predicted equilibrating premium.”

2. Compute the expected profit of the insurer given the predicted equilibrating premium and the actual age distribution of the pool they insure.

3. Do Step 1 and Step 2 for a whole bunch (that’s the technical term) of combinations of predicted age distributions and actual age distributions.

Moving from concept to real numbers is not so easy. The challenge comes in getting reasonable data and, since there are an infinite number of age distributions and in developing a sensible parameterization of some subset of plausible distributions.

The Data

The data is interesting in and of itself.  To get the relationship between premiums and age, I used the robust  Kaiser Calculator.  Since itself recommends the web site (their own site seems to have a few problems) and I have personally validated its projected premiums for various groups against what I actually see from various vendors, I believe it is about as reliable a source of data as one is likely to find anywhere right now.  So, by hitting the Kaiser Calculator with a few test cases and doing a linear model fit using Mathematica (or any other decent statistics package), we are able to find a mathematical function that well captures a (quadratic) relationship between age and premium.  (The relationship isn’t “really” quadratic, but quadratics are easy to work with and fit the data very well.) The graphic below shows the result.

Nationwide average health insurance premium  for a silver plan as a function of age
Nationwide average health insurance premium for a silver plan as a function of age

We can normalize the graphic and the relationship such that the premium at age 18 (the lowest age I consider) is 1 and everything else is expressed as a ratio of the premium at age 18. Here’s the new graphic.  The vertical axis is now just expressed in ratios.

Nationwide average health insurance premium ratio for a silver plan as a function of age
Nationwide average health insurance premium ratio for a silver plan as a function of age

To get the relationship between cost and age, I used a peer reviewed report from Health Services Research titled “The Lifetime Distribution of Health Care Costs.”  It’s from 2004 but that should not matter much: although the absolute numbers have clearly escalated since that time, there is no reason to think that the age distribution has moved much. I can likewise do a linear model fit and find a quadratic function that fits well (R^2 = 0.982).  Again, I can normalize the function so that its value at age 18 is 1 and everything else is expressed as a ratio of the average costs incurred by someone at age 18.  Here’s a graphic showing the both the relationship between age and normalized premiums in the Exchanges under the Affordable Care Act and normalized costs.


The key thing to see is that health care claims escalate at a faster rate than health care premiums. Others have noted this point as well. They do so because the Affordable Care Act (42 U.S.C. § 300gg(a)(1)(A)(iii)) prohibits insurers from charging the oldest people in the Exchanges more than 3 times what they charge the youngest people. Reality, however, is under no such constraint.

Parameterizing the Age Distribution

There are an infinite number of potential age distributions for people purchasing health insurance.  I can’t test all of them and I certainly can make a graph that shows profit as a function of every possible combination of two infinite possibilities. But, what I can do — and rather cleverly, if I say so myself — is to “triangulate” a distribution by saying how close it is to the age distribution of California as a whole and how close it is to the age distribution of those currently in the California Exchange pool.  I’ll say a distribution has a “Pool Parameter Value” of 0 if it comes purely from California as a whole and has value of 1 if it comes purely from the California Exchange pool.  A value of 0.4 means the distribution comes 40% from California as a whole and 60% from the current California Exchange pool. The animation below shows how the cumulative age distribution varies as the Pool Parameter Value changes.


How the age distribution varies as the pool goes from looking more like California as a whole to looking more like the current pool as a whole.
How the age distribution varies as the pool goes from looking more like California as a whole to looking more like the current pool as a whole.

Equilibration and Results

The last step is to compute a function showing the equilibrium premium as a function of the predicted pool parameter value. We can then use this equilibrating premium to compute and graph profit as a function of both predicted pool parameter value and actual pool parameter value.

The figure below shows some  of the Mathematica code used to accomplish this task.

Mathematica code used to produce graphic showing relationship between insurer profit in the California exchanges and the nature of the predicted pool and the actual pool
Mathematica code used to produce graphic showing relationship between insurer profit in the California exchanges and the nature of the predicted pool and the actual pool

Stare at the graphic at the bottom.  What it shows is that if, for example, California insurers based their premiums on the pool having a “parameter value” of  0 (looks like California) and the actual pool ends up having a “parameter value of 1 (looks like the current pool), they will, everything else being equal, lose something like 10% on their policies and probably need to raise rates by about 10% the following year. If, on the other hand, they thought the pool would have a parameter value of 0.5 and it ended up having a parameter value of 0.75 the insurers might lose only about 3.5%.

