Tag Archives: risk corridors

Winter is coming?

For the past year or so, ACA proponents have gloated over the fact that markets have not yet collapsed in a death spiral and that enrollment in Exchange plans has grown to 9 million.  There are at least four recent developments, however, that suggest the ACA is in greater trouble than many realize.

Enrollments Way Lower Than Projected

The first piece of troubling news comes from CMS itself: Notwithstanding the full implementation of the individual mandate, CMS is projecting anywhere from 9.4 million to 11.4 million people enrolled in the Exchanges, an increase of 3-25% over its figure for 2015.  And, while ordinarily growth rates of this nature might please insurers, the projections on the basis of which Obamacare was enacted asserted that 21 million would be in the Exchanges by 2016.  Thus, while the Exchanges were running at 70% of original projections in 2015, they are now projected to run at just 45 – 52% of projections for 2016.  Moreover, between 0.9 million and 1.5 million of the enrollees for 2016 are projected to come  not from the uninsured but from those already holding off-Exchange individual market policies.

The new projection
The new projection
The premise on which the ACA was enacted
The premise on which the ACA was enacted

The reduced enrollment in the Exchanges has several ramifications. First, it likely means the pool in the Exchanges is less healthy on average than expected. Second it means the significant overhead expended in establishing the Exchanges and running them is spread over a lot fewer people. And third it means that Obamacare was essentially passed on greatly exaggerated assertions of its benefits.  Does the extraordinarily elaborate and expensive apparatus is establishes make sense when the a far lower than projected number of people gain health insurance of quality? One also must wonder how the dilution of the individual mandate through various “hardship exemptions” may have lowered the number of people enrolled on the Exchanges.

[[Added 10/20/2015]] For an excellent analysis of this issue, look also at Brian Blase’s recent article in Forbes. (http://www.forbes.com/sites/theapothecary/2015/10/19/examining-plummeting-obamacare-enrollment-part-i/)

Footnote 1: CMS is now “unable” to make projections for the SHOP Exchanges.  Are we now prepared to call them a bust?

Footnote 2: It is not clear whether the CMS enrollment projections took into account the very substantial gross and net premium that appear to be coming (see below).

More Coops Closing

The second piece of disturbing news is that at least four more coops insuring a significant number of people on the Exchanges are going out of business.  They are as follows:

Health Republic Insurance of Oregon (10,000 members; $50 million startup “loan”). By the way, Dawn Bonder, CEO of Health Republic, was quoted in The Oregonian just a month ago as follows: “We are strong and we are sticking to our plan, which has always been slow and steady growth. We’re very financially stable,” Bonder said. “We see a long,healthy life in front of us.”

Colorado HealthOP (83,000 members; $72 million in startup “loans”).  According to the Denver Post, this comes after the coop increased its enrollment seven-fold and captured 39% of the market in Colorado by cutting rates in 2015 (notwithstanding losses the year before).

Kentucky Health Cooperative (51,000 members; $146 million in federal loans, with a $65 million “emergency solvency loan” in 2014).  Again, this coop managed to capture 75% of the Kentucky Exchange market by offering insurance at lower prices.  Before shutting down, it had requested a 25% increase in premiums for 2016.  By the way, anyone remember those stories about how Kentucky was the success poster child for the ACA? It looks like its success may have been built primarily by selling insurance at cut-rate prices hoping that most of the losses would be bankrolled by the federal government.

Tennessee Community Health Alliance (27,000 members; $73 million in federal startup loans).  How had this coop captured market share?  Apparently by charging premiums so low that, as reported by The Tennessean, it had to request a 32% increase for 2016 and was granted/directed — get this — to offer premiums at a 45% higher rate.

Many of the coops blame their failure on the Cromnibus law enacted in December of 2015 that prohibited use of non-appropriated funds to pay for the federal Risk Corridors program that, on paper, was supposed to have the federal government backstop up to 80% of losses.  Given the magnitude of insurer losses thus far, the federal government is thus able to pay only 12.6% of the obligations created on paper by this program.  If one assumes, however, that the coops are correct in blaming Risk Corridors rather than mismanagement for their failure, this would confirm the suspicions of many that insurers priced their policies deliberately low in order to bring in business, relying on the federal taxpayer to cover their losses. I would also not be surprised to see some sort of legal action relating to coops who, notwithstanding Cromnibus and the handwriting on the wall persisted in booking Risk Corridor receivables at full value until very recently.

There will surely be lots of finger pointing over the failure of these coops: Democrats pointing to the “evil” Cromnibus bill as the source (although many Democrats voted for the legislation) and Republicans pointing to the inherent flaws in the ACA as the root of the problem. In the meantime, however, in many states, one of the sources of lower-priced insurance has been eliminated, meaning that many will be seeing substantial increases in gross premiums.

The fall of the PPO?

One of the promises of the ACA was that it would continue to offer choice to consumers and that they would be able to keep their doctor.  Not so in many states.  Plans that offer greater degrees of choice in selecting one’s provider appear to be in some trouble, closing in the shadow of an impending adverse selection death spiral. In Florida, for example, zero PPOs will now be available on the Exchanges in 2016.  In Texas, the state’s largest insurer, Blue Cross and Blue Shield, has announced that it lost so much money on individual PPO plans that it will no longer sell any in 2016. This development means 367,000 people will have to find other types of plans. In Illinois, Blue Cross is continuing PPOs for now, but only with narrower networks than had been available under a plan that had served 173,000 individuals.

I suspect this is just the beginning of problems for PPOs sold on the individual market in an era when insurers can not medically underwrite.  Between 2014 and 2015, PPO premiums went up at a far higher rate than other plan types.  We will shortly have the data to see whether this trend continued in 2016.

Rates

We don’t have all the information yet, but if ACA proponents like Charles Gaba are correct, we are looking at some substantial gross premium rate hikes in the United States, and extremely high rate hikes in some states.  What Mr. Gaba has done is to go state by state through various filings and do what no one else has tried: correlate premium rates with actual enrollments.  Although I do not always agree with Mr. Gaba, I must praise him for a very worthy and time consuming enterprise. The fact that some insurer is charging an astronomical premium for insurance doesn’t mean as much when few people are buying their product as it does when an insurer is getting a large share of the business.  Unfortunately, the federal government does not publish in any place I can discover insurer-by-insurer breakdowns of enrollment.

The research suggests gross premiums will go up 12.45% nationwide once enrollment weighting is taken into account.  Statewide figures range from a high of 41.4% in Minnesota, 39.0% in Alaska, and 30% in Hawaii to lows of 0.7% in Maine, 0.7% in Indiana and  3.5% in Connecticut.  Among the bigger states, the estimates are 4% for California, 15.8% for Texas, 9.5% in Florida, and 7% in New York. As I have noted on this blog and in testimony before a Congressional committee, net premium increases — which is what really matters to purchasers — can often be considerably greater than these figures, particularly for poorer individuals, but also can be lower.

 

More to come

We will, of course, see what plays out.  But for those who thought the brilliant engineering of Obamacare had forever slain the adverse selection dragon, beware. Dragon eggs can hatch.

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Bad news for Obamacare: Insurers lost a lot of money in 2014

In testimony before Congress last June,  I think I may have shocked some Representatives by estimating that insurers selling policies on the individual exchanges as part of the Affordable Care Act would be sufficiently unprofitable that they would get only 37% of what they would have received under the Risk Corridors program had the federal government not required that the budget for that program be balanced.  It turns out, however, that my gloomy estimate was, in fact, wrong — but only because it was far too cheery.  In fact, according to data released yesterday, insurers will receive only 12.5% of what they thought at one time they would receive.  There is a $2.5 billion shortfall between the money taken in under that program from profitable insurers and the money now owed to those who lost money, at least as the government measures it.

The shortfall spells trouble for Obamacare in a number of ways.  And it is difficult to overestimate how troubling this development should be for supporters of that program.

Some Exchange insurers are likely in serious trouble

First, it likely means that some of the smaller insurers who, at least  before passage of section 227 of the Cromnibus bill last December,  had anticipated receiving full payment for the money the government owes under the Risk Corridors program, are going to find themselves with a serious cash flow problem. Some may even find  themselves with solvency problems given the improbability that the full amount of the Risk Corridor obligation will ever be paid.  Companies that had booked Risk Corridor payments as receivables valued at 100% of the face amount, may have to start writing off at least part of them off as uncollectable.  Thus, when CMS says that the government’s inability to pay 87.5% of what it owes may create “some isolated solvency and liquidity challenges,” that is likely an understatement. Fortunately, as the Wall Street Journal reports, some insurers apparently saw the handwriting on the wall and accounted for the Cromnibus limitation properly so as not to deceive shareholders or state regulators.

Bad news for Exchange premiums

Second, it augurs severe pressure on insurance pricing in the healthcare exchanges.  The reason that there is a $2.5 billion shortfall is that a lot of insurers lost a lot of money selling policies on the Exchanges during 2014.  Insurers, like other businesses, have this habit of trying to make up for past losses by charging more in the future.  So we will see later this month some of the effect when the Obama administration releases data on premiums for 2016, but the massive losses in 2014 shown by the Risk Corridors results is likely to add to pricing pressures.

The Obama plan to rescue insurers has failed

Third, it shows that broken promises have consequences.  Let’s go through some history here.  Remember the infamous promise, “if you like your healthcare plan, you can keep it.  Period.”?  That was, of course, not exactly true in light of what the statute actually said.  And, when Americans saw their policies cancelled as a result, the Obama administration decided it would delay and relax enforcement of the various provisions of the ACA that would have killed enough many non-Exchange insurance plans.

