Probably illegal and unquestionably stupid: Covered California’s release of personally identifiable information

Los Angeles Times article
Los Angeles Times article

The Los Angeles Times has reported that Covered California, the largest state’s health insurance exchange under the Affordable Care Act, has started releasing to insurance agents throughout the state the names and contact information of tens of thousands of persons who started an application using the state’s online system but failed to complete it. The Covered California director Peter Lee acknowledges the practice but says that the outreach program still complies with privacy laws and was reviewed by the exchange’s legal counsel. “I can see a lot of people will be comforted and relieved at getting the help they need to navigate a confusing process,” explained Lee.

I am hardly as confident as Covered California’s lawyers apparently were that this practice was legal. The law requires that disclosures to third parties be necessary and I do not see why Covered California could not have contacted non-completers directly and ask them if they wanted help from an insurance agent rather than disclosing their identify to insurance agents.  But even if the practice could be said to be borderline legal, it is difficult to imagine a practice more likely to sabotage enrollment efforts in California — and, since California’s interpretation could be precedent for other states — elsewhere.  For every person unable to complete their application online in California and who will, with the comforting help provided by insurance agents, now want to complete it, there are likely 10 who will be turned off by the cavalier attitude towards privacy exhibited by this government agency.  Beyond a violation of ACA privacy safeguards, the action is either a sign of desperation about enrollment figures, even in a state that boasts of its success such as Peter Lee’s California, or monumental stupidity.

If California wanted to create an adverse selection death spiral, it would be difficult to be more effective than, without notice or consent,  releasing personally identifiable information to insurance agents.

The Law

Let’s start with the Affordable Care Act itself. Section 1411(g)(2), codified at 42 U.S.C. § 18081(g)(2), reads

(g) CONFIDENTIALITY OF APPLICANT INFORMATION.— 

 

(2) RECEIPT OF INFORMATION.—Any person who receives information provided by an applicant under subsection (b) (whether directly or by another person at the request of the
applicant), or receives information from a Federal agency under subsection (c), (d), or (e), shall—
(A) use the information only for the purposes of, and to the extent necessary in, ensuring the efficient operation of the Exchange, including verifying the eligibility of an individual to enroll through an Exchange or to claim a premium tax credit or cost-sharing reduction or the amount of the credit or reduction; and

(B) not disclose the information to any other person except as provided in this section.

 

Health and Human Services, one of the key agencies in charge of administering the Affordable Care Act has implemented this statutory provision in  section 155.260 of Title 45 of the Code of Federal Regulations. It says:

§ 155.260 Privacy and security of personally identifiable information.

(a) Creation, collection, use and disclosure.
(1) Where the Exchange creates or collects personally identifiable information for the purposes of determining eligibility for enrollment in a qualified health plan; determining eligibility for other insurance affordability programs, as defined in 155.20; or determining eligibility for exemptions from the individual responsibility provisions in section 5000A of the Code, the Exchange may only use or disclose such personally identifiable information to the extent such information is necessary to carry out the functions described in § 155.200 of this subpart.
This regulation requires us to answer several questions: (1) was the information in question “personally identifiable information” ; (2) was it collected for one of the purposes set forth in subparagraph (a)(1); (3) and was its use or disclosure necessary to carry out a permitted function.

Did Covered California release personally identifiable information? Yes.

Section 155.260 of the Code of Federal Regulations does not appear to define personally identifiable information — although it is difficult to imagine anything that would fit it better than one’s name, address, phone number and email address. And, if one consults the Department of Labor, they say “PII” is:
Any representation of information that permits the identity of an individual to whom the information applies to be reasonably inferred by either direct or indirect means. Further, PII is defined as information: (i) that directly identifies an individual (e.g., name, address, social security number or other identifying number or code, telephone number, email address, etc.) or (ii) [omitted] Additionally, information permitting the physical or online contacting of a specific individual is the same as personally identifiable information. This information can be maintained in either paper, electronic or other media.
This definition fits what Covered California released to the letter.
Examples of personally identifiable information
Examples of personally identifiable information

Or, if Department of Labor regulations are not enough, consider HHS’s own privacy training materials.  They list name and email address — exactly what Covered California released — as emblematic personally identifiable information. HHS didn’t make this list up; they borrowed from footnote 1 of the White House’s Office of Management and Budget memorandum on Safeguarding Against and Responding to the Breach of Personally Identifiable Information

Was it personal information collected for the right purpose? Yes

Apparently it is not just any collection of PII that triggers obligations under 155.260. It is collection for certain purposes.  One of those purposes is “determining eligibility for enrollment in a qualified health plan.” It would surely appear that this was the purpose for which the information was provided. The individuals contacting the website were unlikely, except in peculiar cases, to be doing it for academic purposes or research. They wanted to find out whether they could get health insurance in an Exchange, what plans might be available, and what the price might be.  That’s what everyone has been advertising as the purpose of the Exchange. And, although one would think this goes without saying, that’s the reason Covered California wanted the person’s name and other personally identifiable information. Covered California wanted to determine whether that person — not some anonymous shopper — was eligible and what plans were available to that person. Covered California wanted very much to be able to link the determinations made by the back end of the web site to the identity of the person requesting that the determination be made.

Was this a necessary disclosure? Dubious

If I were representing Peter Lee or others involved with this privacy incident, this is where I might want to rest my defense. (But if I were running other health insurance exchanges or hoping for the success of the ACA, I think I’d try to stop him from doing so). The regulation does not prohibit all uses of personally identifiable information. Nor does it actually prohibit release of the information outside of the health insurance exchange. Rather — and this may be as disturbing to some as the news of what Covered California has done — it actually authorizes external disclosure and external use under some circumstances.

First, the Exchange may only use or disclose such personally identifiable information only “to the extent such information is necessary to carry out the functions described in § 155.200 of this subpart.” When we leaf to section 155.200, we find it says the legitimate functions are those in various subparts of the regulations.  The relevant parts, however, are determining eligibility for subsidies and actually enrolling in a plan. Since these two functions are, I believe, precisely what Covered California had in mind, it would not appear to violate these specific portions of the regulation to third parties so long as the purpose was eligibility determination and enrollment.

There are, however, at least three rebuttals to this argument that, standing alone, might suggest that Covered California’s actions were lawful.

