I'm a law professor at the University of Houston Law Center with an emphasis on insurance law. I also have a long-standing and profound interest in the use of mathematics, and Mathematica, in studying law and policy.
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 healthcare.gov 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.
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.
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.
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 healthcare.gov 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.
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.
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.
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.”
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.
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.
Short answer: My best order-of-magnitude estimate is between $500 million and $1 billion for the coming year of which a third to a half could be attributed to the President’s decision to honor his promise to let Americans keep their existing health insurance.
Insurers are rightfully complaining that the move by the President to fulfill a promise he made to permit Americans with “substandard” but previously grandfathered policies to keep their health insurance is going to destabilize insurance markets. There were such complaints going in to a meeting on November 15 between President Obama and selected insurance leaders and there were somewhat muted complaints coming out of the meeting. Insurers are concerned because the people who are now being given access to another market in which insurance policies may be cheaper are likely to be precisely the healthy people that insurers who wrote policies in the Exchanges assumed would be in those Exchanges. Their concerns are important because unhappy and unprofitable insurers have a tendency either to stop writing insurance or to raise rates. That hurts policyholders and it also hurts politicians who assured the public that the rates would be affordable. (The insurers are also upset because it’s a little challenging to uncancel policies on short notice, but we’ll leave that grievance for others right now.)
The instrument by which some are proposing to pacify the insurance industry for the surprise deprivation of healthy insureds is the hitherto obscure “Risk Corridors” provision baked into the Affordable Care Act (section 1342, 42 U.S.C. § 18062, for those scoring at home). It provides that the government cover up to 80% of losses an insurer incurs on an Exchange. It was always assumed — foolishly in my opinion, but assumed nonetheless — that this backstop would be costless because the government would also effectively tax up to 80% of profits via the same provision. If the insurers systematically lose money, however, because many of the people they thought would improve the Exchange pools with their good health are being given an option to separate themselves out and keep their old often-less-expensive and often-less-generous insurance policies, the Risk Corridors provision could cost the government a fair amount of money.
So, the question is, how much money is Risk Corridors likely to cost? To use the language from my prior post, how much VOOM? If it’s a relatively small amount, that would suggest that the President (and others’) proposal to honor a campaign commitment to let people who liked their health plans keep them is a better idea than if it’s a relatively large amount of previously unbudgeted money. I thought we might try a back of the envelope computation to see what’s involved.
Time to trot out some calculus. The Risk Corridors provision basically creates a mathematical function between profitability (as defined in that provision) and the size of a positive or negative transfer payment from the government to insurers writing policies in the Exchange. So, if we knew the distribution of profitability of insurers under the Exchange we would calculate the mean payment (an “expectation” for those with some statistics background) the government would make (or receive). Of course, we don’t know that distribution yet, but we can make some guesses and get some order-of-magnitude estimates.
If one assumes that the distribution of the ratio between claims and premiums has a mean value of one (i.e. that insurers on average break even), the the expected payment of the government is zero. That’s the assumption on which the Congressional Budget Office worked when it asserted that Risk Corridors would cost nothing. But what if one assumes that the distribution of the ratio between claims and premiums has a mean value of 1.1, i.e. insurers on average lose 10%. We’ll also assume for the moment that the distribution of the ratio is “log normal” and that 95% of insurers have a claims/premiums ratio of between 0.922 and 1.22. If we do the math — here’s the link to the Mathematica notebook that stands behind these computations — it turns out that the average payment of the government is about 3% of the average premium (before subsidies). If the mean of the distribution were 0.5, i.e. insurers on average have claims 50% higher than profits, and we hold everything else the same, the average payment of the government is about 34% of the average premium (again, before subsidies). So if, just for the sake of discussion, one assumed there were 2 million people in the Exchanges and that the average gross premium was $3,500, the government would end up shelling out $210 million per year to provide insurers with some relief if they lose 10% on average and would end up shelling out $2.37 billion per year to provide insurers with similar relief if they lose 50% on average.
The graphic below shows the size of the government’s Risk Corridors obligation as a function of the mean of the claims/premiums ratio under the continued assumption that the distribution is log normal and that the spread of the distribution is similar to that described above. With a little wiggle when the mean of the claims/premium ratio is close to one, the relationship is pretty linear.