But this refusal to salvage the political rhetoric by sacrificing the language of the statute got many insurers angry. The insurershad priced their policies on the assumption that of course the Obama promise was the usual political moonshine and that those healthy insureds previously owning now non-compliant policies would migrate their way over to Exchange policies and stabilize that market.  In true Cat in the Hat Comes Back style, the Obama administration “solved” that problem, as I explained twice (here and  here) in December of 2013, by fiddling with the accounting rules in the Risk Corridors program by making it more difficult for insurers to be deemed to have made sufficient money to owe the government and making it easier for insurers to be deemed to have lost money and thus be owed money by the government.  (Although its pronouncements were a bit cryptic, as I noted last April, the CBO may have estimated that the cost of this gimmick was as much as $8 billion).  Now, however, with the Cromnibus bill prohibiting the Obama administration from dipping into unspecified accounts to pay for Risk Corridors,  which I guess is what they planned since no money was ever appropriated for the program, that last bit of  multi-billion tinkering has backfired.   Insurers will not be paid for Risk Corridors for a long time if ever and, thus, they have indeed suffered a significant loss of a chain of make-it-up-as-you-go-along policies designed to salvage the ACA.

Don’t trust government accounting

Fourth, the Risk Corridors deficit exposes as pure bunkum the statements of many in Washington in the post ACA era — and continuing even today — about the state of the insurance market and the Risk Corridors program. Recall that at one point not too long ago the CBO was asserting that the Risk Corridors would actually make the government $8 billion.  This was done, perhaps not coincidentally, after an effort by Senator Marco Rubio gained prominence to defund Risk Corridors as an insurance industry bailout.  Devoted readers may also recall that I found the CBO’s estimate “baffling,” a bit of cynicism whose sagacity may have improved with age.  And even today with the announcement,  officials at CMS repeated the technically correct and yet practically dubious notion that, yes, there were shortfalls today, but Risk Corridor payments made by insurers in 2015 and 2016 might be enough not just to overcome the 2014 deficit now valued at $2.5 billion but also to make whole insurers who lost money in 2015 and 2016.

And the plea to undo Cromnibus

It is no wonder that former CMS head administrator Marilynn Tavener, now speaking for the America’s Health Insurance Plans, is now saying it is “essential that Congress and CMS act to ensure the program works as designed and consumers are protected.” By “as designed, Ms. Tavenner means  before Cromnibus when Congress, in a spasm of fiscal responsibility, required that Risk Corridors, for which no money was ever appropriated, actually pay for itself just like the Risk Adjustment program.  Translation of Ms. Tavenner: find someone else’s money somewhere to bail out insurers who lost money in the Exchanges.

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Obama administration increases insurer subsidies

The Obama administration announced earlier today that it would increase the  rate of subsidy provided insurers under the transitional reinsurance program established by the Affordable Care Act.  This program, in effect for the policies sold in 2014, 2015, and 2016 on one of the individual insurance exchanges fostered by the ACA,  provides free specific stop loss reinsurance to insurers, something insurers would otherwise have to pay a lot of money to obtain.  The Center for Medicare and Medicaid Services  (CMS) announced today that instead of taxpayers giving insurers  80% of the losses on any individual for their claims between $45,000 and $250,000, it would now pay a full 100% of these losses.

The higher rate of reinsurance should not be interpreted as a sign that claims were lower than insurers expected — something that would run contrary to many of the recent insurer rate hike filings or the losses reported by many insurers.  It is not a sign of the success of Obamacare; rather it is an artifact of its problems.  If, for example, there were 14% fewer people enrolled in Obamacare than at the time the reinsurance rates were initially determined (7 million vs. 6 million), reinsurance payments could be, as here, yet more generous to insurers even if claims were 10% higher than originally projected.

There are several implications of today’s announcement.  First, it means that, on a percentage basis, the ACA is subsidizing exchange insurers for 2014 even more than regulations enacted under it had heretofore prescribed.  Since this same money paid to insurers could instead have been used to provide greater subsidies to poorer and middle class individuals trying to purchase health insurance, the candy distributed today to insurers is a bit troubling. Second, because CMS says it will actually have money left over from 2014 even after the increase in reinsurance rates,  and because enrollment in Obamacare remains considerably lower than was estimated at the time of its enactment, there is an increased likelihood of reinsurance payments to insurers being higher than originally authorized in 2015.

We can get some sense of the magnitude of the changes announced today.  To do so, I use data embedded in the Actuarial Value Calculator, a document produced by CMS for the purposes of figuring out whether various insurance plans met the standards for bronze, silver, gold and platinum policies.  For an average silver policy, for example, the reinsurance that would have been provided prior to today would have been expected to save insurers about 11% in expenses, and, quite likely, premiums.  With the new reinsurance parameters, the transitional reinsurance program will save insurers selling the same silver policies about 14%.

We can do the same exercise for platinum, gold and bronze policies.  The results are not much different.  The table below shows the results.

Metal Level Original subsidy New subsidy
Bronze 11% 13%
Silver 11% 14%
Gold 11% 13%
Platinum 10% 12%

Two foootnotes

1. This is actually the second time CMS has made the transitional reinsurance program for 2014 more generous.  Originally, the reinsurance would “attach” at $60,000.  If an individual’s claims were below that amount, no reinsurance would kick in. Leter, CMS changed the attachment point to $45,000.

2.  How could I do this computation so swiftly?  I’ve been preparing for testimony before the House Ways and Means Committee on, among other things, the effect of the transitional reinsurance program on insurer rate changes and I’ve been working on a talk on a similar topic for the R in Insurance Conference later this month.  So, all I had to do was plug the new parameters into my model, and out came the results. Be prepared.

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No, New York Times, “guesswork” is not the reason ACA premiums are rising

The New York Times, whose editorial board has long been a strong supporter of the Affordable Care Act, published an article on its front page yesterday in which the headline read, “Seeking Rate Increases, Insurers Use Guesswork.” And, lest there be much doubt that the article suggested that speculation — the sort that regulators might understandably reject as a basis for premium hikes — rather than hard facts were leading to the frightening premium hikes, here are some quotes selected by author Reed Abelson for publication:

“But many insurers, including those seeking relatively hefty increases below 10 percent, say they are asking for higher premiums because they remain unsure about the future and what their medical costs will be.”

“It’s the year of actuarial uncertainty, and actuaries are conservative,” said Dr. Martin Hickey, chairman of the National Alliance of State Health CO-OPs and the chief executive of the New Mexico exchange. “The safest thing to do is to raise rates.”

Yes, to be sure, there was the suggestion in other parts of the article that higher than expected claims were part of the problem, but both the headline and remaining comments suggest that the high rates of increase were the result of unsupported speculation.

Wrong, New York Times! If you actually read the justifications for the premium increases submitted by insurers and their accompanying actuarial memoranda, you can see there are two dominant themes: (1) higher than expected claims expenses and (2) diminution of federal subsidies to the insurance industry.  You can also see lengthy memoranda containing facts and figures explaining their experience last year and the basis for their trending those experiences into the future. And, while one need not invariably take the insurance industry at its word or at face value, this is an instance where they have to make the best case possible for their rate increases. Regulators will scrutinize insurers’ work. Misstatements or rank guessing would seem to be against the insurance industry’s interest.

So instead of quoting people, who might themselves be guessing, let’s look at what the insurers actually said. I am going to bore you with 17 representative filings from across the nation. I do so because I want to make clear that the evidence is overwhelming. Most of these are contained in or accompanied by lengthy memoranda containing elaborate tables justifying the increases. I’ve attempted to be diverse in my selection of insurers to avoid repetition of, for example, the Blue Cross position or the Aetna position.

1. Blue Cross and Blue Shield of Alabama

BCBSAL proposes an average 28% increase to rates for the products offered in 2015. The main drivers of the need for a rate increase are as follows:

• Single risk pool experience which is significantly more adverse than that assumed in current rates

• Medical inflation and increased utilization as indicated in Section 5: Projection Factors

• Expected increases in the average population morbidity of the Individual Market, also described in Section 5: Projection Factors

• Reinsurance program changes, described in Section 9: Risk Adjustment and Reinsurance

BCBSAL determined that the following items did not contribute significantly to the need for a rate increase:

• Taxes and fees: Minimal changes in the amount needed for taxes and fees, described in Section 10: Non-benefit Expenses and Profit & Risk

• Benefit changes: No changes to offered benefits for 2016

2. HealthNet of Arizona

The projected claims experience was developed using calendar year non-grandfathered 2014 experience. If our rate request is approved, the expected premium for the entire risk pool is $313.91 PMPM. This represents an increase of 24.7% in average premium. 2014 premiums received were $127,867,744. Claims paid were $171,764,569. Since 2014 medical costs are increasing with an annual trend of 5.5%. Prescription drug costs are increasing with an annual trend of 10.3%. Claims costs are 85.1% of premium. Administrative costs are 14.5% of premium. Profit is -4.8% of premium.

3. Cigna Health and Life Insurance Company (Connecticut)

The most significant factors requiring the rate increase are:

Changes in Medical Service Costs: The increasing cost of medical services accounts for the majority of the premium rate increases. Cigna anticipates that the cost of medical services in 2016 will increase over the 2015 level because of prices charged by doctors and hospitals and more frequent use of medical services by customers.