Rebuttal 1: But surely this does not mean that Covered California could publish the names of incomplete enrollers in the Los Angeles Times or on some internet list and ask that the public help them out. The regulations also place limits on the persons to whom disclosure may be made. Read this part of section 155.260:

(b) Application to non-Exchange entities.  … [W]hen collection, use or disclosure is not otherwise required by law, an Exchange must require the same or more stringent privacy and security standards (as § 155.260(a)) as a condition of contract or agreement with individuals or entities, such as Navigators, agents, and brokers, that:
(1) Gain access to personally identifiable information submitted to an Exchange; or
(2) Collect, use or disclose personally identifiable information gathered directly from applicants, qualified individuals, or enrollees while that individual or entity is performing the functions outlined in the agreement with the Exchange.
Thus, if the third parties themselves agree to abide by the privacy regulations, perhaps they could use personally identifiable information the same way as the Exchanges themselves might. But I have doubts that all the parties to whom the information was released had entered into such “subect-to agreements.”  The Los Angeles Times article understandably leaves the issue a bit unclear, but it appears the disclosure of the information went in two stages, first to some agencies with whom California had pre-existing agreements and second to various insurance agents. While I would not be surprised if Covered California had “subject-to agreements” with the four agencies, I would be surprised if they had agreements with all to whom the second stage disclosure was met.  This is a factual issue that will need to be resolved should a formal dispute arise over the release of the information.
Rebuttal 2: Just because one could disclose the information to certain third parties does not mean it was “necessary” to do so. Section 155.260(b) does not authorize all disclosures to third parties that have entered into subject-to agreements. Rather, it authorizes only necessary disclosures. Was it really necessary for third parties to contact these individuals? Why could Covered California not keep the matter in house and do it itself? They had the information. They could inform those individuals that if they wanted to contact an insurance agent, there was a list of authorized agents who could help them.
Which brings me to …
Rebuttal #3:  There’s another provision in the regulations that needs to be considered: the idea of informed consent. Section 155.260(a)(3)(iv) states:
Individuals should be provided a reasonable opportunity and capability to make informed decisions about the collection, use, and disclosure of their personally identifiable information.
If the Los Angeles Times article is complete and accurate, this was not done here. There appears to have been no effort to ask enrollees whether, if they were unable to complete their enrollment, they wanted to be contacted by an insurance agent for help. Rather, contrary to the “informed decision” principle in (a)(3)(iv), Covered California just assumed that they would.  And, although some web site users might indeed have wanted such assistance, many others, I suspect, would not want third parties with potential commercial motives and who may not have been well vetted informed about personal medical insurance and financial matters. The whole point of (a)(3)(iv) is that the individuals should have some notice and say about the matter.  And it is that provision that appears to have been completely ignored here.

Legal conclusion

In the end, it appears to boil down to whether the disclosures to insurance agents was necessary and done in the right way. As to whether it was necessary, I have serious doubts. I don’t see why Covered California could not itself just have easily sent the incomplete enrollers a communication with a list of insurance agents. Moreover, even if many users would prefer that the communication flow go first to insurance agents and then to them, the language of the informed consent regulation indicates that notice of such a policy have been provided.

The stupidity

According to a recent poll published in the Christian Science Monitor, eighty percent of the American public say people should be concerned “about the security features of the Obamacare website.” Concerns about the security of the information inside the health care Exchanges has been fanned by many parties. The right wing (and sometimes the left wing) has repeatedly attacked the implementation of Affordable Care Act on grounds that  giving Big Brother all this information about one’s finances, health and identity is dangerous. It is, they have warned, hardly immune from hackers. The government’s abysmal track record in construction of the web site hardly gives one confidence.  

Moreover, whether exaggerated or not, fears about the security of the detailed financial and personal data that will ultimately lie inside the health care exchanges have some technological support. Sources that would ordinarily not be dismissed as kooky or overly politicized have repeated these warnings.  Here are some from the Mitre CorporationPopular Mechanics and Information Week. Mainstream media has noted the problem (CNBC, Fox News). Moreover, the fears have been amplified by commentators that, no matter what one may think of them, have large audiences that take what they say seriously. Here are some from Rush Limbaugh (“single biggest threat to individual security and identity security that we have in this country”), Sean Hannity (“we are hearing from security experts that the website is not safe”), Fox News (“it doesn’t look like anything was fixed from a security perspective”), Mother Jones (“According to several online security experts, Healthcare.gov, the portal where consumers in 35 states are being directed to obtain affordable health coverage, has a coding problem that could allow hackers to deploy a technique called “clickjacking,” where invisible links are planted on a legitimate web page.”).

Given the widespread concern and the dependency of the entire system on enough people risking their personally identifiable information in order to enroll in the health care exchanges under the Affordable Care Act, one would think government officials would be extraordinarily vigilant against hackers and others who would seek to take private information outside the Exchanges. One would think, all the more, that government itself would not be disclosing the information. 

And this is what makes Covered California’s actions so mind-bogglingly stupid. Yes, releasing one’s name and email address might not be the same as releasing information about sexually transmitted diseases or the size of one’s bank account, it is still precisely the sort of information that many Americans seek to block others from having and give up only as absolutely necessary.  And releasing information to insurance agents who promise to abide by privacy rules is not the same as posting names and addresses directly on the Internet. Even so, if government is to give this information out — to those whose bona fides may not always be known and who have a commercial motive to misuse the information —  there better be an awfully good reason. Otherwise, those borderline people thinking about enrolling in an Exchange and on whom the whole of the Affordable Care Act really depends for its full success are going to think that the government places very little weight on privacy.  It is that sort of thinking, perhaps as much as concerns about the economics of the Affordable Care Act, that risks driving the whole system into an adverse selection death spiral from which it will be unable to escape. It is hard to imagine the pressure Covered California must be under to meet enrollment goals that would cause it to lose sight of these central points.

 

Conclusion

Let’s end with a look at one final statutory provision: section 1411(h)(2) of the ACA. It says:

Any person who knowingly and willfully uses or discloses information in violation of subsection(g) shall be subject, in addition to any other penalties that may be prescribed by law, to a civil penalty of not more than $25,000.

I would suggest that Peter Lee of Covered California think very carefully about this provision. I would suggest that insurance agents like  Warner Pacific Insurance Services in Westlake Village, an identified recipient of this information, think very carefully about it too before using it to contact individuals. Perhaps the Obama administration will choose to excuse this apparent breach of the law due to what they may regard as the good motivations of the violators, but if you multiply $25,000 by each phone call or email, it can really add up. Those involved in this release of information better hope that Covered California lawyer did some really good legal research and analysis before apparently giving the practice a clean bill of health.

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Phantom costs: The lawless proposal to buy off the insurance industry via a “fix” to Risk Corridors

In my last blog post, I began to explain the proposed “fix” to the Risk Corridors program that the Obama administration seeks to achieve through modifications of its regulations. This is the provision of the Affordable Care Act under which the federal government reimburses large proportions of money lost by insurers over the next three years selling insurance to individuals in the Exchanges or to small employers.  Originally thought by many to be budget neutral, if, as appears increasingly possible, insurers on average lose significant money in the Exchanges, Risk Corridors could cost the federal government hundreds of millions of dollars or more.

I also suggested in that prior blog post that the “fix” raised serious concerns about the rule of law and separation of powers.  In this post, I want to follow up and explain further the accounting trickery and word play in which the administration is engaged and why it is not authorized by any law passed by Congress. Basically, the proposed changes in the regulations amount to an illegal pay off to the insurance industry so that they do not exit the Exchanges after having had the rug pulled out from under them by another decision not to enforce the law as written.

In sum, the Obama administration is proposing without any statutory authorization to let insurers increase the amount they get from the federal government under the Risk Corridors provision of the Affordable Care Act by treating as a “cost” money that the insurers have not spent and that can not be fairly said to be a cost of doing business.  The Obama administration makes this use of phantom costs appear more palatable by terming it “profit” and likening it to an opportunity cost of capital. But the increased “profits” the Obama administration now seek to permit insurers to subtract as a cost has completely detached itself from anything to do with real opportunity costs of running a business. The Obama administration would have been equally dishonest had they permitted insurers to place triple their rent on their Risk Corridor accounts and term the extra 200% a cost of business that entitled them to yet more money from the government. The proposed regulations should be seen as unlawful as an attempt by the Executive branch to change hard percentages used in the statute such as  80% into 95% simply because the Executive thought it better balanced the interests at stake.