Bottom Line

If I were an insurer in California I’d be concerned about the age numbers coming in, but not panicked.  First, I hope I did not assume that my pool of insureds would look like California as a whole.  I had to assume some degree of adverse selection. But it does not look as though, even if I made a fairly substantial error,  the losses will be that huge.  That’s true without the Risk Corridors subsidies and it is all the more true with Risk Corridor subsidies.

What I would be losing sleep about, however, is that the pool I am getting is composed disproportionately of the sick of all ages. If I underestimated that adverse selection problem, I could be in deep problem. My profound discomfort would arise because,  while I get to charge the aged somewhat more, I don’t get to charge the sick anymore. And there’s one fact that would be troubling me. Section 1101 of the Affordable Care Act established this thing calledthe Pre-Existing Condition Insurance Pool. It’s been in existence (losing boatloads of money) for the past three years.  It held people who couldn’t get insurance because they had pre-existing conditions.  They proved very expensive to insure.  There are 16,000 Californians enrolled in that pool.  But that pool ends on January 1, 2014.  And the people in it have to be pretty motivated to get healthy insurance.  Where are they going to go? If the answer is that a good chunk of the 79,000 people now enrolled in the California pool are former members of the PCIP, the insurers are in trouble unless they get a lot more healthy insureds to offset these individuals.

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California data shows disproportionate enrollment by those over 55

California has frequently been cited as an early Affordable Care Act success story with enrollment coming at least closer to projected numbers than in other states. Today’s release of information from Covered California, the state entity organizing enrollment there, shows a mixed picture about the likelihood that the ACA will become a stable source of non-discriminatory relatively inexpensive health insurance in the nation’s most populous state.

A highlight from the report is that 79,891 have at least gotten as far as selecting a plan since enrollment opened on October 1, 2013.  That’s better than any other state and better — at least as of the last report — of all the other states combined using the portal. And, because, contrary to the wishes of California Insurance Commissioner Dave Jones, Covered California has decided not to permit those with recently enrolled in underwritten individual health insurance to “uncancel” policies that do not provide Essential Health Benefits, there is the potential to add more people to the Exchange pools than would otherwise be possible.  Additional good news: the pace of enrollment has picked up over the past two weeks. Still, to date, the 79,891 who have at least selected a plan are only 6% of the 1.3 million that the federal government projected California would enroll through 2014. And the web site in California appears to be working acceptably.

Perhaps the news on the number of enrollees is equivocal.  It’s better than other states, and it’s still early, but, relative to the projections on which the ACA was premised, it is not good at all.  There is also, however, what appears to me to be distinctly troubling news coming from California.  We have another report on the age distribution of enrollees: so far, it is disproportionately old. And this is true in the state in which enrollment has progressed the furthest and in the nation’s most populous state. So, the data is potentially significant not just as an augury of what may be seen in other states but because a disproportionately elderly population in the largest state is, in an of itself, a problem.

Although persons age 55 through 64 constitute about 18% of the California population aged 18 through 64, they constitute double that, 36%, of persons in that same age segment who have enrolled for a plan. Similarly, although persons age 45 through 64 constitute about 41% of the California population, they constitute 59% of those who have enrolled thus far. As discussed earlier on this blog and elsewhere, because premium ratios between old and young are capped at 3 to 1, whereas actual claim ratios are likely to be higher, disproportionate enrollment of the elderly can help drive an adverse selection death cycle.  This would be all the more true if the older people — it’s hard to call people age 55 “elderly”” —  that are enrolling are disproportionately unhealthy relative to their age-group peers. Claims, therefore, by Covered California Director Peter Lee that “enrollment in key demographics like the so-called young invincibles is very encouraging” rest on theories of economics and statistics that I do not understand.