Transitional Reinsurance Program Changes: The federally mandated transitional reinsurance program is in effect for three years (2104, 2015, and 2016). The amount of funding available to issuers under the reinsurance program to offset adverse claim experience decreases each year ($10B in 2014, $6B in 2015, and $4B in 2016). Additional premium is required to compensate for the reduced reinsurance support in 2016.

Morbidity (Risk Pool) Adjustments: The marketplace for non-grandfathered individual plans is affected by provisions of the Patient Protection and Affordable Care Act (the Affordable Care Act) that became effective in 2014, including:
guarantee issue and renewal requirements
modified community-rating requirement
federal premium subsidies for low and moderate income individuals.

The effects of these 2014 changes when coupled with previous regulatory changes and overall utilization experienced in 2014 suggest that it is appropriate to increase the overall claim level assumption reflected in the premiums for individual plans in Connecticut.

4. Aetna Health, Inc. (Florida)

Why We Need to Increase Premiums
Medical costs are going up and we are changing our rates to reflect this increase. We expect medical costs to go up 10%. Medical costs go up mainly for two reasons – providers raise their prices and members get more medical care.
For policies issued to individuals in Florida, some examples of increasing medical costs we have experienced in the last 12 months include:
· The cost for an inpatient hospital admission has increased 8.0%.
· The average cost for outpatient has increased 8.4%.
· Costs for pharmacy prescriptions have gone up 8.0%.
· The use of outpatient hospital services has increased 4.5%.

What Else Affects Our Request to Increase Premiums
Several requirements related to the Affordable Care Act (ACA) impact these rates. These include:
· “Keep What you Have” and its impact on the population that will enroll in the plans covered by this filing
· Enhanced network access standards – which limit our ability to control the cost and quality of medical care
· Changes to required taxes and fees
· Phase-out of the Transitional Reinsurance Program which increases rates for plans issued to individuals

5. Humana Employers Health Plan of Georgia, Inc. (Georgia)

Many factors influence this rate calculation. The primary factors include
‐ Population health‐ Expected changes in the aggregate health level of all individuals insured by all carriers in the individual health insurance market.
‐ Claims cost trend‐ Changes in expected claims costs associated with changes in the unit cost of medical services, changes in Humana’s contracts with hospitals, physicians, and other health care providers, and the increase or decrease in utilization of medical services including changes in the severity and mix of services used.
‐ Plan Changes‐ Changes to plan designs due to changes in federal requirements.

6. Wellmark Health Plan of Iowa, Inc. (Iowa)

Reason for Rate Increases The effective average rate increase for these products is 28.7%, varying by plan as listed in the table above. The primary drivers of the proposed rate increases include, but are not limited to:

• Adverse Experience/Risk Adjustment Transfer: The risk of the market is more adverse than what we had assumed in the current rates; which leads to a significant projected risk adjustment transfer payment to other carriers.

• Medical and Drug Inflation: Both increased utilization and increased cost per service/script contribute to projected claims trend.

• Phase out of Federal Transitional Reinsurance Program: As this program phases out over three years, the expected receivables from this program are smaller for 2016 than they were for 2015.

7. CareFirst of Maryland (Maryland)

The main driver of the financial performance of these products and the proposed rate increase is the very significant increase in average morbidity between 2013 (the pre-ACA pool which underwent underwriting) and 2014 (the post-ACA guarantee-issue pool). The allowed claims per member per month (PMPM) increased from $197 in 2013 to $391 in 2014, a much higher and faster increase than anticipated.

8. HealthPlus Insurance Company

The biggest driver of rate change is 2014 claims experience that is more adverse than assumed in current rates. Another driver is due to the lower Federal reinsurance recoveries.

9. Coventry Health & Life Insurance (Missouri)

Why We Need to Increase Premiums
Medical costs are going up and we are changing our rates to reflect this increase. We expect medical costs to go up 9.4%. Medical costs go up mainly for two reasons – providers raise their prices and members get more medical care.

What Else Affects Our Request to Increase Premiums
We offer individuals in Missouri a variety of plans to choose from. We are changing some benefits for these plans to comply with state and federal requirements.
Several requirements related to the Affordable Care Act (ACA) may also impact these rates. These include:
• Changes to our expected projected average population morbidity and its relationship to the projected market average for risk adjustment.
• Changes to required taxes and fees
• Phase-out of the Transitional Reinsurance Program which increases rates for plans issued to individuals

10. Aetna Health Inc. (Nevada)

Why We Need to Increase Premiums
Medical costs are going up and we are changing our rates to reflect this increase. We expect medical costs to go up 10.6%, excluding the effect of benefit changes described below. Medical costs go up mainly for two reasons – providers raise their prices and members get more medical care.

For Individuals in Nevada, some examples of increasing medical costs we have experienced in the last 12 months include:
• Primary Care Physician visits have increased by 124.2%.
• Inpatient bed days have increased by 51.0%.
• Expenses for emergency treatment have increased 22.7%.

What Else Affects Our Request to Increase Premiums
A prominent hospital system in Nevada moved from participating to non-participating in 2014 and is expected to stay that way into 2016. This has an adverse impact on claims costs since the more favorable lower-cost in-network reimbursement rates no longer apply.

Several requirements related to the Affordable Care Act (ACA) also impact these rates. These include:
• Enhanced network access standards – which limit our ability to control the cost and quality of medical care
• Changes to required taxes and fees
• Phase-out of the Transitional Reinsurance Program which increases rates for plans issued to individuals

11. Blue Cross Blue Shield of New Mexico (New Mexico)

[E]arned premiums for all non-grandfathered Individual plans during calendar year 2014 were $84,497,659, and total claims incurred were $105,605,811.

After application of the ACA federal risk mitigation provisions, the total BCBSNM Individual non-grandfathered block of business experienced a financial loss of 17% of premium in 2014.

The proposed rates effective January 1, 2016, are expected to achieve the loss ratio assumed in the rate development.

Changes in Medical Service Costs:

The main driver of the increase in the proposed rates is that the actual claims experience of the members in these Individual ACA metallic policies is significantly higher than expected. After application of the ACA federal risk mitigation provisions, the total BCBSNM ACA block of business experienced a loss of 19% of premium in 2014.

12. Medical Mutual of Ohio (Ohio)

Medical Mutual of Ohio is proposing an overall rate increase of 16.9% for plans effective January 1, 2016. This increase will potentially impact the 37,673 existing MMO members. The rate change ranges from 7.4% to 26.0%, varying by plan, age, change in tobacco user status, change in family composition, and the geographic area where the member resides.
The experience of MMO Individual ACA plans was not favorable in 2014. MMO has paid nearly $167 million claims and only received $114 million in premium. In 2014, MMO lost about $42 million dollars on its individual ACA business alone. With the rate increase implemented for 2015 and proposed for 2016, MMO’s experience is expected to improve, becoming profitable in 2016.
The following items are the main drivers for the proposed rate increase:
1. The transitional reinsurance recovery decreased from the 2015 level and will have a smaller impact offsetting the total claims.
2. The increase in the medical and drug cost is about 6.2% annually. Out of that increase, 40% is due to the change in unit cost, 31% is due to the change in utilization and the rest is due to the change in the mixture of services.
3. We expected the morbidity and demographics to improve in 2016 due to increased penalty of non-compliance, a greater understanding of the ACA law, and a reduction in the amount of pent-up demand for services. This alleviates the rate increase needed based on the experience.
4. There’s no changes in benefit from 2015 to 2016.
5. The administrative cost and commission will decrease $2.51 per member per month. The profit and risk will increase $7.92 per member per month. The taxes and fees will increase $4.51 per member per month.

13. Geisinger Quality Options (Pennsylvania)

Geisinger Quality Options has proposed an overall base rate increase of 58.36% for Individual PPO members renewing in the Marketplace effective January 1, 2016 through December 1, 2016. The overall increase is largely due to the claims experience in ACA compliant individual market plans being much higher than what was assumed in current rates. Other contributing factors include annual claims trend, federally-prescribed ACA fees and reduced benefits in the Transitional Reinsurance Program.

14. Pacific Source Health Plans (Oregon)

This filing requests an aggregate increase of 42.7 percent over the rates approved in our 2015 Oregon Individual filing. The proposed rates are based on PacificSource’s historical Oregon Individual claims experience adjusted for PacificSource’s historical average risk compared to the market average risk, anticipated medical and pharmacy claims trend, expected change in market morbidity from 2014 experience period to 2016 projection period, changes in benefits, and expected state and federal reinsurance recoveries. The proposed rates also reflect changes in the taxes and fees imposed on health insurers for 2016. The range of rate increases is 23.4 percent to 60.4 percent and impacts PacificSource’s 8,216 Oregon Individual members. The variation in rate increases is driven by some changes in benefits i.e. copays, deductibles, OOP max, as well as adjustments to geographic area factors. The overall average impact of benefit changes on the requested rate increase is 0.0 percent.

The increase in rates from 2015 to 2016 is primarily driven by a dramatic worsening of claims experience in 2014 as compared to 2013, and the reduction of expected reinsurance recoveries in 2016. Note that this is the first rate filing where a full year of post ACA experience data was available. This data shows that the overall increase in morbidity from PacificSource pre ACA experience to post ACA market experience is much greater than originally projected in our 2014 and 2015 rate filings. The combined medical and pharmacy annual trend used in this filing is 7.0 percent, which reflects expected changes in costs, changes in utilization, and the impact of leveraging. The primary driver of the annual trend assumption is specialty drug cost and utilization, particularly Hepatitis C drugs. Administrative expenses and margin are budgeted to decline compared to the 2015 rate filing.