Background

The fundamental problem stems from the divergence between what the President repeatedly told Americans during his presidency — if you like your health care plan, you can keep it — and what the Affordable Care Act (a/k/a Obamacare) really said, particularly as it ended up being implemented by the President’s own executive agencies (here and here). The insurance industry acted as if the rule of law mattered, not the campaign rhetoric or people’s perceptions of it, and set its prices in the healthcare Exchanges in accord with the law and the administration’s own forecasts of its effects on competing policies otherwise available to healthy people.  So, when the President announced on November 14, 2013, that his administration would conform the law to his rhetoric and public expectations (by declining under certain circumstances to execute sections 2701-2709 of the Public Health Service Act as modified by the Affordable Care Act), the insurance industry had a fit. It appropriately warned the President that, by reviving competitive sources of health insurance for some of their healthiest potential insureds, he was destabilizing the insurance markets. And, since the keystone of the President’s signature piece of legislation, the Affordable Care Act, depends on happy private, profitable insurers, this was a warning the President and his executive agencies had to heed.  Instead of backing down on the November 14, 2013 announcement, the President doubled down on regulatory change. This past week the Department of Health and Human Services proposed in the Federal Register how current Risk Corridor regulations might be amended to give insurers relief.

A Quick Look at the Statute

For ready reference, here’s an excerpt of the key part of the Risk Corridors statute in question.  You can try to read it now or refer to it periodically as you progress through the remainder of this blog entry.

(b) PAYMENT METHODOLOGY.—
(1) PAYMENTS OUT.—The Secretary shall provide under the
program established under subsection (a) that if—
(A) a participating plan’s allowable costs for any plan
year are more than 103 percent but not more than 108
percent of the target amount, the Secretary shall pay to
the plan an amount equal to 50 percent of the target
amount in excess of 103 percent of the target amount;
and
(B) a participating plan’s allowable costs for any plan
year are more than 108 percent of the target amount,
the Secretary shall pay to the plan an amount equal to
the sum of 2.5 percent of the target amount plus 80 percent
of allowable costs in excess of 108 percent of the target
amount.

The Federal Register Proposal

The fundamental idea in the new Risk Corridors proposal is to put the insurers back in the same position they would have been in had the non-enforcement announcement (“the transitional policy”) not been made.One can see this point made repeatedly in the Federal Register proposal:

Therefore, for the 2014 benefit year, we are considering whether we should make an adjustment to the risk corridors formula that would help to further mitigate any unexpected losses for issuers of plans subject to risk corridors that are attributable to the effects of the transition policy. (78 FR 72349)

We are considering calculating the State-specific percentage adjustment to the risk corridors profit margin floor and allowable administrative costs ceiling in a manner that would help to offset the effects of the transitional policy upon the model plan’s claims costs. (78 FR 72350)

Although the adjustment that we are considering would affect each issuer differently, depending on its particular claims experience and administrative cost rate, we believe that, on average, the adjustment would suitably offset the losses that a standard issuer might experience as a result of the transitional policy. (78 FR 72350)

Two clearly illegal ways to “fix” the problem

The problem the administering agency (Health and Human Services) faces, however, is how. How does HHS “suitably offset the losses that a standard issuer might experience as a result of the transitional policy?” One simple way might have been to adjust the reimbursement percentages contained in the statute, changing them from 50% and 80% for different levels of losses to higher levels. The problem is that the statute (42 U.S.C. § 18062) specifically sets forth the 50% and 80% reimbursement percentages and it would challenge even the most fertile imaginations to contend that it was within the province of an administrative agency to interpret those, as, say, 70% and 95%. And in the current gridlock — and with proposals to repeal Risk Corridors circulating —  getting such a proposal through Congress would seem impossible.

Alternatively, the administration might have made the insurers whole by adding state-by-state constant terms to the formula for reimbursement that roughly approximated the amount a typical insurer might lose in that state. Again, though, that would just constitute a statutorily unauthorized give away of federal taxpayer to the insurance industry.  Congress did not authorize payments so that insurers could maintain the same profits they would have earned in an alternative regulatory environment; instead Congress attempted to compress the profits and losses of insurers based on the regulatory environment that they in fact were in.

The “fix” suggested by the Federal Register proposal: what’s the difference?

What I now want to persuade you of, however, is that, after one strips away the confusing accounting, the Federal Register proposal, in its essence, amount to the same thing as these clearly unauthorized alternatives.  They are, in effect, a coverup for a giveaway of government money. The are very much the assumption of legislative powers by the executive branch of government.

The conceptual problem

One can almost see the problem without doing the math. The very objective set forth repeatedly in the Federal Register proposal — of putting the insurer back into some alternative financial condition, almost as if the government had taken their property or committed a tort by changing the rules — is nowhere to be found in the Risk Corridors statute. Section 1342 speaks of real premiums earned and real costs incurred and looks at their ratio in order to determine federal aid to insurers writing in the Exchanges. That perspective is echoed in the initial regulations published in the Federal Register months before the “transitional policy” brouhaha broke out. The definitions of critical terms adopted in those regulations speak of costs “incurred” or the “sum of incurred claims” or “premiums earned.” (See note below on definitions). Moreover, the definitions are nationwide. There is no sense that the values in the regulations (such as limits on the amount of administrative costs that can be claimed by an insurer) need to be adjusted on a state-by-state basis. And that refusal to adjust the regulations based on different economics in different states exists under the current regulations even if insurers in different jurisdictions have different financial experiences under the Affordable Care Act or face different state regulatory environments.

So, with those darned percentages statutorily nailed down, how does one achieve the objective in the Federal Register proposal of giving insurers their anticipated profits back? The answer is that the Federal Register proposal attempts to add a phantom cost that will vary state-by-state in precisely the amount needed to do the job.  Of course, writing “state-specific phantom cost” into the regulations would alert everyone that the plan was just to shovel money to insurers to keep them happy regardless of what was in the law. So, instead, the idea was to seize upon a word already in the regulations — “profit” — and alter its definition beyond recognition. Expanded “profit” could then do the same job as “state specific phantom cost.”

The math

Here are the specifics. The statute makes the amount the insurer receives in Risk Corridor payments (or pays) depend on a ratio.  A higher ratio often results in more payments and never results in smaller payments from HHS. The numerator of the ratio is something called “allowed costs,” so the higher the allowed costs, the better HHS treats the insurer under Risk Corridors.  The denominator of the ratio is something called “the target amount.” Because higher ratios are good for the insurer, the smaller the “target amount” the better HHS treats the insures under Risk Corridors. (Remember, dividing by a smaller number yields a higher result.) And “target amount” is defined as total premiums less administrative costs.  So, the more an insurer can stuff into administrative costs, the smaller the denominator, the higher the ratio, and the better the insurer fares under Risk Corridors. Indeed, much of the regulatory effort has been appropriately devoted to deterring insurers from exploiting the formula by stuffing overhead they incur servicing non-ACA policies into “administrative costs” that increase their Risk Corridor payments. (Good idea!)