A Side Note on Market Concentration

By the way, who’s on the hook in the event the ultimate pool is distinctly more expensive than insurers anticipated?  It’s the usual suspects. The big “winners” in California thus far are the usual suspects: Anthem Blue Cross has 28.1%, Kaiser Permanente, a California fixture, has 26.8%, Blue Shield of California has 25.6% and Health Net (with headquarters in Southern California) has 15.7%. Together, these four have 96% of the market with a “Herfindahl Index” of a moderately concentrated 2410. Dreams, therefore, of new competitors entering the marketplace, thus far seem illusory.  But it is these “winners” that stand to lose the most money — and be the greatest recipient of federal redistributions under Transitional Reinsurance, Risk Corridors and Risk Adjustments — in the coming year if the trends hold up.

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Could the American Enterprise Institute possibly be right there is this massive second wave of cancellations coming?

Short answer: The AEI estimate looks high but, yes, a massive second wave of cancellations is coming

The American Enterprise Institute (AEI) has received considerable press over the past 24 hours for asserting that the Affordable Care Act will generate a massive second wave of insurance cancellations this summer as small employers (and their employees) will be compelled to abandon policies that do not provide “Essential Health Benefits” and meet other standards of the Affordable Care Act.  Fox News has asserted that the AEI statement means that up to 100 million people could be canceled next year.  Other news sources and  at least one influential conservative radio talk show host are making similar claims.

If this were true, it would obviously be a subject of considerable importance.  Anyone doubting this point should consider the firestorm that erupted over the recent cancellations of a much lower number of individual health insurance policies as a result of the Affordable Care Act’s insistence that health insurance meet its full standards starting in 2014 and the tough limitations on “grandfathering” exemptions for older health insurance plans.

But, is it true?  Is it really true that there could be a large number of cancellations?  Could we really be talking about 100 million people? Could the very conservative AEI  be making political hay rather than something more factual? Let’s look at the argument.  It’s part legal and part statistical. I’m going to break the argument down into pieces and see how it holds up.

1. Legal Basis

The legal part stems from the claim that although large businesses (more than 100 employees) are not required to provide “Essential Health Benefits” under the Affordable Care Act for all insurance plans beginning after January 2, 2014, small businesses are.  That appears to be true.  Section 1201 of the Affordable Care Act, which, among other things, amends section 2707 of the Public Health Service Act, reads as follows: “A health insurance issuer that offers health insurance coverage in the individual or small group market shall ensure that such coverage includes the essential health benefits package required under section 1302(a) of the Patient Protection and Affordable Care.”  (emphasis added. It does not say “in the individual, small group or large group market” but rather “in the individual or small group market.”  And if one goes through the statutory labyrinth from Section 1304(a)(3) of the ACA to 1304(b), one learns that, at least until 2016, the small group market means insurance purchased by employers with 100 or fewer employees.

There is, however, an exemption for grandfathered plans.  Section 1251(a)(2) makes clear that almost all of the provisions of the Subtitle that contains section 1201 of the ACA doe not apply to “to a group health plan or health insurance coverage in which an individual was enrolled on the date of enactment of this Act.” There’s an exception to the exemption, but it does not apply to this situation.

So, it sure looks to me as if all non-grandfathered plans issued in by 100 of fewer workers will, beginning for plan years that begin after January 1, 2014, be compelled to provide “Essential Health Benefits” along with other requirements of the ACA.

2. How many policies are we talking about?

The Census Bureau keeps track of how many employees are employed by firms of different sizes. The last time they looked, 2010, there were roughly 39 million people employed in such firms.  So, an upper bound on the number of policies — note, policies, not persons — affected is 39 million.

The 39 million policy figure must be reduced, however, in figuring out how many cancellation notices are likely to go out in 2014. This is so for several reasons (two of which I will confess to having forgotten about during a very transitory first posting of this blog entry).

The first reason the 39 million figure is too high is that not all small employers provide health benefits.  According to the Kaiser Family Foundation’s 2013 Annual Survey of Employer Health Benefits (page 39), about 57% of employees in firms with under 200 employees provide health benefits.  It doesn’t have data on firms under 100 employees, but if one eyeballs the data that is provided, I don’t think one would be too far off estimating that about 50% of firms with fewer than 100 employees provide health benefits. So, this takes us down to about 19.5 million employees.