Over the calendar year 2014, the Oregon Individual block earned 30.2 million in premium and incurred an estimated 50.0 million in claims, for a raw medical loss ratio of 165.2 percent. Premium and claims expenses are shown before the impact of reinsurance, risk adjustment, and risk corridor. At this time we do not expect risk corridor payments to be made to issuers. After expected risk adjustment and state and federal reinsurance recoveries, we estimate a 2014 loss ratio of 116.5 percent. Combined administrative expenses, commissions, taxes, and assessments were approximately 24.6 percent of premium.

15. Scott & White Health Plan (Texas)

The Scott & White Health Plan is requesting an average rate increase of 32.3% to the Individual HMO Rating Pool. There are 24,294 covered individuals as of January 2015. 10.0% of the 32.3% increase is due to health care cost inflation, 14.3% of the increase pertains to changes in Risk Adjustment and Reinsurance assumptions, 2.7% is due to changes in fees, and the remaining 5.3% is due to actual and expected unfavorable experience.

16. Optima Health Plan (Virginia)

The rate increase is the same for all members in the same plan. Where the 2016 plan is different than the 2015 plan these members will be automatically enrolled into the 2016 plan shown. Premium rates are effective January 1 2016.
Claims expenses were very high in 2014 relative to earned premium. However payments from the federal transitional reinsurance and risk adjustment programs are expected to help significantly.
The federal reinsurance program is only temporary and while it is continuing into 2016 the amount of reinsurance per claim is less than in 2014 and 2015. As such premium rates will be increased to account for this impact. Additionally the risk adjustment program alone does not appear to provide sufficient relief to enable the Company to meet its pricing targets.
It is anticipated that 2014 had some amount of higher claims due to new members having pent-up demand for services and less healthy people tending to be the first to sign-up for ACA-compliant plans given the new rating and underwriting rules. Because of this we do not assume that 2016 will necessarily be as high a claim level as seen in 2014 but some of what has been experienced will remain.
These reductions from 2014 levels will be countered by upward pressure on costs from other sources such as medical trend as described below.
The proposed rate increase is intended to account for expected claims activity in 2016 given historical experience and changes in morbidity as well as any expected assistance from the federal reinsurance and risk adjustment programs. With the proposed rate increase the anticipated loss ratio is 80 percent.
Medical trend for these products is anticipated to be an average of 7 percent per year on paid claims for example after member cost sharing or a total of 14.5 percent over the period from 2014 to 2016. This was developed based on historical experience as well as consideration for information available on general medical inflation trends. Medical trend includes a combination of utilization and costs of services. This increase in cost is included in the calculation of the rate increase.

17. Security HealthPlan of Wisconsin (Wisconsin)

The biggest driver of the rate change is SHP’s underlying claims experience used in developing the projected index rate. We used SHP’s 2014 individual non-grandfathered, ACA allowed claims as the basis for claim development. The 2014 claims and membership distributions indicate experience is worse than we priced for in 2015 rates. Further, based on a Wisconsin risk score analysis conducted by Milliman, we are projecting no risk adjustment transfer payment. This assumption of no payment results in higher rates in 2016 since we had projected SHP would receive money from the risk adjustment pool when developing the 2015 rates.

Another driver of the rate change is due to the lower federal transitional reinsurance recoveries in 2016. The recoveries assume in 2016 SHP will receive 50% of all SHP’s individual members’ per member per year incurred claims between $90,000 and $250,000. In 2015, rates were priced assuming recoveries to be 50% of claims between $70,000 and $250,000 based on the federal parameters in place at the time of pricing.

The projection of claims from the experience period to the effective period assumes 5.0% annual medical and drug trend. These trends were estimated based on data from SHP, conversations with SHP senior management, Milliman research, general industry knowledge, and our judgment of recent trends.

Conclusion

So, does this sound like “guesswork” to you?  It does not to me.  All of these insurers are lying or mistaken about what is causing their requests for premium hikes? I don’t think so.  Of course, there is “trending” in which insurers approximate how previous increases will continue to the future and this requires some art on the part of insurers.  Of course, insurers may want to present their requests for rate hikes in a way more likely to be approved. But what they have presented is no more “guesswork” here than the work of any insurer in setting rates for almost any form of insurance. It is the sort of actuarial projections that are generally approved by regulators.

Health insurers now have a decent feel what it is going to cost them to participate in Obamacare.  And these insurers have a pretty common perspective: the whopping increase are driven by  greater utilization than expected among those electing coverage  (adverse selection and moral hazard), increases in the cost of medicine, and reduction of federal subsidies.

Exactly what some people predicted.

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The Cons of the ACA

Recently, I was honored to speak before the PIAA, a group of insurance professionals, at the organization’s annual conference in Las Vegas.  The idea was that I would speak on the problems with the ACA and Ardis Hoven, M.D., past president of the the AMA, would speak on positives about the ACA.  I thought the format worked well and I appreciated the high level of discussion and civility of Dr. Hoven.

Here’s what I had to say. Since you can’t use footnotes or hyperlinks in a speech, I’ve provided a few additional annotations here to show the source of some of the information.

The Speech

I’m here to talk about the architecture of the ACA and its problems.

The ACA takes a bold risk.  It places our economy and our health on an metaphorical aircraft whose ability to fly is challenged by history. It proceeds on the assumption that, whereas almost all community rating systems in health insurance have crashed in ugly adverse selection death spirals, the craft engineered by the Obama administration and its consultants is so sophisticated that it will avoid such a fate.  Many will tout what they see as the success of the ACA thus far in reducing the number of uninsured and the absence of many catastrophic failures as evidence that the ACA flies.  But we have not seen turbulence. It is an open question whether, long term, the ACA can survive in its present form.

Let us now talk about how the ACA flies.  It uses a variety of mechanisms to keep it aloft.  The problem is that almost every one of them has the potential for being undermined.

Individual Subsidies

The ACA depends desperately and in perpetuity on taxpayer funded policy subsidies provided directly to the insured. There is a premium subsidy based on household income. And there is another effective premium subsidy achieved through what is termed a “cost sharing reduction program” but this really amounts to people getting gold, platinum or diamond — my term — policies but only having to pay the silver price.  These subsidies have been crucial to the touted success of the ACA.  They have brought low risk individuals into the pool. Without the subsidies, the insurance market would need to depend solely on risk aversion to achieve price stability and escape the death spiral.  Prior experiments relying only on risk aversion alone have been notoriously unsuccessful.

For better or worse, the subsidy has had an immense effect. A recent study conducting by Avalere shows that 83% of Exchange enrollees have incomes at 250% or less of the federal poverty level for their households. The take up rate among those eligible for ACA exchange policies falls from 76% for those earning 100-150% of FPL down to just 16% for those earning 300-400% of FPL. Take up then plummets to 2% for those earning more than 400% of FPL and who are thus ineligible for subsidies.

This elasticity in the demand for health insurance is precisely why the forthcoming Supreme Court decision in King v. Burwell is of such great importance.  If the Supreme Court issues a square holding that the federal government lacks authority to pay the premiums where the state itself has not directly established an Exchange, and neither Congress nor the states does anything to fix the matter, expect insurers in those states rapidly to stop offering individual health insurance on the Exchanges. Indeed, clause IVB in the contracts those insurers negotiated with the federal government precisely in anticipation of King v. Burwell would permit those insurers not just to exit the market next year but to cancel existing policies midstream.

A side point, but one that might trouble this audience.  Every insurer that I know of is accepting payments from the federal government for cost sharing reductions.   But those payments are almost certainly illegal. Congress never appropriated any money for Cost Sharing Reductions.  So, under the law as written, insurers who want to play in the Exchanges are really supposed pay for cost sharing reductions themselves.

Of course, to my knowledge, that’s not happening. The money now landing in insurer’s bank accounts is coming from a fund set up for tax refunds that is, by law, dedicated exclusively to that purpose.  That, I believe is unlawful and, should another party ever control the Executive branch and want to look for a villain or want to extort various favors from someone whom they have over a barrel, might it not chase insurers for receipt of diverted funds?  There is a 1938 Supreme Court decision saying the Government can recover funds paid illegally and a 1990 Supreme Court decision saying that a claim of estoppel can not lie against the federal government.   So, before insurers become accessories or before they count as money on their balance sheets that they might have to pay back, they might want to look at these cases.

Reinsurance subsidies

There are also less visible features of the ACA that are designed to improve the probability of the airplane staying aloft. The ability of the ACA to fly also depends substantially for 2014, 2015 and 2016 on premiums subsidized by free specific stop loss reinsurance given to insurers who agree to risk their capital in untested Exchange markets.  It is, however, a form of support that is going to flame out after 2016.

How much support does it provide? If you use the data from the 2016 draft actuarial value calculator produced by CMS, you can compute that the subsidy will still be about 3% of premiums for 2016.  It was higher in 2014 and 2015. How will the ACA continue when prices increase at least 3% more just due to the elimination of this single subsidy.  The naive might think that 3% is not all that much.  And, without taking adverse selection into account, I would expect the market to shrink only by about an equal percentage.  But if history and economics tells us anything — and it does — because of adverse selection, the actual price increase will be greater and the resulting decline in enrollment will be greater.