Back in March of 2013, in trying to figure out how to operationalize the ideas contained in the Risk Corridors statute, HHS decided to recognize that the insurer risks its capital in order to operate an insurance company. HHS recognized that it is therefore appropriate to treat some of that opportunity cost as a true cost. (I have no particular problem with the concept). Perhaps unfortunately, but as a convenient shorthand, HHS called this opportunity cost “profit.” Be clear, however, the term “profit” as used in the regulations had little to do with how much money the insurer actually made; it was just an easy term to reflect the fact that when insurers use money to establish offices and buy computers they forgo interest and dividends  that they might otherwise have earned.

But how much of this opportunity cost called “profit” should an insurer be entitled to use to reduce its Risk Corridor denominator?  After receiving comments that were apparently almost uniform on the subject — the one dissent advocated a lower number — HHS decided to use 3% of after-tax premiums. It called this number, “the profit margin floor.”

Several things are significant about the decision to use 3% of premiums.  First, the profit margin floor is 3%, not 6% or 9% or some higher number yet. No one apparently thought the number should be higher. Second, the number is uniform across states. This is entirely sensible because, to the extent that an allowance for capital costs is appropriate at all, capital costs of an insurer are incurred in a national market. Insurers in California do not have opportunity costs of capital that differ very much from insurers in Texas. And, third, the number is a coefficient of net premiums rather than assets probably because use of premiums provides a sensible surrogate for the amount of capital risked by running an Exchange insurance operation instead of running one’s entire insurance business.

What the new Federal Register proposal does is to increase the profit margin floor and to do it in a state-specific way. By increasing the profit margin floor, one can decrease the target ratio denominator and increase the Risk Corridors ratio, which in turn can increase the payment made by HHS to the insurer.  Mathematically, increasing the profit margin floor is little different than permitting the insurer to count triple-rent on its offices rather than real rent or to just pad its electric bills by, say, a million dollars. All are additions of non-existent “phantom costs” that act to decrease a denominator and, derivatively, increase a ratio upon which reimbursement depends.

Moreover, the amount by which the profit margin floor will need to be increased is not a trivial amount.  As shown in the Risk Corridors Calculator, “profit margins” may need to be tripled or more to bring an insurer back to the same position they were in originally.  I would not be surprised to see the profit margin floor in some states in which adverse selection proves particularly problematic to be upwards of 12%.  I am not aware of many insurers making 12% of their premiums in profits, which is precisely why, before they saw the need to repair the damage done by the President’s change of mind, HHS was using 3% as the appropriate figure with only lower numbers being suggested.

Why the proposed fix is unlawful

Any thought that the proposed increase in profit margin floor might have something to do with economic reality, with changes in the cost of capital, is belied by the way HHS explains the change and by the state-by-state approach it now proposes to take.  The HHS explanation is that, because different states are implementing “the transitional plan” differently, the need to adjust Risk Corridors to bring insurers back to their former position differs as well.

We believe that the State-wide effect on this risk pool will increase with the increase in the percentage enrollment in transitional plans in the State, and so we are considering having the State-specific percentage adjustment to the risk corridors formula also vary with the percentage enrollment in these transitional plans in the State. (78 FR 72350)

Of course, in some sense, this is true. But this simply highlights the point that the adjustments to profit margin floor have nothing to do with real costs, the concept the statute cares about.

Not enough? Take a look at the explanation for why HHS did not adjust profit margin floors it on an insurer-by-insurer basis.  It has nothing to do with different costs of capital that different insurers might face, but again, the state-by-state approach is used because it is a simpler way of approximating and offsetting the loss insurers would face in each state as a result of differential effects of the transition policy.

Although the adjustment that we are considering would affect each issuer differently, depending on its particular claims experience and administrative cost rate, we believe that, on average, the adjustment would suitably offset the losses that a standard issuer might experience as a result of the transitional policy. (78 FR 72350)

The administrative law and separation of powers issue is whether the agency empowered with administering Risk Corridors can count as a cost not an expense the insurers actually incur as a result of being in an Exchange but the “regulatory taking” that will occur differentially in each state as a result of President Obama changing his mind. I suppose that, if there is someone with standing to challenge this give away of government money, it will ultimately be for the courts to decide this question.  (By the way, if anyone can suggest someone who might have standing, email me). And I suppose someone can argue that it actually fulfills some general intent of the ACA to keep insurers involved in the Exchanges and not have them flee when other regulations change.

Executive administrative agencies such as the Department of Health and Human Services have the authority under some circumstances to interpret statutes; courts will often then defer to their interpretations. But this fix is not a stretch; if it actually does what its drafters intend, it will be a redraft of the Affordable Care Act itself. I see no difference except opacity between what the Obama administration has done by seizing on a code word “profit” and expanding its definition beyond recognition and saying that when the statute says 80% of losses, surely that could be construed as 95%. Both are unlawful.

Two final notes

The allowable administrative cost cap percentage and the medical loss ratio

Careful readers of the Federal Register will note that there are two other matters it discusses.

The Federal Register proposal also discusses the need to adjust the “allowable administrative costs ceiling (from 20 percent of after-tax profits) in an amount sufficient to offset the effects of the transitional policy upon the claims costs of a model plan.” This provision is needed because otherwise, even if the profit margin floor were increased, insurers would bump up against the existing administrative cost ceiling of 20%.  So, to make sure that the phantom cost “profit margin floor” increase really works, the proposed regulations propose removing that constraint. And to make sure that evil insurers do not take advantage of the relaxed constraint to allocate more of their costs to Exchange plans, the regulations make clear that the insurer would had to have met the 20% standard before consideration of increased “profit” was made.

The Federal Register proposal also discusses a need to adjust the Medical Loss Ratio (MLR) percentages. This is the provision of the ACA that says that if insurers spend too much of their money on non-claims matters, they have to pay a rebate to their insureds.  The problem becomes that if insurers are permitted to treat more than 20% of their premiums as administrative costs for purposes of Risk Corridors they might want to treat more than 20% of their premiums as legitimate administrative costs for purposes of MLR rebates. It’s a little fuzzy, but it sounds as if HHS wants to tweak the MLR regulations so that the MLR provisions do not take away from insurers what they will be winning if the remainder of the Federal Register proposal goes into effect.

The typo in the statute

There’s a complication we have to work through. This whole area is complicated by the fact that there is a typographic error in section 1342.  Here again is the relevant part.

(b) PAYMENT METHODOLOGY.—
(1) PAYMENTS OUT.—The Secretary shall provide under the
program established under subsection (a) that if—
(A) a participating plan’s allowable costs for any plan
year are more than 103 percent but not more than 108
percent of the target amount, the Secretary shall pay to
the plan an amount equal to 50 percent of the target
amount in excess of 103 percent of the target amount;
and
(B) a participating plan’s allowable costs for any plan
year are more than 108 percent of the target amount,
the Secretary shall pay to the plan an amount equal to
the sum of 2.5 percent of the target amount plus 80 percent
of allowable costs in excess of 108 percent of the target
amount.

