Tag Archives: President Obama

Eliminating Risk Corridors jeopardizes Exchange Insurance

Draft of S.1726
Draft of S.1726

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

Marco Rubio portrait
Marco Rubio

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

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

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

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

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

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

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

A Footnote on the cost of Risk Corridors

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

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




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

Short answer: My best order-of-magnitude estimate is between $500 million and $1 billion for the coming year of which a third to a half could be attributed to the President’s decision to honor his promise to let Americans keep their existing health insurance.

Insurers are rightfully complaining that the move by the President to fulfill a promise he made to permit Americans with “substandard” but previously grandfathered policies to keep their health insurance is going to destabilize insurance markets.  There were such complaints going in to a meeting on November 15 between President Obama and selected insurance leaders and there were somewhat muted complaints coming out of the meeting. Insurers are concerned because the people who are now being given access to another market in which insurance policies may be cheaper are likely to be precisely the healthy people that insurers who wrote policies in the Exchanges assumed would be in those Exchanges.  Their concerns are important because unhappy and unprofitable insurers have a tendency either to stop writing insurance or to raise rates.  That hurts policyholders and it also hurts politicians who assured the public that the rates would be affordable. (The insurers are also upset because it’s a little challenging to uncancel policies on short notice, but we’ll leave that grievance for others right now.)

The instrument by which some are proposing to pacify the insurance industry for the surprise deprivation of healthy insureds is the hitherto obscure “Risk Corridors” provision baked into the Affordable Care Act (section 1342, 42 U.S.C. § 18062, for those scoring at home). It provides that the government cover up to 80% of losses an insurer incurs on an Exchange. It was always assumed — foolishly in my opinion, but assumed nonetheless — that this backstop would be costless because the government would also effectively tax up to 80% of profits via the same provision. If the insurers systematically lose money, however, because many of the people they thought would improve the Exchange pools with their good health are being given an option to separate themselves out and keep their old often-less-expensive and often-less-generous insurance policies, the Risk Corridors provision could cost the government a fair amount of money.

So, the question is, how much money is Risk Corridors likely to cost? To use the language from my prior post, how much VOOM?  If it’s a relatively small amount, that would suggest that the President (and others’) proposal to honor a campaign commitment to let people who liked their health plans keep them is a better idea than if it’s a relatively large amount of previously unbudgeted money. I thought we might try a back of the envelope computation to see what’s involved.

Time to trot out some calculus.  The Risk Corridors provision basically creates a mathematical function between profitability (as defined in that provision) and the size of a positive or negative transfer payment from the government to insurers writing policies in the Exchange.  So, if we knew the distribution of profitability of insurers under the Exchange we would calculate the mean payment (an “expectation” for those with some statistics background) the government would make (or receive). Of course, we don’t know that distribution yet, but we can make some guesses and get some order-of-magnitude estimates.

If one assumes that the distribution of the ratio between claims and premiums has a mean value of one (i.e. that insurers on average break even), the the expected payment of the government is zero.  That’s the assumption on which the Congressional Budget Office worked when it asserted that Risk Corridors would cost nothing. But what if one assumes that the distribution of the ratio between claims and premiums has a mean value of 1.1, i.e. insurers on average lose 10%.  We’ll also assume for the moment that the distribution of the ratio is “log normal” and that 95% of insurers have a claims/premiums ratio of between 0.922 and 1.22. If we do the math — here’s the link to the Mathematica notebook that stands behind these computations — it turns out that the average payment of the government is about 3% of the average premium (before subsidies).  If the mean of the distribution were 0.5, i.e. insurers on average have claims 50% higher than profits, and we hold everything else the same, the average payment of the government is about 34% of the average premium (again, before subsidies). So if, just for the sake of discussion, one assumed there were 2 million people in the Exchanges and that the average gross premium was $3,500, the government would end up shelling out $210 million per year to provide insurers with some relief if they lose 10% on average and would end up shelling out $2.37 billion per year to provide insurers with similar relief if they lose 50% on average.

The graphic below shows the size of the government’s Risk Corridors obligation as a function of the mean of the claims/premiums ratio under the continued assumption that the distribution is log normal and that the spread of the distribution is similar to that described above. With a little wiggle when the mean of the claims/premium ratio is close to one, the relationship is pretty linear.


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

To get the total bill for the government, however, we not only have to calculate risk corridor payments in relation to a premium amount, we also have to make a guess about how many people will enroll in the Exchanges and what their premiums will be.  It’s complicated because, precisely because of adverse selection, there’s likely an inverse relationship between the number of people that enroll and the mean of the claims/premiums ratio.  But since all we are trying to do here is get some order of magnitude estimates — the discussion of this Act has been hurt all along by false claims of precision — we can try to make some reasonable guesses.

Suppose, for example, that the relationship between the mean of the claims/premium distribution and the number of people enrolling in the Exchanges looks something like this.

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

What we can now do is graph the government’s overall risk corridor payments as a function of enrollment.  I’m going to assume that the average premium is $4,000 per enrollee.  That’s roughly the average $328 per month that Kathleen Sebelius reported for a silver plan.  If people flock to the gold and platinum plans, the average could be somewhat higher. This graph is essentially the headline of this blog entry.

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

So, what we we see is that if, for example, enrollment for this year were to be 1 million, the total risk corridor payments might be somewhat in excess of $1 billion. If enrollment were 2 million, risk corridor payments might be $500 million.  One enrollment crosses 3 million, the government actually could gain money via the risk corridors program.

