Tag Archives: Affordable Care Act

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

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

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

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


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

A Quick Look at the Statute

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

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

The Federal Register Proposal

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

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

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

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

Two clearly illegal ways to “fix” the problem

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

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

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

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

The conceptual problem

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

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

The math

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

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

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

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

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

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

Why the proposed fix is unlawful

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

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

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

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

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

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

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

Two final notes

The allowable administrative cost cap percentage and the medical loss ratio

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

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

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

The typo in the statute

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

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

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

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

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

Note on Definitions

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

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

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

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Shocking secrets of the actuarial value calculator revealed!

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

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

What is the Actuarial Value Calculator?

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

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

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

The Math Stuff

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

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

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

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

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

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

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

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

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

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


 3. Parameterizing health claim distributions based on the actuarial value

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

Here’s what I get.

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

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

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


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

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

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

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


Some initial results

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

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

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

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

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

Plain English Summary

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


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

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

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


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

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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.


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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A quick sketch of issues created by Obamafix


Note: this entry will likely be updated today as new information comes in.

President Obama is stating right now that the Executive branch of the federal government will fix the problems created by insurer cancellation of many individual health policies by forcing insurers to renew cancelled policies.  It may be that state insurance commissioners will be able to veto this imposition within their own states.

A number of legal and economic issues are created by this proposal.  I sketch them here.

1. Where does President Obama get the authority to issue such a regulation?  The President can not rule by decree and it will be challenging to figure out what statute authorizes him to undo parts of the Affordable Care Act that would have prohibited insurers from selling such policies.  Perhaps the President will argue that all he is doing is directing the Secretary of HHS and other executive officials not to prosecute or otherwise punish insurers for selling policies without Essential Health Benefits but only with respect to policies they had just recently cancelled? Or possibly he might expand the definition of what it means to be “grandfathered.” In any event, there is a separation of powers issue here worth thinking about.

But, if I am hearing the President correctly and reading news accounts properly, I am wondering who will have “standing” to challenge the ruling since no one appears to be forced to do anything.  If I’m reading things incorrectly and insurers are indeed going to be forced to uncancel, then, unlike earlier expansionist views of executive authority such as delay of the employer mandate, there will definitely be institutions with “standing” — some insurer that does not want to renew — to challenge the ruling.

As one might expect, law professors are opining on the legality of the President acting here without congressional authority.  Professor Eugene Kontorovich from Northwestern University Law School has published a quick piece on The Volokh Conspiracy, a leading conservative-libertarian blog, arguing that the President’s fix violates separation of powers.  He also cites to the letter actually sent by CMS to State Insurance Commissioners explaining the President’s ruling.

2. From what I am now hearing, it appears that insurers will not be forced to reissue these policies.  Nor will state insurance commissioners be forced to authorize sale of these policies.  That should eliminate federalism issues or possibly due process issues.  Otherwise there would have been a question as to whether forced insurance by the federal government — whether done by a legislature or through executive action — violates any independent protections of the Constitution?  Assuming this is regulation of interstate commerce, nonetheless neither the executive nor the legislature can take property without just compensation and, on occasion,  this provision has been interpreted to encompass regulations that effectively take property.

3. Assuming insurers accept the President’s invitation, doesn’t this create more problems for the Exchange?  The hundreds of thousands or millions of people who are potentially being helped here are people who have recently been medically underwritten and are most likely healthy.  If these people have the chance of being forced into a pool in which there is no medical underwriting and one in which there is, many will opt — even if there is no subsidy — into the underwritten pool, particularly if the Exchange policies offers a feature/price mix that they do not want. But the withdrawal of these people from the Exchange pools makes it ever more likely that an adverse selection death spiral could develop in the Exchange.  The horse journalists and others should be beating now is not about breaches of promise — that’s been thoroughly discussed — but about how insurers who have agreed to write policies in the Exchange on one set of assumptions about the pool are going to react when those assumptions change.