I would not expect Congress to do any sort of mid-flight refueling of reinsurance subsidies, to continue my airplane metaphor. The policy justification for specific reinsurance subsidies seems rather thin.  If reducing the overall risk to insurers was the issue, aggregate stop loss, perhaps available at an actuarially fair price, rather than free specific stop loss reinsurance would make more sense.  And if the government, and, derivatively, the insurance industry, was fearful of there being no market for reinsurance where the risk involved was so untested, Congress could have made a guess and established a fair price and reinsurance facility itself. Moreover, if uncoupling household income from the ability to obtain medical care was a primary goal of the ACA,  why would Congress not just increase individual premium subsidies instead of sending that money to enrich, sorry guys, insurance companies?  This form of corporate welfare helps people at 350% of federal poverty level or even people at 1000% of FPL buying unsubsidized policies on the Exchange as much as it helps the person earning 150% of FPL who might desperately need more assistance. If one accepts major premises of the ACA, one might seriously question why such is the case.

Risk Corridors: The Free Derivative

The ACA depends somewhat for 2014, 2015 and 2016 on another form of subsidies for the insurance industry.  It indirectly subsidizes premiums by providing insurers with a free financial derivative: risk corridors that reduce the amount of capital prudent insurers might otherwise need to stockpile or aggressive state regulators might require them to stockpile. This reduction occurs because Risk Corridors reduces the probability of insurers losing substantial amounts of money via participation in the Exchanges. To use a finance term, Risk Corridors reduces Value at Risk, which is a decent estimate of the amount of money participating insurers need to keep in more liquid and probably less lucrative investments.

If you run the computations — ask me how — it looks as if Risk Corridors reduces the amount insurers need to charge for Exchange policies by a little less than 1%.  Again, you might say, in what I suspect would be a deprecating tone, big deal. And, I agree that, taken by itself, the ACA is unlikely to crash based on a 1% increase standing alone.  But it’s all cumulative and the problem with death spirals is that once you find yourself in their clutches they are a bit like a black hole, very difficult to escape.

Insurers may not have to wait until 2017 for Risk Corridors to disappear.  They are already in grave trouble.  Congress also never appropriated any money for Risk Corridors. And this wasn’t an accident. The statute, as written, depends on assessments on insurers based on a formula to magically equal payments out to insurers based on a formula over the 3-year span of the program.  We are already seeing, as many predicted, however that such an assumption was unwarranted.  Due perhaps to loss leader pricing and the predictable propensity of consumers to pick precisely those plans that were charging too little relative to actuarial risk, it appears that, on balance, at least after what I would hope would be clever but lawful accounting, that few insurers are making enough money under Obamacare policies to provide any funding to the many insurers who gained volume at the expense of profitability. So, when the Obama administration suggested it might lawlessly raid other government accounts to fund Risk Corridor deficits, Congress responded in section 227 of the Cromnibus bill by walling off the plump Medicare Parts A and B trust funds and CMS operating accounts as a source to repay obligations created by the Risk Corridor program.

Might deficits in early years of Risk Corridors be funded out of profits in later years as the Obama administration has suggested? The omens aren’t good. According to a review of 2014 industry filings by Standard & Poors, Risk Corridors will likely collect less than 10 percent of what industry is expecting to be reimbursed. 14% of insurers will likely pay into Risk Corridors.  56% expect money out. The absence of Risk Corridor money will be fatal to some insurers.

Already, we are seeing the death and near death of some less well capitalized insurers, particularly the co-ops capitalized, I might add, not so much by private investors but by $2.4 billion from the taxpayers in a less well publicized cost of Obamacare. Low premiums are not of terribly great value if they end up bankrupting private insurers on whom the success of Obamacare depends.

Individual Punishment

Thus far, I have spoken of the carrots to get even people of low risk to participate in the Exchange marketplaces.  Obamacare is fueled, however, not just by subsidies but by punishment. Obamacare chose a different punishment model than for programs such as Medicare Part B or Medigap.  In those programs, and in some Republican proposals for Obamacare reform, if you don’t select insurance when you are first eligible, you just pay a lot more for insurance if you elect coverage later.  No commerce clause problems, no tax. Obamacare, by contrast, increases administrative costs by potentially assessing  a penalty each year if you don’t have coverage. The ability of this punishment to stem a death spiral depends on the size of the punishment and the number of people who are subject to it.  And what I now wish to suggest is that even without its formal repeal, the Individual Mandate was weak to begin with and has been further enfeebled by administrative moves taken in response to political uproar.

Consider, for example, a slightly fictionalized version of one typical American. According to the Kaiser Foundation Calculator, a 45 year old non-smoking person making $48,000 per year would expect to pay $3,742 on average for a Silver Policy.  Suppose, however, that the individual considers themselves to be only 30 in health years. The individual thus considers its average expenses that would be covered by insurance to be $2,941.  Would the $746 difference in tax created by the mandate be sufficient to get that person to purchase an Exchange policy.  Not if that person was risk neutral.  $746 in tax is less than the $801 excess in medical expenses.

Alternatively, eliminate $3,000 from the person’s income. Now, because the premium the individual would have to pay is more than 8% of household income, the individual is exempt from the individual mandate. There are a significant number of uninsured people thus exempted from the mandate on grounds that they are simply too poor to purchase Obamacare.

But there’s more to make sure, as the CBO recently confirmed, that only one in six of the uninsured will actually be subject to the mandate.  There is the absurdly expanded hardship exemption. There’s the health sharing ministry exception mostly for evangelical Christians. And there’s the peculiar 3 months off exemption (26 USC § 5000A(e)(4)).

In short, one of the reasons Obamacare will have difficulty flying is that we are afraid of our inability accurately to determine whether people can really afford insurance and at what price.  For now, though, if one wants to rely on sticks, the stick is actually too weak and hits too few people.

The Employer Mandate

Another key component of the ACA has been the employer mandate.  Or, at least it was supposed to be a key component.  In fact, in what a lot of people, including me, think is a very dangerous precedent that will, one day, bite ACA proponents in the proverbial behind, the Obama administration simply decided, without any apparent discretion, to delay enforcement of the law for one year and, for the current year, to apply the statute only to employers with more than 100 employees, even though the number the statute picks is 50. If a change to the tax code is so complicated that it takes mid sized businesses with financial advisors 5 years to understand it, perhaps that’s a sign there is something more fundamentally wrong.

At any rate, the employer mandate is, for lack of a more sophisticated term, stupid. If it actually works, it keeps people off the individual exchanges, which is exactly what should not be happening. The employer mandate perpetuates both symbolically and literally the counterproductive tie between a poorly functioning and lumpy labor market and something as important as health.  It puts the employers’ decision as to what sort of coverage best suits the employee ahead of the ability of the individual to choose.  The tax deductibility of payments helps the wealthy more.  The lack of portability between jobs decreases the sort of continuity of care that might improve health. It is everything a good liberal should hate.  (Indeed, some have had the courage to note the many flaws with the current law.) And so I wonder if King v. Burwell comes out against the government, whether the employer mandate, which has barely made it on to the Obamacare Aircraft, might be abortively deplaned with eager Republicans and Democrats in need to save face actually coming together on this issue.  Indeed, if I were a Limbaugh-style Republican who wanted Obama to fail, I would actually insist on the employer mandate continuing as a way of starving the individual exchanges of healthy people who might stabilize their prices and of helping high income voters more.

Conclusion

One’s perspective on the ACA can’t be whether it helps insurers or whether it helps the medical profession.  In fact it shouldn’t even be on whether more people have health insurance.  The positive factor to be considered is whether it has improved health.  I will concede that, on balance, it probably has — slightly. Many medical interactions are beneficial and, although supply of medical practitioners has not increased much, there are 2-4% more such interactions thanks to the ACA.   In any event, whether the ACA marginally improves health is not the exclusive test.  These programs have to be paid for and they come at a heavy price.  The CBO now estimates the ACA will increase our budget deficit by $849 billion dollars through 2026. It is not, contrary to prior representations, paid for.

If you forget about Medicaid expansion and take the net increase the uninsured as a result of the ACA and divide that by the cost of providing coverage to them, it turns over 10 years to average with premium subsidies, cost sharing reductions, the 3Rs, and administrative costs about $7,600 per person.  And in addition to racking up our already bloated deficit, there will be be taxes, fees and subsidies that have their own perverse incentives. Some have estimated the cost of providing a currently uninsured person an additional year of a quality life at over $200,000 possibly over $1 million. That’s enough that we have to look hard at whether there might be some better and simpler alternatives.

As we move forward  ought to be looking not at Obamacare vs. The Bad Old Days Where Evil Insurers Deprived Sick People of Coverage but rather to a variety of alternatives ranging from, yes, Bernie Sanders Single Payer plan to, better,  libertarian plans to use market mechanisms more effectively  to perhaps better yet, lots in between.  Yes, Obamacare has gotten off into the air, but if they would honestly call “Mayday,” it is my hope that a variety of people would try to help out.

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Continuing Resolution jeopardizes Risk Corridors

Amidst all the passion yesterday at the roasting yesterday by the House Oversight Committee of Glib MIT Professor Jonathan Gruber and Marilyn Tavenner, Administrator for the Center of Medicare and Medicaid Services, many have missed what may be the most important development of the day: Congress is closer to stopping the Obama administration from funding the Risk Corridors programs that insulates insurance carriers selling policies on the Exchanges from much of the financial risk.  Chapter G of the Continuing Resolution currently in the works  (the “Consolidated and Further Continuing Appropriations Act, 2015”) appears to block the Obama administration’s apparent plan of using a “slush fund” — the “CMS Program Management Account” — to pay insurers when obligations under the program exceed receipts. Many, including the non-partisan Congressional Research Service and Senator Jeff Sessions, believe that the earlier contemplated use of this account to pay for Risk Corridors was unlawful under the Antideficiency Act and Article I, section 9, clause 7 of the United States Constitution (“No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law”).

