Category Archives: Risk adjustment

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

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

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

Less reinsurance

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Final Note

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

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Older enrollments in Exchanges could cost insurers about 10%

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

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

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

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

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

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

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

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

Notes

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

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

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Eliminating Risk Corridors jeopardizes Exchange Insurance

Draft of S.1726
Draft of S.1726

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

Marco Rubio portrait
Marco Rubio

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

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

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

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

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

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

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

A Footnote on the cost of Risk Corridors

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

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

 

 

 

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How much will it cost to restabilize the Exchange insurance markets?

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.

 

Relationship between mean insurer claims/premiums and risk corridor payments
Relationship between mean insurer claims/premiums and risk corridor payments

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.

Hypothesized ratio between enrollment and mean of claims/premium distribution
Hypothesized ratio between enrollment and mean of claims/premium distribution

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.

Hypothetical relationship between enrollment and risk corridor payments
Hypothetical relationship between enrollment and risk corridor payments

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.

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Risk Corridors making it to the mainstream media

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.

CNN report
CNN report on risk corridors

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.

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Can its reinsurance and risk adjustment provisions salvage the Affordable Care Act?

The Problem

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

  1. sticker shock,
  2. the small and difficult-to-enforce penalties for 2014,
  3. President Obama’s decision to let insurers “uncancel” ungrandfatherable policies and let some of those insureds stay out the Exchanges,
  4. the website debacle, and
  5. whatever short-sightedness or financial liquidity issues led to most of even the sickest uninsured Americans not enrolling in the Pre-existing Condition Insurance Plan

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.

Profit as a function of premiums before and after 42 USC 18062
Profit as a function of premiums before and after 42 USC 18062

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.

Insurers profits as a function of claims before and after 42 USC 18062
Insurers profits as a function of claims before and after 42 USC 18062

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.

Profit as a function of premiums in a competitive market before and after 42 USC 18062
Profit as a function of premiums in a competitive market before and after 42 USC 18062

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.

Acknowledgements

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.

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