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The unmagical H.R. 3350

One of the fixes being seriously considered this week to address the “discovery” that the Affordable Care Act will not permit all people to keep the health insurance plan they may previously had in effect is H.R. 3350, a bill that would permit — though not require — insurers to continue to offer all individual insurance plans they had in effect at the start of 2013 and to treat such plans as “grandfathered” even when, perhaps, they would not be so treated under either the existing Affordable Care Act or the regulations promulgated thereunder. Unfortunately, this “Keep Your Health Plan Act of 2013” is likely to cause more problems than it solves. I also think there may be some technical problems with the bill that someone ought to think about.

The reason the Keep Your Health Plan Act will create problems is that, contrary to the rhetoric formerly used by its supporter-in-chief, the success of the Act depends precisely on many people not being able to keep their healthcare plans.  And contrary to the Renaultian shock now being exclaimed by many politicians, depriving people of their existing individual health insurance plans, was part of the plan all along. Since the Affordable Care Act is an intricately woven web of provisions, it may well not be possible simply to excise one part without fatally destabilizing the remainder of the bill.

They Knew

First, as to the allegation that depriving people of their individual healthcare plans was part of the plan all along, I offer several exhibits.  To set the background for the evidence, consider that a central philosophical tenet of what became the Affordable Care Act was that medical underwriting of health insurance was unfair because it punished those who, often through no fault of their own, had poor health to begin with, and created needless hardship as a result of their resulting inability to obtain efficiently delivered American-style healthcare.  The “genius” of the Affordable Care Act was the notion that one could remedy this problem not just through the previously advanced — and previously rejected — idea of expanding single payor systems such as Medicare in which the government provides insurance, but in a way that preserved at least the fig leaf of a private, entrepreneurial insurance system.  And the intellectual key to that alternative path of assuring insurance equality was to show, contrary to the prevailing wisdom, that private insurance could in fact function in an appropriately structured health insurance marketplace notwithstanding the absence of medical underwriting ordinarily thought necessary to prevent an adverse selection death spiral.

The Studies

The RAND studies

And studies there were that supported the idea that, with appropriate penalties for failing to purchase insurance and with a large enough pool enrolling in the nascent Health Insurance Exchanges, the market could stabilize without a fatal adverse selection death spiral taking place.  Consider the various studies undertaken by the RAND corporation, one of the nation’s longest standing think tanks and one not known for being given to sentimentality.  The first study undertaken by RAND in 2010 found that the number of persons in the “Nongroup” (a/k/a individual) market for health insurance would decline as a result of enactment of an ACA predecessor from the existing 17 million in 2013, to 5 million in 2014 and then down to 0 by 2016.

RAND prediction in 2010
RAND prediction in 2010

RAND does a second study as the actual Patient Protection and Affordable Care Act (which is the same thing as the Affordable Care Act and the same thing as Obamacare) is enacted. This one is commissioned by the United States Department of Labor. As shown below, the study likewise concludes that of the 18 million they now believe will be enrolled in nongroup health insurance prior to 2014 essentially none will be left; 14 million will migrate to the Exchanges and 4 million will find their way into employer-sponsored insurance. No one will have “kept their plan.”


RAND: 2010 Establishing State Health Insurance Exchanges study
RAND: 2010 Establishing State Health Insurance Exchanges study (red box added by me)

The CBO and Other Government Assertions

But it was not just RAND that was assuming that many persons with individual health insurance policies would be impelled to enter the Exchanges, in which policies with Essential Health Benefits and other expensive protections would prevail, it was also Congressional Budget Office, another source relied upon critically in forecasting the effects of what was becoming the Affordable Care Act. Consider the CBO’s letter of November 30, 2009, to Senator Evan Bayh.  It estimates that 5 million people (14 million now outside Exchanges; 9 million left by 2016) will be move from nongroup coverage to coverage inside the Exchanges. While some of these may move voluntarily, there is no assertion that all will cheerfully accept the “better” coverage offered inside the Exchanges.  The key quote comes in an explanation of why the ACA will actually lower premiums.