Page 75 of Division G of the summary of the Appropriations Act of 2015
Page 75 of Division G of the summary of the Appropriations Act of 2015

The inability of the Obama administration to finance the Risk Corridors program is a direct threat to the operation of the Affordable Care Act.  Insurers who priced policies based on the assumption that, if they went too low in their premiums, they would be protected against substantial financial risk by Risk Corridor payments from the federal government, will now be facing — to their surprise — an environment in which at least some of the Risk Corridor payments will not be forthcoming. Insurers contemplating entry  or continued participation into the insurance markets created by Obamacare will now hesitate for at least 2016 — either that or they will price their policies higher to protect against the now assumed risk of loss. The effect for 2015 policies is unclear. In light of the forthcoming Supreme Court decision in King v. Burwell, insurers negotiated for a provision in their contract that gives them the ability to terminate their participate in the program if either cost sharing reduction payments or premium tax credits are not available to purchasers. They are not known, however, to have negotiated for a similar provision with respect to Risk Corridor underfunding and thus might be held by a court to have assumed that risk.

§_261Discharge_by_Supervening_Impracticability_-_WestlawNext
Section 261 of the Restatement of Contracts 2d

 

How severe the effect of this Risk Corridor limitation will be depends on how CMS uses whatever authority remains to make at least partial payments to insurers and, of course, the amount by which obligations under the program exceed receipts.  Suppose, for example, that obligations to losing insurers under the Risk Corridors program are three times receipts from winning insurers.  This means  that losing insurers would receive only 33 cents on the dollar, at least until any future surplus from the program could make them whole.  Such a result would likely infuriate insurers and induce them to seek further regulatory concessions from the Obama administration as a price of continued participation in the ACA exchanges. If as the Obama administration predicted, Risk Corridors will break even or even run a surplus, the limitation in Division G will have no effect at all.

In any event, the Continuing Resolution in which all this is contained is not yet law.  And there are apparently many points of contention — some possibly even more important than Risk Corridors — up for debate.  Who knows what weapons insurance lobbyists will bring to bear in the mean time to rid Division G of this critical limitation?  If, however, Division G’s limitation on Risk Corridor payments survives, expect further trouble in the market for individual and small business insurance created by the Affordable Care Act.

Addendum

It didn’t take long for my prognostication in the last paragraph to bear out.  Insurers are already in an uproar.  As reported in The Hill just now:

“American budgets are already strained by healthcare costs, and this change will lead to higher premiums for consumers and make it more difficult to achieve affordability,” said Clare Krusing, a spokesperson for the America’s Health Insurance Plans.

We shall see what happens.

And a thanks to Professor Josh Blackman of South Texas College of Law for bringing this development to my attention.

 

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CBO implies Obama regulation shoveled $8 billion to insurers

The Congressional Budget Office issued a report this week revising its February projections of the cost of the Affordable Care Act.  Although there is much to discuss regarding the report, I want to focus here on its troubling discussion of “Risk Corridors.”  That’s the part of the law under which the federal government reimburses insurers selling policies on the new Exchanges for sizable fractions of their losses. It also taxes insurers if they happen to make money selling policies on the new Exchanges. Between February and April, the CBO estimated cost of Risk Corridors jumped $8 billion.  In February, Risk Corridors were predicted to make the government a net of $8 billion over the three years of the program. Now, Risk Corridors are expected to net the government nothing. The CBO claims that this jump was caused by regulations issued by the Obama administration in March that drove up the cost of the program.

There’s a second explanation, however, for the $8 billion change between February and April that’s possibly more troubling. This past February I wrote a blog entry with a lot of math explaining that the CBO prior analysis of the Risk Corridors provision was baffling and rested on extremely dubious and factually unsupported assumptions about the profitability of insurers selling on the Exchanges.  That error, if it was one, was particularly salient because it ended up forestalling growing efforts within Congress to repeal Risk Corridors as an unwarranted “bailout” of the insurance industry.  Could it be that with the repeal threat gone, CBO is now using the “noise” created by an Obamacare regulation as cover for rectifying the unduly optimistic assumptions it made back in February regarding Risk Corridors? That would be very troubling, because while math errors merely challenge the CBO’s competence, the alternative behavior about which I am speculating here goes to something more important: the CBO’s integrity.

The CBO explanation means the Obama administration shoveled $8 billion to insurers through a regulatory “tweak”

The official explanation from the CBO on its change of $8 billion in the cost of Risk Corridors is as follows:

“In March 2014, the Department of Health and Human Services issued a final regulation stating that its implementation of the risk corridor program will result in equal payments to and from the government, and thus will have no net budgetary effect.  CBO believes that the Administration has sufficient flexibility to ensure that payments to insurers will approximately equal payments from insurers to the federal government and thus that the program will have no net budgetary effect over the three years of its operation. (Previously, CBO had estimated that the risk corridor program would yield net budgetary savings of $8 billion).”

So, if the CBO is to be believed, the change isn’t due to any earlier error, but due to an administration regulation promulgated by the Obama administration that has resulted in a net of $8 billion more going to insurers.  That’s a big change for several reasons. First, it means that the regulatory changes instituted by the Obama administration cost the federal government $8 billion.  All of that money went to the insurance industry.  And so, in March of 2014, without much fanfare, the Obama administration would in effect have written a check to the insurance industry for $8 billion.  That payment would only have been motivated by one thing: a desire to keep insurers pacified and in the Exchanges after having deprived them of perhaps their most healthy potential insureds by a prior administrative ruling  — in violation of the ACA — that insurers could keep selling non-compliant policies.  The $8 billion would thus have been “damages” paid by the taxpayer in order to permit the President to honor his campaign promise that if you liked your insurance plan you could keep it.

In short, if you believe the CBO, a regulation for which statutory support will be extremely hard to find, resulted in the government shoveling $8 billion to insurers, basically to pacify them for the losses they suffered as a result of further regulatory changes of dubious legality.  The Obama administration can not afford to have its signature program enter a death spiral as a result of regulatory actions that, while mollifying those who otherwise would have lost their health insurance coverage, caused insurers to lose more money in the Exchanges. And, again, the Obama administration did so in a clever way that made it difficult for anyone to have legal standing to challenge them.  So far as I can discern, no insurer will be worse off as a result of the March 2014 regulatory changes. The real victims are taxpayers with diffuse interests and, of course, the Rule of Law.  

The CBO math is still baffling

A second reason the change by the CBO is big comes from a look at the math.  As I said in my February 2014 post calling the CBO February report “baffling,” consider the implications of asserting that the insurers would make so much money on the Exchanges that they would, on net owe the federal government $8 billion. If you do the math, it means that the CBO assumed that, over the course of three years, insurers would be earning about 8 cents on every dollar they earned via policies sold on the Exchanges.   I just ran the numbers again and came up with a very similar conclusion: the earlier estimate could only be true if insurers were supposed to make a hefty 8% or greater return on premiums. That estimate of 8 cents on the dollar was really peculiar at the time because enrollment — let alone actually paying customers — was running seriously behind projections and the number of “young invincibles” was particularly low.  Low overall insurance purchases and particularly low rates of purchases by the people who were most needed in the Exchanges caused many people to believe back in February that insurers would hardly make hefty profits and pay money to the government under Risk Corridors.  Instead, they thought insurers would fare poorly and probably have to be subsidized (or “bailed out”) by the government.

The effect of the February CBO pronouncement was to dampen enthusiasm for a bill proposed by Senator Marco Rubio that would have repealed the Risk Corridors provision as a bailout to the insurance industry.  If, after all, the federal government was, on balance, making money on Risk Corridors, it was hard to see it as a “bailout” to the insurance industry. Whether intended or not, the political effect of the February CBO announcement was to pull the rug out from one justification for repeal of Risk Corridors.

But is it even plausible to believe that the regulatory change made by the Obama administration in March without the approval of Congress could cause such a large change in the Risk Corridors program? I have done the math again and the answer is no.  I do not see how it is possible to get $8 billion out of the regulatory tweak that was made. Again, the calculations are baffling.

Here’s how we know.  The $8 billion the CBO thought back in February the government would make off of Risk Corridors represents about 4% of the premiums insurers on the Exchanges would take in during that time period. One can use that and other information from the CBO to reverse out a distribution for  “allowable costs” (basically claims expenses) We can thus make a respectable estimate of how many insurers would make money on the Exchanges, how many would lose, and how much these insurers would gain and lose. I describe the gory process in my post from February.  Call this distribution the CBO Insurer Profitability Distribution.  Then assume the government tweaks, as it did, two regulatory parameters used in the computation of Risk Corridor payments, changing something called a profit margin floor from 0.03 to 0.05 and changing an “administrative cost cap” from 0.2 to 0.22. If one then takes the CBO Insurer Profitability Distribution and computes how much the government would now make on Risk Corridors does one emerge with the CBO’s new prediction that Risk Corridors will produce no net revenue? No! One gets that the Risk Corridors program now generates about 2.8% of premiums for the government. In other words, the reduction in Risk Corridor revenue resulting from the administrative tweak is only 1/3 of what the government claims.