But the 19.5 million employee figure needs to be reduced because not all employees accept health insurance even when it is offered. According to Kaiser (same report as above, page 49), the take up rate among those with fewer than 200 employees is 62%.  It doesn’t look like it varies too much according to firm size in that range, so we’ll say there are roughly 12 million employees in small firms who get health insurance through their jobs.

But the 12 million figure needs to be yet further reduced because some policies will remain grandfathered and thus exempt from the Essential Health Benefits requirement.  According to the same Kaiser report  (page 223), about 49% of employees in firms with under 200 employees were in grandfathered plans.  It doesn’t have data on firms under 100 employees, but if one eyeballs the data that is provided, I think it is fair to say that about 50% of employees in firms with under 200 employees were in grandfathered plans as of 2013. This figure needs to be reduced, however, to take account of the decay in the proportion of plans that can remain grandfathered as time goes on.  From 2011 to 2012, for example, the percentage of workers in smallish firms in  non-grandfathered plans grew from 37% to 46%. And from 2012 to 2013,  the percentage of workers in smallish firms in  non-grandfathered plans grew from 46% to 51%.  So, it’s not unreasonable to believe that something like 56% of workers in firms with 100 or fewer workers will be in non-grandfathered plans at some point during 2014.  Could be a few percentage points higher, could be a few percentage points lower.

If we do the multiplication, however, that means that we are at roughly 7 million policies that will be required to provide Essential Health Benefits at some point during 2014.  But we need to do a little more subtraction because, surely, there must be some of these policies that are essentially in compliance with the ACA right now.  There might be “cancellation notices” with respect to these policies but if the policy content and prices doesn’t change as a result, few people will care.  How many such compliant policies are there?

I will confess that I don’t know how many small group policies already comply with the requirements of the ACA and would thus likely not change substantially if they needed to be cancelled. But my guess is that the number is rather small.  The Robert Wood Johnson Foundation noted several years back that a lot of individual and small group policies did not provide Essential Health Benefits such as substance abuse benefits. The independent research firm HealthPocket found recently that only 2% of individual health insurance plans covered all Essential Health Benefits and that the average plan covered about 76% of those benefits.  HealthPocket did not, however, study small group policies.

In the absence of great evidence, I am going to assume, probably quite liberally, that 1/3 of the plans that will be required to provide Essential Health Benefits either already provide them or provide something sufficiently close to them that any cancellation of those policies will not require significant alteration of the plan. This means, however, there are — just to keep the numbers round — 5 million small group policies that will be cancelled in 2014 and that will need to be altered significantly as a result of the ACA’s EHB requirement.

3. How many people are we talking about?

But policies do not equal people.  There is often more than one person on a policy: a spouse and a dependent or two. This means that while 5 million is a plausible lower bound on the number of people who will be getting potentially unwelcome cancellation notices in 2014, it is likely to low an estimate. And on this point, we have decent data. A 2009 report by America’s Health Insurance Plans found that the average policy covered 3.03 lives.  There is no reason to think that this number has either materially changed over the past few years or that small group plans are different from other plans.

So, again doing some rounding, if we do the multiplication of 5 million policies by 3 lives per policy, that means that 15 million or so Americans now getting health insurance through a small employer are likely to get meaningful cancellation notices this coming year. Another 6 million Americans now getting health insurance through a small employer will get cancellation notices but might receive similar coverage without large disruption. 

4. Conclusion

Is the claim true?

Bottom line: so far as I can see at this time, the American Enterprise Institute statement is truthy but somewhat exaggerated. The 100 million figure looks very high to me, but the real number of something like 15 million Americans (many of whom will be voting in Congressional elections right after receiving the notice) should be high enough to get the nation’s attention. Indeed, if my figures on the number of already-compliant policies is overly generous, the real number might be as high as 21 million Americans.

Does it matter?

To be sure, some of the plans into which these displaced Americans may end up may be better than those they have presently. Not being able to keep your health insurance doesn’t always make you worse off.  Some of the adjustments that need to be made to bring the policies into compliance may be relatively small and relatively inexpensive.  Many of the policies will not have been the sort of “junk” that can exist in the individual market. and thus transitioning to compliant plans, though initially stressful, may not end up being permanently traumatic. Moreover, under section 1421 of the ACA (26 U.S.C. § 45R), for some employers with 25 or fewer (not well paid) employees there will be tax credits of up to 50% to help them purchase insurance.