To get the total bill for the government, however, we not only have to calculate risk corridor payments in relation to a premium amount, we also have to make a guess about how many people will enroll in the Exchanges and what their premiums will be. It’s complicated because, precisely because of adverse selection, there’s likely an inverse relationship between the number of people that enroll and the mean of the claims/premiums ratio. But since all we are trying to do here is get some order of magnitude estimates — the discussion of this Act has been hurt all along by false claims of precision — we can try to make some reasonable guesses.
Suppose, for example, that the relationship between the mean of the claims/premium distribution and the number of people enrolling in the Exchanges looks something like this.
What we can now do is graph the government’s overall risk corridor payments as a function of enrollment. I’m going to assume that the average premium is $4,000 per enrollee. That’s roughly the average $328 per month that Kathleen Sebelius reported for a silver plan. If people flock to the gold and platinum plans, the average could be somewhat higher. This graph is essentially the headline of this blog entry.
So, what we we see is that if, for example, enrollment for this year were to be 1 million, the total risk corridor payments might be somewhat in excess of $1 billion. If enrollment were 2 million, risk corridor payments might be $500 million. One enrollment crosses 3 million, the government actually could gain money via the risk corridors program.
There are a lot of unknowns going in to the graphic above. I do not pretend that it is precise. I do not even contend that it is accurate. Nonetheless, I believe it is useful. I do believe it provides a plausible order-of-magnitude estimate of an unforseen cost of the Affordable Care Act. If you asked for my best guess, I would tell you the Risk Corridor payments will likely be between $500 million and $1 billion this coming year as I would guess enrollment in the Exchanges will come out between 1 and 2 million (assuming they ever fix healthcare.gov). This does not mean, by the way, that the cost of the President’s fix (or of the similar bills now in Congress) is the full amount of the Risk Corridor payments. Some of these risk corridor payments might have been made even without the Obamafix. That is so because enrollments in the Exchanges may always have been overestimated and may have been made considerably lower as a result of all the fallout from the debacle of the healthcare.gov website rollout.
In the end, then, I suspect that for the coming year the price tag for the President keeping his promise that “If you like your health plan, you can keep your health plan” is going to be somewhere in the $200 million to $400 million range for the coming year. That’s about a third of the overall stabilization bill. And we’ll never know for sure because we won’t know how many of those that in fact do keep their health plan would have enrolled on the Exchange. In one sense, the money cited above may be seen as a rather inexpensive price to pay to make good on an alluring promise. On the other hand, it may also be seen as yet another unforeseen or unadvertised cost of a bill to transform American healthcare. It’s easy to make feel-good campaign promises when you aren’t fully honest about the cost.
Surely all parents — or very young readers of this blog — will recall The Cat in the Hat Comes Back. It’s a marvelous tale of a feline visitor creating chaos as two young children are again questionably left alone by an apparently single parent. But the basic idea of the story is that the Cat in the Hat eats cake with pink icing in the bathtub, which results in a dreadful pink ring being left in the tub once the decision is made to empty the water. Upon the horrified pleas of the children that this tell tale sign of a poor decision on both their part — not acting more aggressively to prevent the cat from entering — and the cat’s — choosing a vulnerable household site in which to ingest potentially polluting pink icing — might anger their mother, the ever-confident Cat develops a series of fixes. They begin with the cat’s use of mother’s new dress to wipe off the ring. But, of course, this “fix” simply transfers the horror of the pink ring from the bathroom to the wardrobe.
Much of the remainder of the story is then spent detailing how each successive “fix” simply makes matters worse until there is complete (and delightful) chaos and the entire landscape is covered in the apparently undilutable horror of the original pink ring. The situation is salvaged only when the Cat pulls mysterious “VOOM” out of one of his nested hats and uses its power instantly to remove all traces of the pink icing and restore order to the snow-filled landscape in which the book is set.
As the most thoughtful parents and fiscally conservative children recognize, however, the apparent victory of the cat over chaos may be illusory, placating the mother for now in its restoration of a superficial benevolent equilibrium, but creating potentially grave systematic consequences later on. For no consideration has been given as to whether this use of apparently scarce VOOM — so small you can not see it — resulting from an obvious poor choice will deplete the VOOM supply and thereby prevent subsequent VOOM expenditures to deal with future problems. Might it not be better, the more clever readers recognize, for incentives to be established to deter future bathtub cake eating at all.
