Concerns about whether insurance sold on the individual Exchanges under the Affordable Care Act will succumb to an adverse selection death spiral have focused mainly on the shortage of younger enrollees into the system. This shortage is potentially a problem because, due to section 1201 of the ACA, premiums for younger enrollees must be at least one third of that for older enrollees even though actuarial science tells us that younger enrollee expenses are perhaps just one fifth of those for older enrollees. Younger enrollees are needed in large numbers to subsidize the premiums of the older enrollees. But at least premiums under the ACA respond at least somewhat to age.
The lesser studied potential source of adverse selection problems, however, is the fact that medical expenses of women for many ages are essentially double those of men and yet the ACA forbids rating based on gender. In a rational world, one would therefore expect women of most of the ages eligible for coverage in the individual Exchanges to enroll in plans on the Exchange at a higher rate than men. But, since the women have higher than average expenses than men, premiums based on the average expenses of men and women will prove too low, creating pressure on insurers to raise prices. And, of course, there could also be some disproportionate enrollment by older men who have higher medical expenses than women of equal age. While I welcome contrary arguments in what I regard as a fairly new area of study involving the ACA, gender-based adverse selection would certainly appear to be a real problem created by the structure of that law. To me, it looks to be potentially as large a problem as age-based adverse selection. It is certainly one that needs continuing and careful evaluation.
I see only three limited factors that reduce what would otherwise appear to be a significant additional source for significant adverse selection. As set forth below, however, I do not believe that any of these factors are likely to materially reduce the problem.
The first is ignorance. Adverse selection emerges only if individuals can accurately foretell their future medical expenses with some accuracy. To the extent, therefore, that men and women are ignorant of the effect of gender on their projected medical expenses, adverse selection is potentially diminished. I say “potentially,” however, because of a subtlety: people don’t have to know why their expenses are what they are in order for adverse selection to emerge; they only have to be somewhat accurate in their guess. Thus, even if men and women don’t make the cognitive leap from seeing lower (or higher) medical expenses to issues of gender, but they still on balance get it right, adverse selection can exist. Thus, I end up doubting that ignorance of the correlation between gender and medical expense is going to retard adverse selection problems very much.
2. Correlation between gender and expense is lower for those 50-65.
The second factor that might reduce adverse selection based on gender is, curiously enough, adverse selection based on age. The difference between male and female medical expenses diminishes as one exits the middle 40s and heads into the 60s. Indeed, somewhere in the late 50s, the rates cross and men have slightly higher average medical expenses than women. Therefore, to the extent that it is the 50-65 set that is disproportionately purchasing coverage in the individual Exchanges, the potential for gender-based adverse selection is diminished — but only somewhat . I say “but only somewhat” because if males over the age of about 55 or 58 enroll at higher rates than women of similar ages there will actually be adverse selection pressures due to the higher medical expenses of men that age. On the other hand, to the extents efforts are made to reduce age-based adverse selection by promoting coverage to the younger (potentially child-bearing) set, the potential for most forms of gender-based adverse selection increases.
3. Gender-correlated risk aversion
The third factor that could in theory reduce adverse selection problems is if men are more risk averse than women with respect to medical expenses and therefore purchase health insurance at equivalent rates even though their risk is objectively lower. Men could conceivably be somewhat more risk averse due to prevailing gender roles in the economy: on average it is possible that health problems among men may affect the family’s income more than health problems among women. Although as an academic I feel I would be remiss in failing to at least mention this possibility, in the end I doubt it amounts to very much. The roles of men and women in the family economy are complex and variegated. And the sources of risk aversion with respect to health are likewise multifold, having a lot to due with individual psychology, family history and family structure. And, of course, it could be that middle aged men are less risk averse than women, in which case the effects of adverse selection are worse.
How do we know about the effects of gender? The graphics below show two studies on the topic. The first is from the Society of Actuaries and was relied on by the Kaiser Family Foundation in its recent study of the effect of age rating. Look at the solid blue (male) and pink (female) lines. (Cute, Kaiser). One can see that until age 18, the costs for men and women in the commercial market has been about the same. By the time we get to, say, age 32, the cost for women is about 2.5 times that for men. The gap then shrinks so that by the time we get to age 58 or so, men’s costs actually start to somewhat exceed women’s.
A study by the respected Milliman actuarial firm, although differing in detail, shows roughly the same pattern. At age 30 or so, female expenses (blue) and about double those of males (green). The gap shrinks until about age 55, at which point male expenses exceed female expenses. (I’m not sure why Milliman shows female expenses being so much higher than male expenses for the age bracket marked “to 25” unless by “to 25” they mean ages 18-25.)
Is Gender-Based Adverse Selection Actually Happening?
As to whether the theoretical possibility of gender-based adverse selection is actually materializing, there is yet strikingly little evidence. I have scoured the Internet and found almost nothing on the gender of enrollees. In some sense this is not surprising since, unlike age, on which we have a trickle of data from CMS, which somehow is just unable to compile and release more complete information, gender is completely irrelevant to premium rates. On the other hand, as shown below, the federal application asks about gender, as do a few other state applications such as California, Kentucky and Washington State. So, in theory we should be able to get the information at some point. In the meantime, if anyone has information on this issue, I would love to see it. What we really need is a breakdown of enrollees based on both age and gender because the ratio’s role varies depending on whether enrollees below age 55 or so are involved or whether enrollees above age 55 are involved.
Two other notes
1. Someone might, I suppose, think that since the role of gender reverses at about age 55, the effects of gender on adverse selection cancel each other out. This would be totally wrong. If women have higher medical expenses than men up to about age 55 and if women therefore enroll at higher rates, that can cause adverse selection and premium pressures for enrollees of those ages. And if men have have higher medical expenses than women after about age 55 and if men therefore enroll at higher rates, that can cause adverse selection and premium pressures for enrollees of those ages. The effects are cumulative and not offsetting.
2. Does this mean I am opposed to unisex rating? No, not necessarily. First, women face higher medical expenses than men from about 20 to 50 significantly because of childbearing expenses. A family law expert on my faculty confirms what I suspected, which is that there is certainly no routine cause of action by the pregnant female against the prospective father for prenatal maternity expenses. We currently ascribe these expenses to the woman even though a male generally has contributed to those expenses through consensual sex. One could argue that unisex rating offsets this proxy for responsibility.
Second, if there are adverse selection problems caused by unisex rating, they can, in theory, be addressed by programs that that subsidize insurers for female enrollees. Impolitic as it might be to say so, one could treat being a fertile woman as a “risk factor” in the same way that section 1343 of the ACA currently treats medical conditions such as heart disease. The cost of the subsidies resulting therefrom could be seen as compensating somewhat for the transaction costs of figuring out which childbearing expenses the male partner has contributed to as well as tracking down the male partner and trying to hold him financially responsible.
What I am concerned about, however, is ignoring the issues created by unisex rating. Since it is not currently corrected for by section 1343 of the ACA and corrected for only in a very indirect and partial way by sections 1341 and 1342 of the ACA, there is the potential for the absence of gender rating to destabilize and ultimately shrink the insurance markets in ways that do few people any good. Wishing that a problem would go away or hoping that people don’t see the opportunities to optimize their behavior is seldom a recipe for successful government programs.
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.
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.
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