But the fact that the cancellation notices may not be calamitous for some does not mean that they will not pose serious problems for millions of employers and employees. For the many employees in firms with more than 25 employees or who are in firms with fewer than 25 employees but who are somewhat better paid, the tax credit provision offers no relief.  For the many small businesses whose policies were close to compliant, even having to pay a little more for “better” policies may be a big deal.  If the experience of these 15 million policyholders is similar to those of the millions of those with recently ACA-cancelled individual policies, many of them are going to find that the better insurance policies mandated by the ACA comes with a significant price tag that they or their employer, or a combination of the two, are going to pay.

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What happens if just some states enter the death spiral?

The Affordable Care Act does not establish a uniform national pool for persons purchasing Bronze, Silver, Gold and Platinum policies on the Exchanges. Rather, it creates at least one such pool for each of the states involved in the program .  And that is true even if multiple states use the same “Exchange” — the one in Washington D.C. — to establish coverage.

This fracturing of the pool and of the administrative apparatus creates an architectural problem: what happens if, as may well be the case, insurers in the Exchanges muddle through in a few states but suffer massive losses in many others? Most likely, insurers in the problem states will exit from the Exchanges or require significant premium hikes on top of rates that already give many potential customers sticker shock. But this reaction by profit-motivated insurance companies could lead more Americans to complain that imposition of a uniform individual mandate tax under 26 U.S.C. § 5000A throughout the nation is unfair. And, if the increases are large enough and a large enough number of people stick with the Exchanges — because they don’t see another choice — this  could increase the cost of premium subsidies to the federal government and its taxpayers beyond the substantial numbers already projected.

The key point I want to make here is that even the best and brightest people often fall into the trap of thinking that the Affordable Care Act Exchange-based system for reducing the number of uninsureds will either succeed or fail.  Either the system will fall into an adverse selection death spiral or it will not. Perhaps that is the case. But this binary thinking probably is not right.  It’s kind of like quantum physics: the Exchanges could both succeed and fail at the same time.  It just depends what state you’re in. (Physics pun intended).

Here’s how. Although it is too early to tell for sure — and the persistent failure of and many of the state exchange sites such as Maryland and Oregon hinders augury — it looks as though the Affordable Care Act is having somewhat more success in some states than others. Proponents of the ACA like to point to California experience where it is claimed that 70,000 people have made it through at least some more advanced state of the enrollment process.  The gloomy point to Oregon where apparently no one has successfully enrolled or Texas, which, despite having the largest number of uninsureds, had only 2,991 enrolled in a plan last time anyone counted. (Here’s the handy chart in the Washington Post.) Both the optimistic and pessimistic point to Kentucky where the number of enrollees is proportionately higher than in many states but in which the population of insureds seems disproportionately old.

So, in a few months it could be that Exchange insurance in some states such as California where the technology has worked better and the political environment is more sympathetic to the ACA is able to persist into 2015 without major rate hikes or insurer withdrawals. In those states, there remains some considerable logic to imposing a tax of what will be 2% of household income or roughly $325 per household member (kids count as half) for failure to buy health insurance.  But what might we do in states such as Texas or Mississippi or West Virginia or perhaps many others where the insurers experience severe adverse selection that even Risk Corridors (42 U.S.C. § 18062) is unable to cure adequately? If the result is, as one would expect, a reduction in the number of insurers continuing to participate in the Exchange and an increase in rates, the Affordable Care Act is likely to become even less popular in those jurisdictions.  This would be all the more true for those people — a small group, but still people nonetheless — whose income is such that the rates remain less than the 8% of household income level that would otherwise excuse them under 26 U.S.C. § 5000A(e)(1) from having to buy the expensive policies.