Does everyone then see it? The pink ring is the adverse selection problem created by assuming that private insurance could operate in a system without medical underwriting when only mild punitive measures would be taken for the failure to procure insurance and when many, however shortsightedly, would prefer to use their scarce resources other than for insurance that covers not only catastrophic medical expenses but also all sorts of medical services that they either might not need or might be able to acquire without resort to the complexities and expense of third party payment. The Cat is, of course, President Obama, trying assiduously and with false or foolish confidence to fix the situation. (Are the little sub-cats state insurance regulators only making matters worse?) The chaos is a metaphor for the problem that erupts when one attempts symptomatic cure of more fundamental and architectural design problems — frequently, these ill-thought-through attempts only make matters worse. (Pacifying the people whose insurance was cancelled but, to the extent such an effort actually succeeds, destabilizing the Exchange-based insurance pools that formed the core of the statutory reform.)
And VOOM, what is VOOM? VOOM is money. VOOM is “Risk Corridor” payments under section 1342 of the Act (42 U.S.C. 18062). Those payments are what it will take to “clean up the snow,” to restore any semblance of stability in the Exchange markets otherwise destabilized by removing a large segment of largely healthy individuals from their pools. But, again, I suspect, no consideration has been given as to the true bill for the underlying mistake, thinking that a system could be designed that, without requiring massive government subsidization, so defied economic laws which have, for a long time, told us that systems of private insurance in which underwriting is prohibited sooner or later — often sooner — contract due to adverse selection and, on occasion, fall into the black hole of a death spiral.
OK, OK. It’s a flawed analogy. I agree. And I do have some concerns that Dr. Seuss would not appreciate this political appropriation of one of his surely apolitical masterpieces. I ask for some indulgence and promise that far more scientific posts are forthcoming. But if Jonathan Gruber, one of the intellectual chiefs behind the Affordable Care Act, can write a politicized graphic novel extolling the virtues of the ACA, surely I may be indulged some literary criticism as a way of constructing an operating metaphor for the issues currently plaguing the same statute.
More people are starting to pay attention to the stealth “Risk Corridors” provision contained in section 1342 of the Affordable Care Act (18 U.S.C. § 18062) . They are looking at whether that provision of the law, which calls for transfers by the Secretary of HHS from profitable exchange insurers to unprofitable ones, might persuade insurers to retain greater enthusiasm about participation in the Exchanges and whether the financial bill for section 1342 might not be the zero projected by the Congressional Budget Office. One of those paying attention is the influential CNN.
In a story this evening titled “Obamacare fix could add millions of collars in government costs” by Adam Aigner-Treworgy, CNN pretty much tracks the analysis offered on this blog in previous days. It quotes the Kaiser Family Foundation, usually a pretty reliable source on the finances of the ACA as saying that the difference between the amount previously thought owed under Risk Corridors and the amount that might be owed as a result of recent developments “could be tens of millions or even hundreds of millions of dollars.” The story likewise quotes Melinda Buntin, a former deputy director for health at the Congressional Budget Office and current chair of the Department of Health Policy at Vanderbilt University:
To the extent that the risk pool changes in ways that were not foreseen by the insurers because of the announcement yesterday and they are not included in the bids that they proposed to the government and that their selection is riskier and more adverse that they anticipated then that could be an additional cost to the government.
Risk corridors was also the topic of remarks today by White House press secretary Jay Carney. As reported on the blog, The Hill, Carney said the following today. “If the costs are higher, then [the Department of Health and Human Services] can mitigate those costs with insurers,” Carney said at a briefing. “If costs come in significantly lower, then the insurers will replenish the fund by passing back some of those profits.”
The question again is where does the money come from? Just saying “the treasury,” as law professor and ACA zealot Timothy Jost is quoted as saying in the CNN report, is not precise enough. Someone needs to find a specific appropriation that can be used for this purpose. On the other hand, if the Kaiser Foundation is right and we are talking about sums less than a billion dollars, that may be a very small amount for President Obama to dig up from somewhere in order to salvage his signature domestic achievement. I guess I’m a little less confident that the bill is going to be that small — unless, of course, enrollment in the Exchanges continues to be minuscule.