See in subparagraph (1)(A) where it says “the Secretary shall pay to the plan an amount equal to 50 percent of the target amount in excess of 103 percent of the target amount.” But if you think about it, this could never happen.  Taken literally, there could never be a payment under this provision. So long as the target amount is a positive number, which it always will be since premiums are positive, the target amount can NEVER be in excess of 103% of the target amount.  5 can never be in excess of 103% of 5 (5.15).  10 can never be in excess of 103% of 10 (10.30). Can’t happen.

Looking at the next subparagraph, (1)(B), resolves the mystery of subparagraph (1)(A). It speaks about paying “ 80 percent of allowable costs in excess of 108 percent of the target amount.” (emphasis mine). And this makes complete sense.  The more the insurer loses, the more the government reimburses the insurer.  That’s the whole point of the provision.  I therefore believe that  subparagraph (1)(A) should be interpreted to mean “the Secretary shall pay to the plan an amount equal to 50 percent of  allowable costs in excess of 103 percent of the target amount.”

So, I assume that courts will interpret the statute to read as Congress must have intended it and not as some sort of cute joke resting on a mathematical impossibility.  See United States v. Ron Pair Enterprises, 489 U.S. 235 (1989) (“The plain meaning of legislation should be conclusive, except in the ‘rare cases [in which] the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters.’ Griffin v. Oceanic Contractors, Inc., 458 U. S. 564, 571 (1982). In such cases, the intention of the drafters, rather than the strict language, controls. Ibid.” )

Note on Definitions

As set forth in the regulations, “Allowable costs mean, with respect to a QHP [Qualified Health Plan], an amount equal to the sum of incurred claims of the QHP issuer for the QHP.” The regulation sensibly uses the word “incurred.” This is so because costs are things the insurer has to pay out or has to accrue liabilities for, not things that, under some other set of circumstances they might otherwise have had to pay out.  If that were not the case, the administration could redefine costs to include anything at all, such as the costs the insurer would have faced if every one of their insureds had cancer.

The regulations tweak the definition of “administrative costs” by adding an extra adjective. They introduce the concept of “allowable administrative costs.”  The insurer is not permitted to reduce its “target amount” by claiming some enormous sum (such as private jets for the CEO) as non-claims costs, subtracting them from premiums and reporting low net premiums (target amount) in order to get paid more by the government under the Risk Corridors program. Instead, the regulations define “allowable administrative costs” as non-claims costs that are not more than 20% of premiums. That makes some sense because section 10101 of the ACA (42 U.S.C. § 300gg-18) often requires insurers whose administrative costs are more than 20% of premiums to pay a rebate to their insureds.

Premiums are also reasonably defined under the existing regulations. They sensibly say, “Premiums earned mean, with respect to a QHP, all monies paid by or for enrollees with respect to that plan as a condition of receiving coverage.” Thus, under the statute and existing regulations, premiums must refer to real premiums, not hypothetical premiums. Premiums are moneys the insurer receives, not money the insurer might have received under some other set of circumstances. Again, this just has to be the case; if it were not true, the administration could funnel virtually an infinite amount of money to the insurance industry by saying that premiums are funds the insurer would have received if no one signed up for their plan. 

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The Risk Corridor Calculator: How the government plans to use fictitious profits to shovel more money to insurers

Snapshot of the Risk Corridor Calculator
Snapshot of the Risk Corridor Calculator

This is a different kind of blog entry.  There isn’t going to be too much text here. Instead, I want to direct you to a spreadsheet I created (The Risk Corridors Calculator) available on Google Docs and the first (click here to watch it on YouTube) of two videos I’ll be making that explain

(1) how Risk Corridors work under the regulations originally proposed by the Department of Health and Human Services (HHS)

(2) how the insurance industry could lose money notwithstanding Risk Corridors as a result of President Obama changing his mind and conditionally permitting certain insurers for one year to “uncancel” certain  policies that the Affordable Care Act would otherwise have have prohibited starting in 2014; and

(3) how the proposed revisions to the Risk Corridor regulations will shovel money to many insurers and could put them back in the same position they would have been had President Obama not changed his mind.

[Note from 8:32 a.m. 12/6/2014: I discovered a small error in the Risk Corridors Calculator. It has been fixed.  It does not affect anything essential in this blog. Unfortunately, I will need to conform the video to the Calculator, which is likely not to happen until later today. So, if you watch the video today, it is conceptually fine, but just be aware that one of the formulas was off.]

In essence, however, the proposed HHS regulations impute fictitious “profits” to insurers that they then get to subtract from their net premiums.  As a result, it will look to the Risk Corridors program as if the insurer is losing more money in an Exchange plan and therefore entitled to greater government assistance.  (The government has now acknowledged that, although the Congressional Budget Office scored it as costing nothing, Risk Corridors need not be budget neutral.) Another way of thinking about the proposal is that it creates phantom costs that affect the apparent (though not the real) profitability of the insurer and then shovels money to insurers based in part on those phantom costs. It is little different than the government insisting that the insurer lost money due to claims that it actually did not pay and is therefore entitled — even under a formula that is formally unchanged — to greater payments from the government.  Viewed yet another way, it is almost as if the proposed regulations treat what President Obama did as a “tort,” and remedy the wrong by licensing the aggrieved insurers to use contorted accounting to place themselves back in the same position they would have been in had the President not, in effect, interfered with the prospective economic advantage they thought they had in the Exchanges.

Neither this blog entry nor the video will address whether the proposed regulations are permissible as a matter of administrative law or separation of powers. Nor will I explore today whether the regulatory changes can be seen as a necessarily evil. Exposing what is actually going on here, however, must create some serious concerns for all concerned about the rule of law. When section 1342 of the Affordable Care Act (42 U.S.C. § 18062) speaks of “allowable costs,” one would initially think it referred to costs actually incurred by the insurer as a result of running its program. Those costs might be paying claims, paying the electric bill, marketing costs and, perhaps, some reasonable allowance for profit — such as the 3% of after tax premiums actually placed in the original regulations.

But it is going to take some work to show that, by “allowable costs,” the statute meant costs that the insurer did not actually incur in running its program. The burden will be even higher due to the fact that the proposed regulations apparently contemplate varying this heightened profit allowance from state to state. This will be done not in response to different rates of return on capital in the different states, but only to take account of differential losses to insurers caused by different state responses to President Obama’s about-face on whether certain plans that violate ACA requirements could continue to be sold outside of the Exchanges.

In short, the increase in “profit” sure looks like a book-keeping entry whose sole purpose has nothing to do with anything in the statute but is instead designed to restore the insurer to the position it would have been in had federal policy not changed. It is as if the insurers are being given some sort of entitlement to the profits they would otherwise have made and the administration is looking for any term in the statute not glued down (such as an 80% reimbursement rate on certain losses) in order to accomplish this goal.

Fleshing out  more fully these matters of statutory interpretation, separation of powers, and administrative law will be left for later, however, along with a fuller explanation of what is going on inside the Risk Corridor Calculator that I created. For now, play with the spreadsheet and enjoy the video.