The easier way to reach the CBO’s April’s conclusion is to assume that the gain of $8 billion resulted from two phenomena: (1) the regulatory tweak mentioned by the CBO and discussed above, but (2) a recognition that the CBO Insurer Probability Distribution the CBO had used in February was, as I have said, wrong.  If, for example, one assumes that insurer claims were about 6% higher than the CBO estimated in February, the regulatory tweaks combined with higher insurer claims expenses indeed generate an $8 billion shift in the amount of revenue the government would make on Risk Corridors.

For those interested in the details, I link here to a Mathematica notebook showing the computations; I try to avoid black boxes.

Conclusion

So, what are we to make of this apparent discrepancy between the CBO’s explanation of its change in estimates and the actual effects of the regulatory changes it asserts to be the cause ?  It could, I suppose, be my mistake.  I have been careful and consider myself pretty knowledgable in this area, but I will hardly claim to be mathematically infallible. The problem is that the for ordinary Americans (like me), the CBO is a black box. It is not subject to the Freedom of Information Act and it does not publish enough of its methodology for even experts in the field to figure out what it is doing.  That, I would submit, is a real problem for the democratic process, where the fate of legislation depends essentially on trust rather than the Reagan doctrine of “trust but verify” (doveryai no proveryai, in the original Russian).

It could also, however, be a coverup for a mistake (or worse) back in February. There is, after all, an alternative explanation of the change in estimate. It was unrealistic all along for the CBO to think that insurers in the Exchange were going to make money on balance. That’s what I suggested in my February 2014 post.  So, rather than admit that the it had been guilty of unwarranted optimism, the CBO simply used a new distribution of likely claims expenses, came up with a different answer, and used the March 2014 regulatory changes as a smokescreen.

I will confess, however, that I am very uncomfortable with conspiracy theories or with theories that are premised on people acting in bad faith.  Nonetheless, I would not find it impossible to believe that a culture could emerge in a politically sensitive agency that was reluctant to expose forcefully the consequences of government programs that proved far more expensive and far less successful than forecast originally.  It would be a culture in which good news, or optimistic speculation, was uncritically embraced. What I challenge the CBO to do, therefore, not only with the Risk Corridors analysis, which is but the tip of a very big iceberg, but with the entirety of its ACA analysis, is to open it up for scrutiny.  When government policy is essentially set on the basis of models that are not subject to peer review or public scrutiny, there is a great chance for error and, frankly, for manipulation. Government by black box breeds suspicion.

Postscript: Is the tweak legal?

I have said before and I say again that the regulatory tweak that the CBO now says will cost the federal government $8 billion is extremely dubious.  It’s an extremely sneaky way of sending money to the insurance industry, resting, as it does, on arcane manipulations of mathematical formulae. And I have serious doubts that the changes are authorized by Congress.The submission of the original regulations in March, 2013 says that essentially all commenters agreed that a 3% margin for profit was appropriate.  No commenters indicated at that time that insurers were entitled to a higher imputed rate of return on capital.  No one said anything about 5%. Back in March of 2013, HHS thought 3% was the right number. There has been no fundamental change in the capital markets since that time.  The only thing that has changed is that the Obama administration has made the pool of insureds making purchases in the Exchanges less healthy on average. The regulatory “tweak” moving the profit margin from 3% to 5% is thus not consistent with the original goal of Congress for the Risk Corridors program, but is simply a way of compensating insurers for another regulatory change.

The change in the administrative cost cap from 20% to 22% that will likewise result in higher payments to insurers is likewise dubious.  The reason 20% was suggested in the original July 2011 proposal and chosen in the March 2013 regulations was to maintain parity with regulations governing the “Medical Loss Ratio” codified at 42 U.S.C. § 300gg-18 as part of the ACA. The idea, which was apparently supported by commenters on the original rules, was that if insurers — even small group and individual insurers — could not claim more than 20% administrative costs without owing rebates pursuant to section 10101(f) of the ACA then they should not be able to claim more than 20% administrative costs under the Risk Corridors provision.  Makes sense!  But, again, nothing has changed.  There is no indication that anything President Obama did that raised the administrative costs of running a health insurance plan on the Exchanges.  There is no indication that any factor in the real world (such as the cost of computers or paper) increased the administrative costs of running a health insurance plan on the Exchanges.  The limits for the Medical Loss Ratio computation have not changed.  There is no better reason now then there was a year ago to let the cap on administrative costs be higher for Risk Corridors than it is for Medical Loss Ratio.  And, yet, it is now 22% instead of 20%.  The only reason it has changed is to provide a vehicle for shoveling money to insurers.

Again, unless one thinks that the goal of keeping insurers in the Exchange is so overwhelming as to permit the Executive Branch to do anything, it is difficult to see a conventional, lawful justification for the regulatory change that results, according to the CBO, in $8 billion of compensation to the insurance industry. And I say that believing fully well that many of the Obama administration’s other regulatory changes — also of dubious legality — such as expanding the hardship exemption and permitting insurers to sell policies off the Exchanges that contain prohibited provisions have significantly hurt insurers selling policies on the Exchanges. Two wrongs do not make a right.

Technical Appendix

The following graphic shows the relationship between the Risk Corridor Ratio and the net receipts of the government for each premium dollar. As one can see, the higher the Risk Corridors Ratio, the less money the government receives or, in some instances, the more money the government pays out.

RiskCorridorsRatioToHHSNetReceipts

The following graphic compares the relationship between claims costs (“allowable costs”) incurred by an insurer as a percentage of premiums and the Risk Corridors Ratio. It does so for two sets of regulatory parameters.  It first uses the regulatory parameters that were in place prior to March of 2014 (3% profit margin and 20% administrative cost cap).  It next using the new regulatory parameters (5% profit margin and 22% administrative cost cap). As one can see, the regulatory changes increased the Risk Corridors Ratio for all levels of allowed costs and thus decreased the amount the government would receive from insurers (or increased the amount the government would pay to insurers).

AllowableCostsToRiskCorridorsRatio

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Reinsurance reduction will add 7% to gross premiums for 2015

That’s in addition to whatever increases are caused by medical inflation and adverse selection

 

As we draw to what was originally to be the close of the 2014 regular open enrollment period for policies sold on Exchanges under the Affordable Care Act and as the evidence comes in on the actual numbers and demographics of purchasers, it’s time to start thinking about 2015. In this post, I’m not going to speculate today about the effects of the expanding the “hardship exemption” from the individual mandate on insurers’ experience in 2014, the effect of the “Honor System” in extending the time in which individuals can purchase coverage on the Exchange without medical underwriting, or on the effects of any of the other the myriad changes in the law that have been promulgated by the Executive Branch since Congress passed the ACA in 2010. Instead, I want to focus on the effect of statutory changes in the government-created reinsurance program on likely premiums in 2015.

First, a refresher. One of the ideas behind Obamacare was to lure people into the Exchanges with carrots and sticks.  The most frequently discussed carrots were advanced premium tax credits that reduced the effective price of insurance for many individuals and, for many of those receiving the premium tax credits, contracts with extra benefits (cost-sharing reductions) for which the purchasers do not have to pay. Not only, however, are Exchange policies subsidized by reducing the price to the consumer but also by reducing the cost the insurer faces in paying claims.  A key mechanism for this latter reduction for the first three years of the program is free “reinsurance” provided to all insurers for slices of their claims. Of course, the reinsurance isn’t really free; there’s a $63 per insured life tax levied on other health insurance policies in order to make policies on the Exchange more attractive, a transfer whose justice will not be considered today.

The reinsurance works in 2014 by having the government reimburse insurers for 80% of the amount of any insureds claim between $45,000 and $250,000. Thus, if an insured had claims of $105,000, the government rather than the insurer would pay for $48,000 of the claim while the insurer itself would pay for the remaining $57,000.  If an insured had claims of $30,000, the insurer would pay the whole bill.  And if an insured had claims of, say, $300,000, the government would cover more than half — $164,000 — while the insurer itself would pay the remaining $136,000.

Sample of the data embedded in the Excel spreadsheet for The Actuarial Value Calculator
Sample of the data embedded in the Excel spreadsheet for The Actuarial Value Calculator

One can use information contained in the government’s own “Actuarial Value Calculator” to estimate the effect of this reinsurance on Exchange premiums.  (I’ve placed a graphic above this paragraph showing some of the information in the Calculator.)  Based on my computations using Mathematica and done in connection with a recent academic conference, the reinsurance should lower the price of an Bronze policy by about $450 (11%), a Silver policy by $531 (11%), a Gold policy by $545 (11%) and a Platinum policy by $616 (10%).

The parameters of the reinsurance policy will change in 2015.  HHS currently says that instead of “attaching” at $45,000, reinsurance will only kick in if an individual’s claims exceed $70,000. And instead of reimbursing the insurer 80% of the slice between the attachment point and the $250,000 limit, the government will now reimburse just 50% of the slice. The table below shows the results of this change in reinsurance on the expected value of the reinsurance policy. If one assumes that medical inflation will be 4%, the value of the reinsurance will range from $192 for Bronze policies to $243 for Platinum policies. These computations are all again done using Mathematica based on data provided by the government itself in its Actuarial Value Calculator.

Value of reinsurance subsidy in 2015 for varying rates of medical inflation
Value of reinsurance subsidy in 2015 for varying rates of medical inflation

Insurers will need to compensate for the diminished reinsurance by raising prices.  How much?  The table below shows the answer: somewhere between 7 and 8% depending on the type of policy being sold and the rate of medical inflation.