I’m hearing a lot of the lazy “but what are the political implication” perpetual horse race questions from the media about recent developments surrounding the Affordable Care Act. That’s fun Inside-the-Beltway stuff, but in the mean time there are real people who are likely to be helped and hurt with matters as essential as their health. So, what I am not hearing enough of yet, however, are tough, substantive questions that get to the heart of whether the Affordable Care Act is going to be stillborn. Here are some questions that I think intelligent journalists and blogger ought to be asking in light of recent developments with the Affordable Care Act. Getting answers in many cases may take persistent questioning and closer scrutiny of existing documents. In others, FOIA requests may be needed.
1. Actual v. Anticipated Age Distributions in the Exchanges
What is the age distribution by state and in the aggregate of persons who it is claimed have enrolled in Exchange-based plans under the Affordable Care Act? Once we have this data, we can compare it to (a) census data on the age distributions in the various states and (b) any prior estimates on what the age distribution of Exchange enrollees would be such as those described in this government document. If there is a significant difference between the age distribution encountered thus far and the anticipated age distribution, that increases the probability of the ACA succumbing to an adverse selection death spiral. This is so because, although the ACA permits some age rating, it damps the actual variation in expected claims from lowest to highest eligible ages down to a 3:1 ratio.
2. Actual v. Anticipated Metal Tier Distributions
What is the distribution of enrollees amongst the various “metal tiers” ranging from bronze through platinum? If the enrollees are flocking disproportionately to the platinum and gold plans, that suggests the people who are enrolling may be disproportionately unhealthy. While those plans were expected to draw a slightly less healthy population, the government planned on there still being a significant number of healthy people in those pools. According to data contained inside the government’s “Actuarial Value Calculator,” the predicted mean claim for bronze policies (across ages, genders, regions, etc.) was $4,977 per person whereas the predicted mean claim for platinum policies (again across ages, genders, regions, etc.) was $5,804. (Cells C88 in various tabs) I believe that significant selection of these more generous plans should give insurers (and insureds) concern about a death spiral materializing.
3. Where is additional “Risk Corridor” money coming from?
3. What the heck does this sentence mean in the letter from Gary Cohen, Director of the Center for Consumer Information and Insurance Oversight (pronounced suh-sy-o) to state insurance commissioners providing details on President Obama’s announcement that he would not be enforcing the Essential Health Benefit restrictions on certain non-grandfathered plans?
Though this transitional policy was not anticipated by health insurance issuers when setting rates for 2014, the risk corridor program should help ameliorate unanticipated changes in premium revenue. We intend to explore ways to modify the risk corridor program final rules to provide additional assistance.
To me, this sounds like the President is saying they will buy off the insurance companies in the Exchanges, who stand to lose as a result of the decision to starve them of mostly healthy insureds forced out of “substandard” nongroup policies. The President may be hinting that he will try to make them whole through providing more money under the Risk Corridors provisions of section 1342 of the Affordable Care Act, 42 U.S.C. § 18062. As discussed in a prior blog post, this may in fact be possible, but it is not clear where the money is coming from. I suspect this issue may form a significant part of the conversations between insurance CEOs and President Obama that will apparently occur at the White House later today. If so, journalists need to push on where President Obama is finding the money and how much money are we talking about?
Journalists might also note in pursuing this matter that it has hitherto been assumed by the Congressional Budget Office that the Risk Corridors program would be a net zero. Here’s what they said in their Regulatory Impact Analysis of March 2012:
CBO did not score the impact of risk corridors and assumed collections would equal payments to plans and would therefore be budget neutral.
If, as I have argued, the assumption in the CBO document has always been doubtful and is now almost certainly false, again, where is the money coming from and could we be talking about tens of billions of dollars? Is President Obama going to (a) keep his promise and (b) pacify the insurers by just spending lots of money that was previously unbudgeted and undisclosed?
A shout out, by the way, to blogger Kathleen Pender for being one of the few to focus on this issue.
4. Are any insurers yet threatening to pull out?
Have any state insurance commissioners heard rumblings or worse about various insurers pulling out for 2014 or declining to take on any more enrollees, if that restriction is permitted? I suggested in a Houston Chronicle op-ed yesterday that such a development was likely, but I don’t know of evidence that it has yet occurred. I could imagine, for example, insurers who priced their policies high relative to others of the same metal tier in the same market wanting to exit. They would want to do so because very few people are likely to select their plan and so there may be a lot of administrative costs for very little benefits and because the people who did select their plan may have done so because they believed the networks and coverages were more generous — something the less healthy would particularly care about. I could also imagine insurers who priced their policies low relative to others of the same metal tier in the same market wanting to exit. If, as is feared, the pool of exchange insureds is older and sicker than projected, the victims are likely to be the insurers who price low and thus have the highest amount of business in the Exchanges.