Resources

Society of Actuaries, Health Watch: Risk Corridors under the Affordable Care Act — A Bridge over Troubled Waters, but the Devil’s in the Details

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The incredible increase in pace that will be needed to meet ACA enrollment projections

Healthcare.gov appears to be working much better, at least in enabling individuals to select plans. And some of the state exchange web sites appear to be improving their functionality too. Some have heralded these advances as providing hope that the Exchanges will be able to meet the enrollment projections on which the economics of insurance without medical underwriting in part depend. But do these claims stand up to the cold light of mathematics?  Not very well.

Here’s the headline:

A close look at the numbers shows that the pace of enrollments from here to the close of open enrollment needed to meet projections is high in every state, even those touted as successful, and almost impossibly high in many.  Given the incredibly slow start in most jurisdictions, it will not just take a little pickup over the next few months to achieve the projected and needed number of persons in the Exchanges. It will take a miraculous last minute stampede. Since miracles seldom occur,  the result may be two different stories of the Affordable Care Act: a few states in which the Exchanges proved from the start to be a somewhat stable mechanism for providing health insurance without medical underwriting but a significant number of other states in which the results for at least the first year represent a large failure.

Today’s news

News appears to be breaking today that the federal exchanges enrolled about 100,000 in November.  This is being heralded as somewhat of a success compared to the 26,000 who enrolled in October. And, of course, enrollment figures from healthcare.gov are difficult to assess due to the actual and feared dysfunctionality of the web site. But one way to look at this is to consider what has to happen between December 1, 2013, and March 23, 2014, the close of open enrollment to make projections. The states that are dependent on healthcare.gov need about 4.84 million enrollees by the end of that period if the nation is to meet the goal of having 7 million enrolled in the Exchanges by the close of open enrollment.  If, right now, there are about 126,000 enrollees in those states, we are just 2.5% of the way there.  The pace of enrollment on healthcare.gov will need to increase by a factor of about 20 in order to meet goal.  In absolute terms, healthcare.gov needs to be enrolling about 42,000 people per day. And while perhaps not every single one of those people need to enroll for the system to succeed, the 7 million enrollment goal isn’t just a mere wish. There are, as I and many others have noted potentially serious consequences to the stability of insurance markets if the figures fall well short, even in several states.

Whether healthcare.gov can score the needed come back, however, will basically depend on two related factors: (1) whether healthcare.gov is truly fixed and can stand up to the increased pace that will be needed and (2) whether the requisite increase in pace is likely.  This latter factor depends in turn on where on the following spectrum the possibilities fall. On one end of the spectrum, there is the possibility that there is this pent up demand from procrastinators that will surge forward to access the web site in the coming weeks.  Perhaps March Madness for 2014 will constitute this huge surge — kind of like April 15 rushes to the post office to send in tax returns — as the March 23 “deadline” approaches. On the other end of the spectrum, there is the possibility that most people who wanted to and had the means to enroll — the wealthy sick — did so already and others have looked at the prices, the coverages and the penalties and decided that, for now, Exchange coverage is not for them.  The fact that a surprising 70% of current enrollees in the Exchange plans are unsubsidized gives some support to this gloomier hypothesis.

To get further insights, we can also take a closer look at some representative states.

Connecticut

First, let’s look at what has to happen in the most successful state, Connecticut. There, as of  November 14, 2013 (the date of the last report), 7,591 people had selected a plan.  That’s not all it will take finally to get coverage — among other things, people will have to start actually paying premiums — but it’s a solid start. This 7,591 figure represents 12.9% of the projected total of 58,637 for Connecticut.  A little math shows that in order to make projections, people in Connecticut will need to enroll at a pace 2.3 times faster than they had as of November 14 in order to make the projection by the March 23, 2014 date.

It hardly seems impossible that Connecticut could make the projections.  Whether they do so, however, will basically depend on the location of Connecticut on the spectrum discussed above.  We should have a better sense of where on the spectrum we are falling when Connecticut releases new numbers.

Texas

Connecticut is a small state.  The enrollment there was projected to constitute only about 1.4% of the total enrollment in the Exchanges.  Let’s take a look at a big state: my home state of Texas. With the largest uninsured population in the country and with no Medicaid expansion into which some Exchange eligible persons might otherwise “fudge into,” Texas was supposed to enroll 780,959. As of November 2, 2014, Texas had enrolled just 2,991. This means that Texas will have to enroll at a pace 59 times faster than it had as of that date in order to meet enrollment projections.  And, even if due to failure to the healthcare.gov website, Texas has enrolled, say, just 10,000 as of November 30, 2013, it will still need to up its pace by a factor of 41 in order to meet projections. Viewed in absolute terms, Texas will need to enroll at a pace of over 6,800 per day. Again, we will have a better sense of the plausibility of this increase when the federal government releases newer data.

Another way of thinking about the issue is to consider what would happen if Texas’ future enrollment relative to its prior enrollment is the same as Connecticut needs to be in order to meet the Connecticut projection. If Texas enrolls at a pace 2.3 times faster than it has thus far, Texas enrollment will be something like 29,000. That would be just 4% of what was originally projected, a shortfall of 752,000.  Connecticut could double its projected enrollment and it would barely make a dent in compensating for a shortfall of this magnitude. Even if Texas celebrates the rebirth of healthcare.gov by stepping up its enrollment by a factor of 10, that still gives it less than 150,000 enrollees, a shortfall of 630,000 over the projected value.

It would also help if the government could get the Spanish language version of its website, cuidadodesalud.gov, to accept applications the same way that healthcare.gov does.

California

A problem with projecting Texas numbers is that it has been hamstrung by its chosen dependency on healthcare.gov, which has been completely dysfunctional until recently. So, what about a large state that shares some demographic characteristics of Texas but that has a mostly functional web site?  Let’s look at California.

In California, as of November 19, 2013, there were 78,891 counted as enrolled relative to a projected enrollment as of March 23, 2014 of 691,016. Viewed one way, California is going to need to step up the pace of its enrollment by a factor of 3.07 in order to meet its target. In absolute terms, California needs a pace of about 4,936 per day (including weekends and including the busy holiday season) in order to meet target.

Whether viewed in relative or absolute terms, the pace needed in California is ambitious. Covered California, which brags of a recent tripling in the pace of enrollment, still enrolled just 2,700 per day for Exchange plans in the most recent period for which data currently exists. (It is only by counting Medicaid/Medical enrollments that the numbers get higher).  If California were to persist at that pace for the remainder of the enrollment period, it would have something like 414,000 enrolled by the March 23, 2014 date. Depending on the precise composition of the pool of insureds, such a figure would likely be enough to stave off severe adverse selection but probably not enough to do so entirely. And, again, for those focusing on the 7 million nationwide figure, shortfalls of 277,000 in California or 700,000 in Texas are just difficult to compensate for even if other states are considerably more successful.