CBO and JCT estimate that about 32 million people would obtain coverage in the nongroup market in 2016 under the proposal, consisting of about 23 million who would obtain coverage through the insurance exchanges and about 9 million who would obtain coverage outside the exchanges. Relative to the situation under current law, with about 14 million people buying nongroup coverage, the different mix of enrollees would yield average premiums per person in that market that are about 7 percent to 10 percent lower.

That estimate of 5 million people is reiterated in a March 2010 letter from the CBO to Senator Harry Reid in which the CBO attempts to compute the costs of the ACA.  The table below (a screen capture edited to delete unimportant parts) shows the computation.

Table showing CBO prediction on nongroup policies
Table showing CBO prediction on nongroup policies

Finally, there is what some have called the “smoking gun” contained in the pages of the June 17, 2010 Federal Register, a document (shown below with yellow highlighting) that captures the official views of the Department of Health and Human Services. Although the document does not state the movement out of non-group policies and into the Exchanges would be entirely voluntary, it is difficult to believe that with 40 to 67% moving, all would be doing so cheerfully and because they just “did not like” their existing healthcare plan.

June 17, 2010 Federal Register
June 17, 2010 Federal Register

Whether President Obama knew of this issue or at what level of detail is unclear.  The Republican party is currently running an emotionally charged “stray cats and dogs video” containing some remarks of the President in 2010 from which those undisposed towards him might infer that he was aware of the issue. There are, however, a number of ways of interpreting the President’s elliptical and metaphorical remarks and it may remain to future historians to discern whether the President was simply unaware of the detail that some Americans might be forced from health plans that they truly liked to dispreferred coverage in the Exchanges or whether he, perhaps like some around him, simply regarded that inevitability as a cost of reforming a major American institution in which it was completely bizarre to think that no one at all would be hurt.

The MIT/Gruber Analysis

A leading academic proponent of the Affordable Care Act and consultant to the Obama administration during its development has been MIT economics professor Jonathan Gruber.  (He’s also, by the way, the author by the way of a fantastic (if sometimes fairy tale-esque) graphic novel on Health Care Reform). Professor Gruber’s work has been instrumental in persuading people that an appropriately structured health insurance market can function even in the absence of medical underwriting. In 2011 and under the auspices of the National Bureau of Economic Research, Professor Gruber attempted to assess how reasonable were the projections made regarding the Affordable Care Act and the CBO’s earlier contention that it would actually lower the federal deficit.  Here is what he thought would happen with the individual market.  He thought those who moved from the existing nongroup market to the exchanges would find their premiums increasing 27-30% as a result. (page 16).  He deprecated the potentially significant negative implications many might draw from such a finding by contending, however, that the purchasers would be rewarded with somewhat better policies: “[g]iven that the minimum standards are fairly modest, however, it seems likely that most of the increase in plan quality reflects voluntary upgrades.” (page 16).  Thus, Professor Gruber did not contend that all would be better off as a result of the prohibition on non-grandfathered policies sold without Essential Health Benefits; he simply contended (possibly with some accuracy) that most would.

They knew and they understandably did nothing

So, if the people in the know knew, why did they do nothing about it.? Why did they not insist that the people be able to keep their health plans even if they evolved and not be impelled to purchase possibly better but possibly more expensive policies inside the Exchanges? And the answer is that they did nothing about it because they needed those people to sacrifice in order to make the whole scheme work. And so long as those people were the faceless masses — the anonymous red shirts of a Star Trek landing mission —  it all made sense. They needed those people inside the Exchanges because many of them would have been recently medically underwritten and have low medical costs.  They needed them because pushing people with low medical costs inside the Exchange was what was needed — and is still needed today — to make a health insurance marketplace without medical underwriting work. They needed them to prevent the adverse selection death spiral. They were, in short, expendables, and, besides, were getting something better than they had even if they did not value it properly.