5. How serious are the insurance industry groups and actuarial warnings?
Journalists should be pressing people like Karen Ignani, president and chief executive of America’s Health Insurance Plans, Corri Uccello, senior health fellow at the American Academy of Actuaries, Jim Donelon, President of the extremely powerful National Association of Insurance Commissioners, and others on how great they regard the threat of the Exchanges becoming destabilized as a result of the combination of minuscule current enrollments coupled with the competitive alternative that appears to have been created by President Obama’s announcement yesterday or by the Upton and Landrieu bills circulating in Congress that do roughly the same or more to starve the Exchanges of healthy insureds. These individuals are issuing some fairly significant warnings about what is going on. Jim Donelon, for example, states:
This decision continues different rules for different policies and threatens to undermine the new market, and may lead to higher premiums and market disruptions in 2014 and beyond.
The American Academy of Actuaries, via David A. Shea, Jr., Vice President, Health Practice Council, warns:
Premiums in the new 2014 insurance markets would have been higher if the ACA rules regarding cancelled policies had been relaxed.
Approved premiums for 2014 are based on assumptions regarding plan cancellation requirements under ACA rules. The premiums approved for 2014 may not adequately cover the cost of providing benefits for an enrollee population with higher claims than anticipated in the premium calculations.
Costs to the federal government could increase as higher-than-expected average medical claims are more likely to trigger risk corridor payments.
Relaxing the plan cancellation requirements could increase premiums for 2015. Insurers cannot increase premiums in future years to make up for prior losses. However, assumptions regarding the composition of the risk pool would reflect plan experience in 2014.
This sounds very serious. Journalists ought to try to develop some statements from these people on the “order of magnitude” of the threats they see occurring as a result of recent developments.
Let us suppose, for the moment, that enrollment in the Exchanges increases as healthcare.gov becomes less dysfunctional and as we get closer to the January 1, 2014 and March 1, 2014 deadlines. It is, after all, unrealistic to think that enrollment will remain at the pathetic/paltry/miserable levels recounted by today’s testimony from Kathleen Sebelius, notwithstanding her counting of people who merely put a plan in their shopping cart. But it does seem likely to many , including me, that
the small and difficult-to-enforce penalties for 2014,
President Obama’s decision to let insurers “uncancel” ungrandfatherable policies and let some of those insureds stay out the Exchanges,
will likewise lead the enrollment in the Exchanges to be considerably smaller than projected. This is particularly likely to remain true, I believe, in states such as Texas in which institutional forces and political culture often do not encourage participation and in which fewer than 3,000 out the estimated 3,000,000 eligible to do so have enrolled thus far.
The key question is how resilient are the Exchanges to low enrollments in which, one would expect, the enrollees are — even more than they were projected to be — disproportionately older and disproportionately less healthy. And have the Exchanges been rendered yet more fragile by what many cheered as the surprisingly low premiums charged by many insurers? Could those insurers, who are likely to swoop up most of the business in a price sensitive market, in fact be about to face the winners curse? The answer to these questions may lie deep in the details of one of the least studied and yet one of the most important set of provisions in the Affordable Care Act: the reinsurance and risk adjustment provisions contained in sections 1341-1343 of that Act and now codified at 42 U.S.C. §§ 18061-18063.
Here’s the (long) paragraph-length explanation of how these reinsurance and risk adjustment provisions work. 42 U.S.C. § 18061 basically creates a transitional (2014-16) government operated stop-loss reinsurance program funded out of a special tax on other health plans ($63 per covered life). The reinsurance attaches when a person covered by a plan in an Exchange incurs $60,000 or more in claims per year. After that point, the reinsurer pays for 80% of the claims up to a cap of $250,000. Thus, if an individual had claims of $180,000 in a year, the government would reimburse the insurer for $96,000, which is 80% of the difference between $180,000 and $60,000. What this provision appears to do is make insurer profit and loss less sensitive to attracting high claims insureds. 42 U.S.C. § 18062 basically redistributes money in a complex way from insurers whose Exchange plans profit to insurers whose Exchange plans lose money. Again, the idea is to reduce the insurer anxiety either that their plan and their marketing (if any) happens to attract an unhealthy pool or that they selected a premium too low for the actual risk that materializes. Finally, 42 U.S.C. § 18063, the only program that is supposed to persist past 2016, imagines an incredibly complex system in which the risk posed by an insurer’s pool is assessed and the states or, in their default, the federal government (see 42 U.S.C. 18041(c)(1)(B)(ii)(II)), transfers at least some money from those with the riskiest pools to those with the least.