New York

Let’s pick one more big state.  And, again, let’s pick one where the Exchange is generally said to be doing well: New York.  In New York, as of November 24, 2013, 41,021 are claimed to have enrolled in plans out of the 411,304 originally projected.  This means New York will have to quadruple the pace of enrollments (4.09) in order to meet projections. In absolute terms, the state needs to be enrolling 3,111 per day every day until March 23, 2014.  It is thus in roughly the same position as California. Whether it meets its goals depends on why there has thus far been a shortfall.  If it’s massive procrastination, perhaps New York can get pretty close.  If, on the other hand, many New Yorkers are rejecting the product, and the pace of enrollment just doubles from what it has been, expect New York to fall short by about 190,000 people (46%). Again, smaller states that are more successful will have difficulty compensating for such a large absolute shortfall.

Conclusion

There is no state in which a significant uptick in the pace of enrollments will not be needed in order to meet enrollment projections.  This is true in states that have their own Exchanges and states that do not.  It is true in states touted as a success as well, of course, of those seen as failing.  It is most definitely true for states that depend on the federal website, healthcare.gov.

In a few states, the burden may be met. Many people do indeed procrastinate, even perhaps when it comes to subsidized health insurance that they now lack. To meet enrollment projections in many other states,however,  we need for Exchange applications to be far more the province of procrastinators than even income tax returns.  After all,  only 25% or so wait until the last two weeks to file those. In these other states, the appropriate analogy may not be tax procrastination but the miracle of The Heidi Game in which two touchdowns were scored in the closing 9 seconds after the mainstream media (NBC Sports) assumed the game was lost.  But it’s been 45 years since that turnaround occurred.  It just might happen again with applications for health insurance on the Exchanges, but it seems unlikely.

Could I add one more point?

People are focusing on March 23, 2014 (earlier March 15, 2014) as the measuring date.  The ACA will presumably be deemed a success if enrollment figures meet projections by that date.  But this strikes me as an awfully generous measure. The problem for insurers is that there will be a smaller pool during the first three months of the policy year. And smaller pools generally have higher claims per person.  So, if I ran the world, I’d be looking at two dates to examine enrollments: January 1, 2014 when the plans kick in and March 23, 2014 when open enrollment ends.  Yes, great enrollment by March 23 will ultimately go a long way to reassuring insurers if enrollment is problematic on New Years Day. But if enrollment is really bad come Rose Bowl time, expect insurers to lose a lot of money on claims filed between then and the close of open enrollment.  If they can’t make that money back on the late filers, expect insurers to figure out some way of getting even for 2015.

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Shocking secrets of the actuarial value calculator revealed!

That might be how the National Enquirer would title this blog entry.  And, hey, if mimicking its headline usage attracts more readers than “Reconstructing mixture distributions  with a log normal component from compressed health insurance claims data,” why not just take a hint from a highly read journal?  But seriously, it’s time to continue delving into some of the math and science behind the issues with the Affordable Care Act. And, to do this, I’d like to take a glance at a valuable data source on modern American health care, the data embedded in the Actuarial Value Calculator created by our friends at the Center for Consumer Information and Insurance Oversight (CCIIO).

This will be the first in a series of posts taking another look at the Actuarial Value Calculator (AVC) and its implications on the future of the Affordable Care Act. (I looked at it briefly before in exploring the effects of reductions in the transitional reinsurance that will take effect in 2015).  I promise there are yet more important implications hidden in the data.  What I hope to show in my next post, for example, is how the data in the Actuarial Value Calculator exposes the fragility of the ACA to small variations in the composition of the risk pool.  If, for example, the pool of insureds purchasing Silver Plans has claims distributions similar to those that were anticipated to purchase Platinum Plans, the insurer might lose more than 30% before Risk Corridors were taken into account and something like 10% even after Risk Corridors were taken into account. And, yes, this takes account of transitional reinsurance. That’s potentially a major risk for the stability of the insurance markets.

What is the Actuarial Value Calculator?

The AVC is intended as a fairly elaborate Microsoft Excel spreadsheet that takes embedded data and macros (essentially programs) written in Visual Basic, and is intended to help insurers determine whether their proposed Exchange plans conform to the requirements for the various “metal tiers” created by the ACA. These metal tiers in turn attempt to quantify the ratio of the expected value of the benefits paid by the insurer to the expected value of claims covered by the policy and incurred by insureds. The programs, I will confess, are a bit inscrutable — and it would be quite an ambitious (and, I must confess, tempting) project to decrypt their underlying logic — but the data they contain is a more accessible goldmine. The AVC contains, for example, the approximate distribution of claims the government expects insurers writing plans in the various metal tiers to encounter.

There are serious limitations in the AVC, to be sure. The data exposed has been aggregated and compressed; rather than providing the amount of actual claims, the AVC has binned claims and then simply presented the average claim within each bin.  This space-saving compression is somewhat unfortunate, however, because real claims distributions are essentially continuous. Everyone with annual claims between $600 and $700 does not really have claims of $649. This distortion of the real claims distribution makes it more challenging to find analytic distributions (such as variations of log normal distributions or Weibull distributions) that can depend on the generosity of the plan and that can be extrapolated to consider implications of serious adverse selection. It’s going to take some high-powered math to unscramble the egg and create continuous distributions out of data that has had its “x-values” jiggled.  Moreover, there is no breakdown of claim distributions by age, gender, region or other factors that might be useful in trying to predict experience in the Exchanges.  (Can you say “FOIA Request”?)

This blog entry is going to make a first attempt, however, to see if there aren’t some good analytic approximations to the data that must have underlain the AVC. It undertakes this exercise in reverse engineering because once we have this data, we can make some reasonable extrapolations and examine the resilience — or fragility — of the system created by the Affordable Care Act. The math may be a little frightening to some, but either try to work with me and get it or just skip to the end where I try to include a plain English summary.

The Math Stuff

1. Reverse engineering approximate continuous approximations to the data underlying the Actuarial Value Calculator

Nothwithstanding the irritating compression of data used to produce the AVC, I can reconstruct a mixture distribution composed mostly of truncated exponential distributions that well approximates the data presented in the AVC.   I create one such mixture distribution for each metal tier. I use distributions from this family because they have been proven to be “maximum entropy distributions“, i.e. they contain the fewest assumptions about the actual shape of the data. The idea is to say that when the AVC says that there were 10,273 claims for silver-like policies between $800 and $900 and that they averaged $849.09, that average could well have been the result of an exponential distribution  that has been truncated to lie between $800 and $900.  With some heavy duty math, shown in the Mathematica notebook available here, we are able, however, to find the member of the truncated exponential family that would produce such an average. We can do this for each bin defined by the data, resorting to uniform distributions for lower values of claims.

The result of this process is a  messy mixture distribution, one for each metal tier. The number of components in the distribution is essentially the same as the number of bins in the AVC data. This will be our first approximation of “the true distribution” from which the claims data presented in the AVC calculator derives. The graphic below shows the cumulative density functions (CDF) for this first approximation. (A cumulative density function shows, for each value on the x-axis the probability that the value of a random draw from that distribution will be less than the value on the x-axis).   I present the data in semi-log form: claim size is scaled logarithmically for better visibility on the x-axis and percentage of claims less than or equal to the value on the x-axis is shown on the y-axis.