Fixing such a problem will be extraordinarily difficult. If Congress remains in gridlock with some finding the ACA so abhorrent that reform of even its worst excesses is unacceptable and others divided on the merits of any particular reform, Congress will have little ability to address the genuine problems of those in the failure states.  And would Congress be willing to write a statute that excused people in some states from paying an individual mandate tax while insisting that it continue in others? What criterion would be used to distinguish the tax paying from the tax exempt states?  If Congress tries, expect some heavy duty litigation on the constitutionality of such a non-uniform tax: “all Duties, Imposts and Excises shall be uniform throughout the United States.” (U.S. Constitution, Article I, Section 8, clause 1). Would Congress be willing to adjust “Risk Corridors” or “Risk Adjustment” (section 1343 of the ACA) to give special preference to insurers in states whose Exchanges have effectively failed? If Congress can not relieve the difficulties of the death spiral states, expect pressure to grow yet further for repeal of the entire law.

Again, we are left with a design problem in the Affordable Care Act.  Blinded by the dream of reducing the number of uninsureds and providing healthcare to a broader segment of American society, it creates a system in which, conceivably, under just the right circumstances it might work, but in which even small departures from desired assumptions risk plunging that system into a “basin of attraction” aptly known as “the death spiral.” We end up torn asunder in a black hole of insurance market failure from which there is no escape. Worse, it is constructed in a way such that state-by-state adjustments, even with a less dysfunctional Congress, will prove difficult indeed.


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Older enrollments in Exchanges could cost insurers about 10%

According to a news report from Reuters, which is being picked up widely, early figures from four states are suggesting that the pool of insureds enrolling in the Exchanges is older than anticipated.  If this situation persists and is not an artifact of either the particular states involved or simply the urgency with which older people applied, it further threatens the ability of the Affordable Care Act to sustain its plan of equalizing opportunity to acquire health insurance. This is so because, although older people do pay more in the Exchanges established by the Affordable Care Act, they pay less than would be actuarially appropriate.  Young people, by contrast, pay more.

Here’s the key passage from the Reuter’s report.

The Obama administration is aiming to enroll about 2.7 million 18- to 35-year-olds in the exchanges by the end of March, out of 7 million total, or about 38 percent.

Early data from Connecticut, Kentucky, Washington and Maryland show that so far more than 20 percent of the 23,500 combined enrollees in private insurance plans are 18 to 34 years old, ranging from about 19 percent in Kentucky and Connecticut to about 27 percent in Maryland. About 36 percent of enrollees across the four states are 55 to 64. Additional demographic data is expected from California on Thursday.

A back of the envelope computation shows that this situation could result in additional losses of about 10% by insurers before risk adjustment payments are taken into account. And this is true even if each age group in the pool is as healthy as anticipated.  The insurer  losses resulting from disproportionate enrollment of older insureds has several important consequences: (1) insurers may decide to exit the pool in the future; (2) insurers may decide to raise premiums to adjust to the real pool as opposed to the projected pool; and (3) the government is going to pay more in Risk Corridor payments than anticipated.

Relationship between "true ratio", percent young in the pool, and Exchange insurer profitability
Relationship between “true ratio”, percent young in the pool, and Exchange insurer profitability

The graphic above attempts to explain the issue.  The x-axis shows the “true ratio” of expected medical claims to be paid between the oldest people in the pool and the expected medical claims to be paid of the youngest people in the pool.  No one knows this figure for sure, but it could well be about 5 to 1.  (This is why the Affordable Care Act is forced to hold premiums to a 3 to 1 ratio; otherwise premiums for the older group would be extremely high.) The y-axis shows the percentage of people entering the Exchange pools who are between 18 and 35. As the Reuters story indicates, it was hoped this group would comprise 38% of the pool.  The green dot shows the result that might be hoped for if the young (18-35) indeed constitute 38% of the pool and the true ratio of claims paid between oldest and youngest is 5 to 1.  At this level, insurers neither make unusual profits nor suffer unusual losses.  The blue dot shows the result that might be seen if the young end up constituting — as the Reuters says the early evidence shows — about 20% of the pool. As one can see the red dot produces losses that are close to 10% of the risk assumed by insurers.

I’m placing a Mathematica notebook on Dropbox showing the computation. The idea,  is that one finds a linear relationship between age and premium relationship that just covers claims payments for any value of the true ratio but subject to the constraint that the premium the oldest person pays can not be more than three times bigger than the premium the youngest person pays and under the assumption that those under age 35 constitute 38% of the pool. One then determines profits for any combination of true ratio and percentage of the pool under age 35. The process takes a little algebra (mostly rescaling operations), some calculus (finding “expectations” of distributions) and some visualization.