And what was perhaps sadly true back in 2010 is sadly true today.  The Exchanges are already unbelievably fragile and becoming more unstable each day that healthcare.gov stays more the butt of jokes than of a system for purchasing insurance. They are even more likely to break if people — the ones with low expected medical expenses — are permitted to separate themselves out and permitted to purchase cheaper and possibly less lavish policies outside the Exchanges.  In economics, one might think of the availability of off-the-Exchange lower-benefit policies as permitting a “separating equilibrium” in which the healthier group stay in the tin policies found outside the Exchanges and the more expensive group head for the bronze, silver, gold and platinum to be found inside the Exchanges.  And while one might think that everyone would be happy with this broader set of choices, the problem is that the removal of a large chunk of healthy people from the Exchanges means that there will be tremendous pressure on prices inside the Exchange to go up. The discrimination against the unhealthy, opposition to which formed an intellectual premise of the Affordable Care Act, will reappear.

So, do not expect insurers to take the Keep Your Plan Act lying down.  Insurers priced their policies inside the Exchanges on the assumption — that sophisticated people knew about — that the Exchanges would be receiving an influx of generally healthy people that had recently been underwritten for insurance outside the Exchanges. Insurers knew — because they had the power to make it so — that those people would be receiving cancellation notices from their insurers and would thus have a choice either to go bare or to purchase policies inside the Exchanges.  Insurers banked that many of them would invigorate the pools inside the Exchanges by choosing to purchase policies there.  Take all that away, and many insurers will begin to regret — even more than I suspect many of them do as the debacle of healthcare.gov and the enrollment figures become ever more clear — that they ever supported the Affordable Care Act or thought there was gold in the hills of the Exchanges.

Insurers are not without recourse.  There is little I know of that prevents the insurers from walking out of the Exchanges. Some have cancellation clauses built in to their contracts and it would create interesting contract litigation if some insurers decided, notwithstanding the existence of such cancellation clauses, simply to refund the advance premiums of prospective policyholders and say that they were not going to play.  Note for contracts professors only: voluntary restitution in lieu of performance where performance is prevented by government order under Restatement (Second) of Contracts section 264?

But even if the spectre of mass cancellations for 2014 is unrealistic, insurers have to start planning real soon if they want to continue in the Exchanges in 2015.  One expert at a conference in which I served as moderator contended that insurers will likely need to make a decision in April 2014 because that is when they will need to start submitting proposed new rates to insurance regulators. And every single day brings a new alarm bell suggesting they should not.  The individual mandate might be delayed or cancelled.  And although the individual mandate for 2014 is rather weak, still, such a delay will dilute further any otherwise existing incentives for the healthy to enroll in the Exchange.  Healthcare.gov continues not to work well — it is revealed today that even the  poor “Glitch Girl” apparently hasn’t tried to sign up. And now a broad spectrum of legislators and at least one former Democratic President — either embarrassed by what now appears to have been an untruth and/or cowed by the faces of earnest Americans being attached to what was heretofore treated as “statistics” — want to remove a source of potentially healthy insureds from the Exchange pools.

To be sure, there remain some protections for insurers who stay in.  The little-discussed but, as it may turn out, unbelievably important “reinsurance and risk adjustment” provisions of the Affordable Care Act (42 U.S.C. 18061-063) may limit the losses insurers will suffer even if horrible adverse selection results from the confluence of events and hasty reforms.  And, of course, if the enrollment numbers remain as infinitesimal as they now appear to be, not much matters.  Even if premiums are off by a factor of 2, insurers in an absolute sense can’t lose all that much money if only 100,000 people ever enroll.

The Fix is not really a Fix

There are two other matters to discuss with respect to H.R. 3350. The first is use of the word “may” and the second is a technical problem.

“May” not “Must”

The key thing to recognize is that H.R. 3350 does not force insurers to restore insurance that they recently cancelled.  Nowhere does H.R. 3350 say “must” or “shall.”  Instead, it just says that insurers “may continue” to sell the policies they had in effect on January 1, 2013.  It says only that, if they do so, they will not be treated as selling some sort of unlawful insurance prohibited by the Affordable Care Act. Thus, if insurers decide for whatever reason that they would rather not continue with those policies but would rather see those people inside the Exchanges, there is nothing in the Keep Your Health Plan Act that forces insurers to try and reverse their recent actions.  As a result, some insureds will not be able to keep their health plans although failures in such respect will be more clearly the result of insurer choice than of federal compulsion.  This, of course, may come as small consolation to those who truly liked their still cancelled old health insurance plans.