Will these provisions really rescue the insurers?
All of this might seem a comfort to insurers that might permit them to survive and continue in the Exchanges even if the pools are, on average, considerably more expensive than originally projected. But to get a better handle on the degree of solace these provisions might provide, we need to look at some of the limitations of these programs and the actual numbers.
Stop-loss reinsurance under 42 U.S.C. § 18061
First, let’s look at how much risk the transitional reinsurance provided by 42 U.S.C. § 18061 really slurps up. What I contend is that while this provision should — and probably did — lower the premiums the insurer would otherwise need to charge to avoid losing money, it does less to rescue insurers if the pool is less healthy than they foresaw. While to really see this, we need to get deep into the weeds and do some math, I’m going to hold off on that fun for now. We have to save some things, such as the Actuarial Value Calculator, for other blog entries. I believe I have developed a plain English explanation that gets us most of the way there.
The key concept is to recognize that sophisticated insurers (are there other kinds?) took the free reinsurance into account when they priced their policies. They computed an expected value of the reinsurance reimbursements and lowered their rates by something approximating that amount. They were able to charge lower rates than they otherwise would because some of the claims bill would be picked up by the government. But this does not mean that the insurers end up having profits that are insensitive to the actual claims incurred by their pool. Unless all of the higher-than-expected claims are stuffed into the zone in which the reinsurance kicks in ($60,000 to $250,000), the insurers will be hurt when the pool has higher claims than expected. But such an assumption is incredibly implausible. If the insurer assumed that only, say, 2% of its insureds would have claims between $20,000 and $25,000 but, as it turns out, 4% of its insureds have such claims, nothing in 42 U.S.C. § 18061 will help such an insurer with that unanticipated loss. Moreover, because the reinsurance even within the relevant zone is incomplete, the insurer will lose money if claims between $60,000 and $250,000 are higher than expected. The effect of the transitional stop-loss reinsurance on reducing the consequences of adverse selection is thus likely to be small.
In the end, what this transitional reinsurance mostly does is mostly to tax non-Exchange policies $63 per covered life in order to make policies within the Exchange more attractive to policyholders. And, yes, that fact should make Exchange-based policies cheaper and reduce the problem of adverse selection. After all, if the insurance were free presumably there would be little adverse selection — everyone would get it. But the reinsurance fails to reduce insurer vulnerability to adverse selection much more than, say, providing more generous tax credits and cost sharing reductions would have done. If the pool ends up being less healthy than the insurer anticipated — an almost certain consequence of lower-than-expected enrollments, 42 U.S.C. § 18061 is hardly going to end up relieving the insurer of most of the unhappy consequences of having written policies in that environment.
Footnote: There is one more wrinkle, but it only means that the transitional reinsurance is a yet weaker rescue vehicle: the government’s obligations under the transitional reinsurance provisions are limited. There’s “only” $12 billion in 2014 and this ramps down to $4 billion in 2015. If those amounts aren’t adequate to pay reinsurance claims, each claim gets reduced pro rata. The reason I relegate this point to a “footnote,” however, is that if the pools are really small then even if claims per person are way higher than expected, the aggregate amount of claims in the reinsured zone of $60,000 to $250,000 aren’t going to be that big. My back-of-the-envelope computation suggests that the $12 billion allocated for transitional reinsurance should not be insufficient unless at least 2 million people enroll on the exchanges; since right now we are almost certainly at less than 100,000, 2 million seems a lot of insureds away.
“Risk Corridors” under 42 U.S.C. § 18062
The biggie in this field is the “Risk Corridors” provisions contained in 42 U.S.C. § 18062. It essentially creates this massive transfer scheme, taking money from insurers who had profitable pools and giving it to those who did not. In some sense, it converts insurers from entities bearing risk to mere fronts for government funded health insurance. If I were prone to accuse the Affordable Care Act of creating “socialized medicine,” my Exhibit A would be the stealth “Risk Corridors” provision of 42 U.S.C. § 18062.