1.  Although I modeled it that way, I am fully aware that the relationship between age and claims is non-linear.  It’s probably more cubic.  I’m also fully aware the relationship between age and premiums tends not to be linear under the Affordable Care Act. You can use the wonderful Kaiser Calculator or go to the fabulous Health Sherpa website to see that.  And I’m also aware that using a uniform distribution to model the distribution of ages within the 18-35 group and the 35-64 group is imperfect. Still, for purposes of getting just some rapid order of magnitude estimates to guard against those who would dismiss the problem or wildly exaggerate it, I believe the linear assumption is supportable.  It keeps things simple in a situation in which one has to be very careful about false assertions of precision and in which predictions are often hideously wrong.

2. As mentioned earlier, if the disproportionate enrollment of the elderly does not persist, as supporters of the ACA hope, the problem identified in this entry is reduced.  Other problems, such as disproportionate enrollment of the unhealthy — which is a far more significant issue — may persist.  But we don’t have data at present on the health of those enrolling.  It is troublesome, however, that most of the time proponents of the ACA trot out someone who has actually enrolled in the Exchanges (or  is  a Jessica Sanford who thought they would), it is someone who has higher-than-average medical expenses. I wish they would more frequently show off someone who is healthy now but just wants protection against the possibility of an adverse health event.

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Eliminating Risk Corridors jeopardizes Exchange Insurance

Draft of S.1726
Draft of S.1726

In a Wall Street Journal op-ed today that tracks much of what has been said on this blog in recent years, Florida Senator Marco Rubio announced that he will introduce later today a bill (provisionally numbered S.1726 ) that would apparently eliminate “Risk Corridors,” the provision of the Affordable Care Act under which the government would reimburse insurers selling insurance on an Exchange for the next three years from a good portion of any losses that they suffer there. Rubio contends  that “ObamaCare’s risk corridors are designed in such an open-ended manner that the president’s action now exposes taxpayers to a bailout of the health-insurance industry if and when the law fails.”

Marco Rubio portrait
Marco Rubio

Senator Rubio is largely correct, I believe, in his understanding of Risk Corridors (section 1342 of the ACA, codified at 42 U.S.C. 18062) both as drafted in the statute and as implemented by the Department of Health and Human Services.  Unlike its cousins, the reinsurance provisions (42 U.S.C. § 18061) and the risk adjustment provisions (42 U.S.C. § 18063), both of which likewise help reduce the risks of writing policies for sale on an Exchange, Risk Corridors is not drafted to be budget neutral.  That was the way the Congressional Budget Office scored it — it assumed that receipts under the provision would equal outlays — but this was clearly a blunder that should have been apparent at the time and that minimized the advertised budgetary risk entailed by passage of the Affordable Care Act. As discussed in an earlier blog post, if the distribution of profit and loss by insurers selling in the Exchanges is skewed in the loss direction, the government will be obligated to pay out more than it takes in.  Where the funding for this new “entitlement” for the insurance industry would come from is unclear. Senator Rubio is thus correct again when he says that the bill will be paid for by the taxpayer.

Senator Rubio is not correct to imply, however, that, standing by itself, the underestimate of Risk Corridor exposure represents this enormous understatement of the cost to the taxpayer of the Affordable Care Act.  That law, for better or worse, always called for large taxpayer outlays to help prop up an insurance system that, as one of its critical architectural features, would attack medical underwriting by insurers.  Indeed, although it was not apparent to many until recently, precisely because of the Three Rs of Risk Corridors, “free” reinsurance and future “risk adjustments,” the Affordable Care Act always created this scheme that looked like it preserved private insurance but in fact converted insurers largely into claims processors in a system in which profitability and core insurance functions were largely controlled by the federal government.

To see the relative magnitude of the Risk Corridors program, consider the bigger picture. The CBO projected most recently, for example, that subsidies to help individuals purchase insurance via tax credits and cost sharing reductions would total $26 billion in 2014 and ramp up to $108 billion by 2017.  To be sure, that figure was based on the assumption, which is beginning to look very suspect, that there would be 7 million people in the Exchanges in 2014, and thus might decrease if enrollment is considerably lower.  Still, since by my calculations it seems unlikely that the Risk Corridor payments will amount to more than $1 billion per year (but see footnote below), it is not as if the cost of “Obamacare” suddenly went through the roof. Maybe Risk Corridors could be considered the “straw that broke the camel’s back,” but the Affordable Care Act has always been a stretch of the federal budget and it has been a stretch that many have long found deeply troubling.