CDF of the four tiers derived from the first approximation of the data in the AVC
CDF of the four tiers derived from the first approximation of the data in the AVC

There are two features of the claims distributions that are shown by these graphics.  The first is that the distributions are not radically different.  The model suggests that the government did not expect massive adverse selection as a result of people who anticipated higher medical expenses to disproportionately select gold and platinum plans while people who anticipated lower medical expenses to disproportionately select bronze and silver plans. The second is that, when viewed on a semi-logarithmic scale, the distributions for values greater than 100 look somewhat symmetric about a vertical axis.  They look as if they derive from some mixture distribution composed of a part that produces a value close to zero and something kind of log normalish. If this were the case, it would be a comforting result, both because such mixture distributions would be easy to parameterize and extrapolate to lesser and greater forms of adverse selection and because such mixture distributions with a log normal component are often discussed in the literature on health insurance.

2. Constructing a single Mixture Distribution (or Spliced Distribution) using random draws from the first approximation

One way of finding parameterizable analytic approximations of “the true distribution” is to use our first approximation to produce thousands of random draws and then to use mathematical  (and Mathematica) algorithms to find the member of various analytic distribution families that best approximate the random draws. When we do this, we find that the claims data underlying each of the metal tiers is indeed decently approximated by a three-component mixture distribution in which one component essentially produces zeros and the second component is a uniform distribution on the interval 0.1 to 100 and the third component is a truncated log normal distribution starting at 100.  (This mixture distribution is also a “spliced distribution” because the domains of each component do not overlap). This three component distribution is much simpler than our first approximation, which contains many more components.

We can see how good the second-stage distributions are by comparing their cumulative distributions (red) to histograms created from random data drawn from the actuarial value calculator (blue).  The graphic below show the fits to look excellent.

Note: I do not contend that a mixture distribution with a log normal distribution perfectly conforms to the data.  It is, however, pretty good for practical computation.

Actual v. Analytic distributions for various metal tiers
Actual v. Analytic distributions for various metal tiers

 

 3. Parameterizing health claim distributions based on the actuarial value

The final step here is to create a function that describes the distribution of health claims as a function of a number (v) greater than zero. The concept is that, when v assumes a value equal to the actuarial value of one of the metal tiers, the distribution that results mimics the distribution of AVC-anticipated claims for that tier.  By constructing such a function, instead of having just four distributions, I obtain an infinite number of possible distributions. These distributions collapse as special cases to the actual distribution of health care claims produced by the AVC. This process enables us to describe a health claim distribution and to extrapolate what can happen if the claims experience is either better (smaller) than that anticipated for bronze plans or worse (higher) than that anticipated for platinum plans. One can also use this process to compute statistics of the distribution as a function of v such as mean and standard deviation.

Here’s what I get.

Mixture distribution as a function of the actuarial value parameter v
Mixture distribution as a function of the actuarial value parameter v

Here is a animation showing, as a function of the actuarial value parameter v, the cumulative distribution function of this analytic approximation to the AVC distribution.  

Animated GIF showing Cumulative distribution of claims by "actuarial value
Cumulative distribution of claims by “actuarial value”

 

One can see the cumulative distribution function sweeping down and to the right as the actuarial value of the plan increases. This is as one would expect: people with higher claims distributions tend to separate themselves into more lavish plans.

Note: I permit the actuarial value of the plan to exceed 1. I do so recognizing full well that no plan would ever have such an actuarial value but allow myself to ignore this false constraint.  It is false because what one is really doing is showing a family of mixture distributions in which the parameter v can mathematically assume any positive value but calibrated such that (a)  at values of 0.6, 0.7, 0.8 and 0.9 they correspond respectively with the anticipated distribution of health care claims found in the AVC for bronze, silver, gold and platinum plans respectively and (b) they interpolate and extrapolate smoothly and, I think, sensibly from those values.

The animation below presents largely the same information but uses the probability density function (PDF) rather than the sigmoid cumulative distribution function. (If you don’t know the difference, you can read about it here.)  I do so via a log-log plot rather than a semi-log plot to enhance visualization.  Again, you can see that the right hand segment of the plot is rather symmetric when plotted using a logarithmic x-axis, which suggests that a log normal distribution is not a bad analytic candidate to emulate the true distribution.

Log Log plot of probability density function of claims for different actuarial values of plans

 

Some initial results

One useful computation we can do immediately with our parameterized mixture distribution is to see how the mean claim varies with this actuarial parameter v. The graphic below shows the result.  The blue line shows the mean claim as a function of “actuarial value” without consideration of any reinsurance under section 1341 (18 U.S.C. § 18061) of the ACA.  The red line shows the mean claim net of reinsurance (assuming 2014 rates of reinsurance) as a function of “actuarial value.” And the gold line shows the shows the mean claim net of reinsurance (assuming 2015 rates of reinsurance) as a function of “actuarial value.” One can see that the mean is sensitive to the actuarial value of the plan.  Small errors in assumptions about the pool can lead to significantly higher mean claims, even with reinsurance figured in.

Mean claims as a function of actuarial value parameter for various assumptions about reinsurance
Mean claims as a function of actuarial value parameter for various assumptions about reinsurance

I can also show how the claims experience of the insurer can vary as a result of differences between the anticipated actuarial value parameter v1 that might characterize the distribution of claims in the pool and the actual actuarial value parameter v2 that ends up best characterizing the distribution of claims in the pool.  This is done in the three dimensional graphic below. The x-axis shows the actuarial value anticipated to best characterize an insured pool. The y-axis shows the actuarial value that ends up best characterizing that pool.  The z-axis shows the ratio of mean actual claims to mean anticipated claims.  A value higher than 1 means that the insurer is going to lose money. Values higher than 2 mean that the insurer is going to lose a lot of money.  Contours on the graphic show combinations of anticipated and actual actuarial value parameters that yield ratios of 0.93, 1.0, 1.08, 1.5 and 2. This graphic does not take into account Risk Corridors under section 1342 of the ACA.

What one can see immediately is that there are a lot of combinations that cause the insurer to lose a lot of money.  There are also combinations that permit the insurer to profit greatly.

Ratio of mean actual claims to mean expected claims for different combinations of anticipated and actual actuarial value parameters
Ratio of mean actual claims to mean expected claims for different combinations of anticipated and actual actuarial value parameters

Plain English Summary

One can use data provided by the government inside its Actuarial Value Calculator to derive accurate analytic statistical distributions for claims expected to occur under the Affordable Care Act.  Not only can one derive such distributions for the pools anticipated to purchase policies in the various metal tiers (bronze, silver, gold, and platinum) but one can interpolate and extrapolate from that data to develop distributions for many plausible pools.  This ability to parameterize plausible claims distributions becomes useful in conducting a variety of experiments about the future of the Exchanges under the ACA and exploring their sensitivity to adverse selection problems.

Resources

You can read about the methodology used to create the calculator here.

You can get the actual spreadsheet here. You’ll need to “enable macros” in order to get the buttons to work.

The actuarial value calculator has a younger cousin, the Minimum Value Calculator.  If one looks at the data contained here, one can see the same pattern as one finds in the Actuarial Value Calculator.

Joke

Probably I should have made the title of this entry “Shocking sex secrets of the actuarial value calculator revealed!” and attracted yet more viewers.  I then could have noted that the actuarial value calculator ignores sex (gender) in showing claims data.  But that would have been going too far.

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