The graphic below shows how the scheme works. The x-axis of the graph shows hypothetical aggregate net premiums (what 18062 calls “the target amount”) an insurer might receive for some plan in some state. The y-axis shows the profits the insurer receives as a function of those aggregate net premiums assuming that claims (a/k/a “allowable costs”) are $11.4 million. The purple line shows what profits would have been as a function of premiums if 42 U.S.C. sec. 18062 did not exist. The blue line shows what profits will be after the payments required by 42 U.S.C. 18062 are taken into account. The khaki-shaded zone shows the payments insurers are supposed to receive (and the Secretary of HHS supposed to pay) under the statute. The green zone shows the payments insurers are supposed to make (and the Secretary of HHS supposed to receive) under the statute.
We can create a similar graphic in which the role of claims and premiums is reversed. The x-axis of the graph shows hypothetical aggregate claims costs (what 18062 calls “the allowable costs”) an insurer might receive for some plan in some state. The y-axis shows the profits the insurer receives as a function of those aggregate claims costs assuming that net premiums are $8.6 million. The purple line again shows what profits would have been as a function of premiums if 42 U.S.C. sec. 18062 did not exist. The blue line again shows what profits will be after the payments required by 42 U.S.C. 18062 are taken into account. The khaki-shaded zone again shows the payments insurers are supposed to receive (and the Secretary of HHS supposed to pay) under the statute. The green zone again shows the payments insurers are supposed to make (and the Secretary of HHS supposed to receive) under the statute.
If one looks at the slope of the blue lines — the ones that show profits after 18062 risk corridors are taken into account — they are much less steep for most of the domain than the purple lines — the one that show profits before 18062 risk corridors are taken into account. What this means is that, in some sense, it doesn’t matter to insurers all that much whether they price too low or too high, whether claims are lower than they thought or — due to adverse selection or otherwise — higher than they thought. Either they are going to pay money to the government or they are going to get money from the government. The risk of writing policies in the Exchange is greatly diminished.
In some sense, then, if section 18062 (1342) is fully implemented — an issue to which I will shortly return — insurers don’t act very much as profit-making enterprises within the Exchange making or losing money on the spread between premiums and claims. (This is even more true after the corporate income tax is taken into account) Instead, they are almost fronting for the government, providing their license, their claims processing abilities and their credibility to a scheme in which the government really bears the risk associated with the new Exchange-based system of providing insurance. A cynic might term the Exchanges as having gone 80% of the way towards a single payor system in which there is but minor variation in the benefits offered by insurance policies and claims processing contracted out to various insurance companies with the experience to do so.
The incentives issue
There are several implications of this consideration of 42 U.S.C. 18062. The first is to consider what incentives the system sets up for insurers. My tentative belief is that it incentivizes insurers to offer a low premium if they want to go into the Exchanges and this statutory provision may explain in substantial part why insurers priced their policies at rates lower than most expected. Let me see if I can sketch out the argument. If the insurer prices high, they are going to get very little business. Other insurers will take their business away by going low. If they price low, they will get a lot of the business. Sure, they may lose money if they price too low, but, if so, the government will reimburse them for most of their losses. And if they price right or still too high, they can make some money.
The graphic below illustrates this concept. The x-axis shows possible premiums the insurer might charge. The y-axis shows the profit of the insurer associated with that profit. As one can see, before section 18062, the insurer does best to charge about $2,840 in premiums; after 18062, the insurer does best to charge about $2,677 in premiums. Although the assumptions chosen to produce this graphic were somewhat arbitrary, it is interesting and suggestive to me that the magnitude of the reduction in premiums is roughly similar to that observed in the actual market place in which premiums came in several hundred dollars below that originally projected.
The imbalance issue
There’s a second issue suggested by the two graphics above (the ones with the shading) showing the effect of premiums and claims on profitability. They highlight that there is is no reason to think that the amount the Secretary receives will be equal to the amount the Secretary takes in. That would be true only if insurers happen, in aggregate, to price the policies just right. If insurers have underpriced the policies because they expected a larger — and correlatively healthier — pool, the graphics may quite accurately reflect what occurs and the Secretary will be obligated to pay out far more than the Secretary takes in. I have found no one who has written on this problem, no one who can explain where the money will come from to make the needed payments, or what mechanism will be used to reduce payments in the event, as I suspect, there will be an imbalance between the money collected and the money the Secretary is supposed to pay out.