CBO projections on the cost of the Exchanges
CBO projections on the cost of the Exchanges

The more serious issue surrounding Senator Rubio’s suggestion that Risk Corridors be repealed is that such an action might well be the straw that broke the insurers’ backs.  Insurers do not have to participate in the Exchanges and they certainly do not have to continue to do so in 2015. I suspect that if, anything stands right now or in the future between the deeply troubling enrollment numbers and an adverse selection death spiral caused by a combination of premium escalation and insurer withdrawals from the exchange marketplace, it is insurers’ belief that Uncle Sam will take care of the insurance industry.  Indeed, that’s the not-too-subtle consolatory hint that accompanied the letter sent last week by the Obama administration to state insurance commissioners. It tells regulators and insurers that, to enable the President to keep his oft-repeated campaign promise — I don’t even have  to tell you which one — the healthy insureds on which Exchange insurers were banking would now be given a sometimes cheaper (and sometimes competitive) alternative. How many of these victims of the previously broken promise would have purchased insurance on the Exchanges if forced to do so is open to question. But, at the present time, every insured helps those Exchanges survive, even if only barely.

By telling insurers that, contrary to the strong hints at the end of  the Obama administration letter, there will be no relief for the additional average costs now imposed on insurers,  passage of Senator Rubio’s bill might lead to the implosion of the insurance Exchanges and the death of a crucial portion of the Affordable Care Act. While such a result would hardly deter many from voting in favor of the bill, those who dislike the Affordable Care Act ought to think hard not just about how much they want it to end but in what way they want it to end. Dismantling the ACA is itself going to be difficult and painful — wait until we hear the cries from the people who deeply craved the subsidized insurance they thought they were receiving or who otherwise benefited from the Act — and ultimately entails very serious and difficult policy choices about how we want to finance healthcare in the United States.  Consumer driven? Single payor? If the law is to be unwound, it would be better if it were done in as deliberate and orderly way as practicable rather than as an unforeseen result of legislation that purported to deal with a narrow aspect of the ACA.

There is, it should be noted, a compromise position that will preserve something of Risk Corridors while not adding to the federal budget deficit.  One could amend the Risk Corridors provision to force it to be budget neutral.  This has already been done in the companion provisions of stop-loss reinsurance and risk adjustment and there is no reason that, if legislators could act in good faith, the law could not be modified to state that payments by the Secretary of HHS to insurers would be reduced pro rata to the extent necessary to make payments in under Risk Corridors equal payments out.  This potential reduction in payments might, it must be acknowledged, scare insurers and contribute to the implosion of Obamacare, but it would be less likely to do so that a bill that repealed Risk Corridors altogether.

A Footnote on the cost of Risk Corridors

Footnote: I’ve been thinking some more about a back of the envelope computations in a blog entry that attempted to develop a relationship between the number of people enrolling in insurance on the Exchanges and the size of the Risk Corridor payments. As those paying the closest attention to my prior blog post will recall, I made an assumption about the spread of the distribution of insurer profits and losses.  The assumption was not unreasonable, but it was also hardly infallible.  What if, I have been wondering, the spread was much narrower than I suggested it might be?

I decided to run the experiment again using a standard deviation of profits and losses only 1/10 of what it had been.  I thus create regimes in which the financial fates of most insurers selling policies are closely tied together.  What I find is that assuming that most insurers will either make money or that most insurers will lose money has a tendency to increase the payments the government will likely have to make if enrollment is small.  In this new experiment, payments peak at about $1.5 billion rather than $1 billion in the prior experiment.  Bottom line: the prior blog post was basically correct — we are dealing here with very rough estimates — but if all insurers are subject to similar economic forces the Risk Corridor moneys paid by the government might grow somewhat. Still, it is not as if the cost of Risk Corridors is suddenly going to dwarf the cost of premium subsidies and cost sharing reductions already required by the ACA.




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