A Technical Problem

There may also be a technical problem with H.R. 3350, a bill that surely has been drafted in haste. The bill says that an insurer that had insurance in place on January 1, 2013, can continue to sell it notwithstanding the rest of the Affordable Care Act.  And, if they do so, they will be treated as selling a grandfathered plan.  The problem is that insurers could already do this.  So long as the insurer did not change the policy a whit, the insurer could, under the existing ACA, continue to sell that policy in 2014.  (A good source on grandfathered plans, by the way, is this Congressional Research Service report.) And that was true, even if the policy failed to provide Essential Health Benefits.

The question is whether an insurer can modify a plan that it sold in January 1, 2013 and still sell it in 2014 even though it does not provide Essential Health Benefits or afford other protections given to Exchange-traded policies.  While one assumes it was the intent of the bill sponsors that an insurer be permitted to do so — otherwise what, exactly, is the point of the statute — such a reading places a strain on its language.  The bill, after all, says, “may continue after such date to offer such coverage for sale during  2014.” But the “such coverage” is, at least grammatically, “health insurance coverage in the individual market as of January 1, 2013.”  While I have doubts about the wisdom of the Keep Your Health Plan Act, I suppose I am majoritarian enough to believe that if it passes, it at least should do the minimum of what its sponsors intended.

The Real Problem with Reform

The real problem with reform of the Affordable Care Act is that is such a tightly integrated statute.  It lacks a severability clause — a provision that says if one part of a statute is struck down the rest can go on — and although no one knows why omission of such a common provision occurred here, it is possible it occurred because the drafters knew much of the statute would be extremely difficult to sever in an intelligent way.  If you make it easy for people to really keep their health plans, that makes it harder for Exchanges in which an anti-discrimination norm prevails to price policies affordably, which in turn creates a need for ever bigger federal subsidies.  I suspect that as the flaws in the Affordable Care Act become ever more apparent in the days ahead, the difficulties of simply excising the disfavored parts will likewise become ever more clear.  Healthcare reform in the United States can not be achieved by magic.

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The aim of this blog

This blog is going to chronicle what I believe will be the implosion of the Affordable Care Act.  I do not believe the Exchange based system of providing health insurance without medical underwriting is likely to work or that, if it does, it will not need far more massive propping up from federal taxes than is conventionally recognized. We’ll be looking at current events, the history of the Act, important court cases, and regulatory developments. Our tools will be a careful review of primary documents, some graphical and mathematical analyses, and references to important and insightful articles written by others.

Also, there is more to the Affordable Care Act than the Exchanges.  There is more than the individual mandate. There is the employer mandate, the complex systems of federal reinsurance needed to backstop the Act, the reintroduction of medical underwriting under the “wellness label” and so much more.  We’ll try as time permits to take a look at developments in these important areas too.

I recognize that many are writing on this topic and that it will be hard to stay a pace of such a fast moving target.  But I do feel that there is a need for some hard and at least somewhat scientific look at what is going on.  It will be my goal and burden to try to provide that in the months ahead.

Oh, and who am I?  I’m Seth Chandler, a law professor at the University of Houston Law Center.  I’ve taught insurance law, including life and health insurance law, for many years, been a co-director of the Health Law & Policy Institute, and done considerable work on the economics of insurance and its regulation.  I’ve been very active using Mathematica, a system for doing mathematics by computer, and have shown how this tool can be used to analyze legal systems and many issues in insurance law such as adverse selection, moral hazard, correlated risk and a variety of issues in life, health, property and casualty insurance.

I should also add that the views expressed here are my own and do not necessarily reflect those of the University of Houston.


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