And one final thing
Extra credit: Can anyone spot the uncorrected typo in 42 U.S.C. 18062? For answer, look here.
Risk Adjustment Under 42 U.S.C. §18063
The transitional reinsurance and risk corridors provisions only last until 2016. After that, assuming the Affordable Care Act survives in something like its present form for that long, insurers are protected from adverse selection only by the sleeping giant among the trio of protection measures: the “risk adjustment” provisions in ACA section 1343, codified at 42 U.S.C. §18063. The idea here is to equalize the playing field for insurers not based on the amount they actually pay out in claims (stop-loss reinsurance) or their actual profits (risk corridors) but on the risk they took in accepting insureds. It thus envisions this massive bureaucratic scheme whereby each individual purchasing a policy on an Exchange is scored (based on a complex federal methodology involving “Hierarchical Condition Codes“) and then, the insurers with high scores get paid by the insurers with low scores with the Secretary of HHS figuring out exactly how it works. To do this, the Secretary will need masses of sensitive information, including fairly granular accounts of the medical conditions of each person enrolled on an Exchange. The idea in the end, though, is to calm insurer fears that because of peculiarities of their plans, bad luck, or other factors, they tend up with a worse than average pool.
This provision will not save the Affordable Care Act from an adverse selection death spiral if enrollment stays low. This is because Risk Adjustment simply protects insurers from worse-than-average draws from the pool of insureds purchasing Exchange policies. It does nothing to protect insurers from having an overall pool of insureds purchasing Exchange policies that is higher risk than anticipated. If that larger pool is high risk on average, however, insurers will need to price their policies high, which will lead the lesser risk insureds to drop out, which will result in prices being raised again — the death spiral story.
The Bottom Line
The bottom line here is that two of the provisions (18061 and 18063) that purport to protect insurers from adverse selection really do little to protect insurers from the sort of adverse selection that is now appearing quite likely to develop: lower risk persons staying out of the Exchanges, period. The remaining provision, 18062, “Risk Corridors” in theory could give insurers some confidence that they will not lose their shirts if the pool stays small and high risk. But this is only true to the extent that insurers believe the Secretary of HHS will find some currently unknown pot of money with which to make payments when the number of insurer losers in the Exchanges far outstrips the number of insurer winners. If insurers doubt that the Secretary will be able to find the money and may simply resort to some pro-rata reduction in payouts under 18062(b)(1), they will have be less pacified in what must be their growing fears that the pool of insureds inside the Exchanges will, on balance, be far higher risk than they anticipated. And, if the Secretary finds money with which to honor the promises in section 18062, look for protests from those who were told that the Affordable Care Act would not have all that large a price tag.
Late Breaking News
As it turns out, the reinsurance and risk adjustment provisions are in the news today in an elliptical remark made at the end of a letter sent by the Center for Consumer Information & Insurance Oversight (CCIIO) that implements President Obama’s transitional “fix” with respect to canceled nongroup policies. He states:
Though this transitional policy was not anticipated by health insurance issuers when setting rates for 2014, the risk corridor program should help ameliorate unanticipated changes in premium revenue. We intend to explore ways to modify the risk corridor program final rules to provide additional assistance.
I believe this passage amounts to recognition by the President that providing a non-Exchange insurance substitute for generally healthy people who otherwise likely would have gone into the Exchanges will end up making adverse selection worse and further increase likely losses by insurers writing in the Exchanges. This, by the way, is why insurers are apparently furious about the President’s “fix.” The question, though, is where is the money going to come from to make the insurer’s whole. The statute appears to envision a zero sum game in which the winners compensate the losers. It does not appear to contemplate what seems ever more likely to occur: a game in which the only winning move is not to play.
If you are interesting in this topic, you should read the articles by Professor Mark Hall. I don’t alway agree with Professor Hall, but I have tremendous respect for his analysis. He is, in my view, one of the leading scholars with a generally positive view about the Affordable Care Act. You can find the articles here and here.
Exploring the likely implosion of the Affordable Care Act