There are a lot of unknowns going in to the graphic above.  I do not pretend that it is precise.  I do not even contend that it is accurate.  Nonetheless, I believe it is useful.  I do believe it provides a plausible order-of-magnitude estimate of an unforseen cost of the Affordable Care Act.  If you asked for my best guess, I would tell you the Risk Corridor payments will likely be between $500 million and $1 billion this coming year as I would guess enrollment in the Exchanges will come out between 1 and 2 million (assuming they ever fix healthcare.gov).  This does not mean, by the way, that the cost of the President’s fix (or of the similar bills now in Congress) is the full amount of the Risk Corridor payments. Some of these risk corridor payments might have been made even without the Obamafix. That is so because enrollments in the Exchanges may always have been overestimated and may have been made considerably lower as a result of all the fallout from the debacle of the healthcare.gov website rollout.

In the end, then, I suspect that for the coming year the price tag for the President keeping his promise that “If you like your health plan, you can keep your health plan” is going to be somewhere in the $200 million to $400 million range for the coming year.  That’s about a third of the overall stabilization bill. And we’ll never know for sure because we won’t know how many of those that in fact do keep their health plan would have enrolled on the Exchange.  In one sense, the money cited above may be seen as a rather inexpensive price to pay to make good on an alluring promise.  On the other hand, it may also be seen as yet another unforeseen or unadvertised cost of a bill to transform American healthcare. It’s easy to make feel-good campaign promises when you aren’t fully honest about the cost.

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The Cat in the Hat Comes Back and the Affordable Care Act

The architectural flaw in the Cat's plan to alleviate the problems of the unfunned
The architectural flaw in the Cat’s plan to alleviate the problems of the unfunned

Surely all parents — or very young readers of this blog — will recall The Cat in the Hat Comes Back.  It’s a marvelous tale of a feline visitor creating chaos as two young children are again questionably left alone by an apparently single parent. But the basic idea of the story is that the Cat in the Hat eats cake with pink icing in the bathtub, which results in a dreadful pink ring being left in the tub once the decision is made to empty the water.  Upon the horrified pleas of the children that this tell tale sign of a poor decision on both their part — not acting more aggressively to prevent the cat from entering — and the cat’s — choosing a vulnerable household site in which to ingest potentially polluting pink icing —  might anger their mother, the ever-confident Cat develops a series of fixes. They begin with the cat’s use of mother’s new dress to wipe off the ring.  But, of course, this “fix” simply transfers the horror of the pink ring from the bathroom to the wardrobe.

Is the analogy to President Obama's plan to permit people to keep their "substandard" health insurance for one more year not readily apparent?
Is the analogy to President Obama’s plan to permit people to keep their “substandard” health insurance for one more year not readily apparent?

Much of the remainder of the story is then spent detailing how each successive “fix” simply makes matters worse until there is complete (and delightful) chaos and the entire landscape is covered in the apparently undilutable horror of the original pink ring. The situation is salvaged only when the Cat pulls mysterious “VOOM” out of one of his nested hats and uses its power instantly to remove all traces of the pink icing and restore order to the snow-filled landscape in which the book is set.


seuss voom 2As the most thoughtful parents and fiscally conservative children recognize, however,  the apparent victory of the cat over chaos may be illusory, placating the mother for now in its restoration of a superficial benevolent equilibrium, but creating potentially grave systematic consequences later on.  For no consideration has been given as to whether this use of apparently scarce VOOM — so small you can not see it — resulting from an obvious poor choice will deplete the VOOM supply and thereby prevent subsequent VOOM expenditures to deal with future problems. Might it not be better, the more clever readers recognize, for incentives to be established to deter future bathtub cake eating at all.

Does everyone then see it?  The pink ring is the adverse selection problem created by assuming that private insurance could operate in a system without medical underwriting when only mild punitive measures would be taken for the failure to procure insurance and when many, however shortsightedly, would prefer to use their scarce resources other than for insurance that covers not only catastrophic medical expenses but also all sorts of medical services that they either might not need or might be able to acquire without resort to the complexities and expense of third party payment. The Cat is, of course, President Obama, trying assiduously and with false or foolish confidence to fix the situation.  (Are the little sub-cats state insurance regulators only making matters worse?) The chaos is a metaphor for the problem that erupts when one attempts symptomatic cure of more fundamental and architectural design problems — frequently, these ill-thought-through attempts only make matters worse.  (Pacifying the people whose insurance was cancelled but, to the extent such an effort actually succeeds, destabilizing the Exchange-based insurance pools that formed the core of the statutory reform.)

And VOOM, what is VOOM?  VOOM is money. VOOM is “Risk Corridor” payments under section 1342 of the Act (42 U.S.C. 18062).  Those payments are what it will take to “clean up the snow,” to restore any semblance of stability in the Exchange markets otherwise destabilized by removing a large segment of largely healthy individuals from their pools.  But, again, I suspect, no consideration has been given as to the true bill for the underlying mistake, thinking that a system could be designed that, without requiring massive government subsidization, so defied economic laws which have, for a long time, told us that systems of private insurance in which underwriting is prohibited sooner or later — often sooner — contract due to adverse selection and, on occasion, fall into the black hole of a death spiral.

OK, OK. It’s a flawed analogy. I agree. And I do have some concerns that Dr. Seuss would not appreciate this political appropriation of one of his surely apolitical masterpieces.  I ask for some indulgence and promise that  far more scientific posts are forthcoming. But if Jonathan Gruber, one of the intellectual chiefs behind the Affordable Care Act, can write a politicized graphic novel extolling the virtues of the ACA, surely I may be indulged some literary criticism as a way of constructing an operating metaphor for the issues currently plaguing the same statute.

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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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