Increase in premiums for 2015 just to cover reduction in reinsurance subsidies
Increase in premiums for 2015 just to cover reduction in reinsurance subsidies

If one adds regular medical inflation to the increases induced by reduced subsidization, here’s a picture of what we get. To obtain a single result for each rate of medical inflation, I’m going to weight the metal tiers according to their rough proportions in the market as last measured.

Projected premium increases for 2015 with reinsurance subsidy reductions taken into account for varying rates of medical inflation
Projected premium increases for 2015 with reinsurance subsidy reductions taken into account for varying rates of medical inflation

The results of combining ordinary medical inflation with reinsurance reductions are a bit scary.  While most people seem to believe the ACA system can survive premium increases of 6% or 8%, what we see is that even if medical inflation is kept to 4%, the results of combining medical inflation with subsidy reduction is a 12% hike.  And, if insurers are nervous about pricing in 2015 due to higher than expected claims experience in the early parts of 2014 or the persistence of problematic demographics such that they expect ordinary claims inflation of 10%, then we start getting into premium increases of about 18%.

Is there a workaround?

It is fair to say that the Obama administration has not been reluctant to change implementation of the Affordable Care Act in response to changing circumstances.  And, I suspect that if the Obama administration starts getting hints that insurers selling on the Exchanges are either thinking of pulling out of the Exchanges or of raising premiums significantly, one of the ways it will respond is by altering the parameters of the reinsurance program.  The attachment point, limit and reimbursement rate are all matters as to which the Obama administration has regulatory flexibility.  Indeed, it changed the 2014 reinsurance parameters favorably for insurers late into the process. And, of course, by providing a lower attachment point, higher reimbursement rate and/or a higher limit, the government can increase the effective subsidy created by the free reinsurance and thereby reduce pressure on insurers to raise premiums.

If, for example, the Obama administration were to go to, say, a 65% reimbursement rate rather than a 50% rate for 2015 and were to go to a $60,000 attachment point rather than a $70,000 one, a 4% increase in medical inflation might result in a lesser 9% increase in premiums rather than 12%.  And even a 10% increase would result in a lesser 14% increase in premiums rather than an 18% one.

The problem with this “fix,” however is that it costs money.  And, by statute, the government is supposed to spend $4 billion less on the reinsurance program on claims for 2015 than it spent on claims for 2014.  That’s why HHS reduced the reinsurance parameters for 2015 in the first place.

I can foresee two ways around this limitation.  The first is for the Obama administration to engage in creative math and find a theory under which the projected cost of its reinsurance program aligns with statutory requirements.  While cynics may be fond of my projection of this response, there is a serious question as to the extent that principled actuaries in the Executive branch will permit this “methodology” to be used. The second possibility is for the Obama administration to stockpile funds from 2014  and use them to pay reinsurance in 2015.  Section 1341(b)(4)(A) of the ACA appears to make this possible.  This scheme only works, however, if the government actually has money left over from its 2014 reinsurance pool.  And, while lower than expected enrollments in the Exchanges increase the probability that there will be money remaining, that potential surplus could well be eaten away if claims for 2014 are higher than expected.

A result of improper conceptualization

Amidst all the technical detail, it’s worth thinking about how this could have happened. How could the architects of the ACA, who were acutely aware of the risks of an adverse selection death spiral, create a system in which there were built in pressures to increase premiums? I think the answer comes in examining the rhetoric of the reinsurance program.  It was not articulated as a subsidy but rather as a way of reducing the risk of entering the Exchanges. See here, here and here for examples.   If adverse selection or moral hazard drove claims costs up, the government would significantly insulate insurers from that risk by providing reinsurance. This, along with Risk Corridors in the first three years of the program, and Risk Adjustment thereafter, was supposed to provide insurers with comfort as they deliberated whether to enter an untested market for health insurance in which most of their conventional underwriting mechanisms were prohibited. And, indeed, the Transitional Reinsurance program does reduce risk. Based on my computations, it reduces the standard deviation of losses for Bronze policies from $16,403 to $11,430 and for Platinum policies from $17,215 to $11,598.

If one conceptualizes the transitional reinsurance program merely as a risk reduction policy, it makes sense to phase it out as insurer experience with the purchasing pools in the ACA.  Insurers gain confidence in how to price their policies.  But what appears to have been forgotten in that calculation is that these reinsurance subsidies also save insurers lots of money.  And insurers will need to respond to the phasing out of these substantial subsidies by raising premiums.  Whether that tunnel vision in conceptualization contributes to an implosion of the ACA, at least in some states, remains to be seen.

 

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CBO projection of $8 billion from Risk Corridors is baffling

The Congressional Budget Office just issued a report that assumes the Affordable Care Act system of individual policies sold in Exchanges without medical underwriting can remain relatively stable. Tightly bound up with that assumption is its prediction about a controversial ACA program known as “Risk Corridors” that requires profitable insurers to pay the federal government up to 80% of profits they make on policies sold on the Exchanges but that also requires the federal government to pay insurers up to 80% of the losses they suffer from policies sold on the Exchanges.  The CBO now believes it has enough information to predict that Risk Corridors will actually make money — $ 8 billion over three years — for the government at the expense of insurers.

This CBO prediction of $8 billion in federal revenue, which has gained much publicity,  pulls the rug out from critics of the ACA such as Senator Marco Rubio who have introduced legislation that would repeal Risk Corridors as an insurance industry “bailout.” Such a blunting of Senator Rubio’s proposed repeal legislation is crucial in the ongoing battle over the ACA because repeal of Risk Corridors could  result in insurers (who just might not believe the CBO’s numbers) exiting the Exchanges for fear of having no government protection against losses resulting from unfavorable experiences in the new market the government has created. On the other hand, if the CBO is just getting its number wrong, Rubio’s case for repeal of Risk Corridors remains as strong (or problematic) as it ever was. The CBO projection is also important because Risk Corridors nets the government money if and only if the ACA works, insurers are able to make some profits, and a death spiral never takes hold. And this, as readers of this blog are aware, is a prediction about which many have serious doubts. 

Here’s the short version of the rest of this post.

I’ve done the math and I don’t see how the CBO is getting this $8 billion number unless it is assuming either very high enrollment in policies covered by Risk Corridors or very high rates of return made by insurers.  Or it made a mistake. I don’t think the CBO’s own numbers support very high enrollment in policies covered by Risk Corridors and I don’t believe either an emerging reality or the CBO’s own rhetoric justify assuming very high rates of return.  So I think the CBO ought to take a second look at its prediction. People should not yet make policy decisions based on the CBO estimate.

Reader, you now have a choice. I’m afraid that the next several paragraphs of this post become very technical. It’s kind of forensic mathematics in which one attempts to use statistics and numerical methods to deduce the circumstances under which something said could be true.  If that sounds dreadful, scary or tedious, I would not protest too loudly were you to skip ahead to the section titled “How could I be wrong?”  Before you leave, however, realize that what I am attempting to accomplish in the part you skip is a form of proof by contradiction. I prove that if what the CBO was saying were true, then insurers would have to be making 8% profit.  But nobody, including the CBO thinks they will make 8% profit, so the $8 billion number can’t be right.

On the other hand, dear reader, if you liked the Numb3rs television show (including my minor contributions thereto) or math or detective work or just care a lot about the Affordable Care Act, the rest of this post is for you.  What I am about to discuss is not only exciting math, but also the soul of the Affordable Care Act — whether the individual Exchanges without medical underwriting can remain relatively stable.

Forensic mathematics in action

Conceptually, here’s the calculation one needs to do.  What we want to figure out is the distribution of insurer profits (measured as a ratio of expenses divided by premium revenues)  upon which the CBO must be relying. I assume the CBO is using a  member from the “Normal” or “Lognormal” family of distributions because those are typical models of financial returns and there is little reason to think that the distributions of insurer profits (expenses minus revenues) will materially depart from those assumptions.  To continue reading this post, you don’t have to know exactly what those distributions are except that they look for our purposes like the “bell curves” you have seen for many years.  I’ve placed a graphic below showing some normal (blue) and lognormal (red) distributions. Although it should not matter all that much, I’m going to use a lognormal distribution from here on in because the ratio of insurer expenses to premiums should never be negative and the lognormal distribution, unlike its normal cousin, never takes on negative values.

Examples of probability density functions for normal and lognormal distributions
Examples of probability density functions for normal and lognormal distributions

The problem is that there are an infinite number of lognormal distributions from which to choose.  How do we know which distribution the CBO is emulating in its computations?  How do we know just how positive the CBO assumes the individual Exchange market is going to be on average or how dispersed insurer profits are going to be? As it turns out, the complexity of the lognormal distribution can be characterized with just two “parameters” often labeled μ (mu, the mean of the distribution) and σ (sigma, the standard deviation of the distribution).  Once we have those two parameters (just two numbers), we can deduce everything we need about the entire distribution.

Now, to solve for two parameters, we often need two relationships. And, thoughtfully, the CBO has given us just enough information.  It has told us how much money in total it intends to raise from Risk Corridors ($8 billion) and the ratio (2:1) between money it collects from profitable insurers and the money it pays out to unprofitable insurers. These two facts help constrain the set of permissible combinations of Risk Corridor populations (the number of people purchasing policies in plans subject to the Risk Corridor program) and insurer profitability distributions. What I want to show is that it takes an extremely high Risk Corridor population in order to get rates of return that are not way larger than most people — including the CBO — think likely to occur.

I first want to calculate the amount of money insurers would pay to HHS under the Risk Corridors program if the total amount of premiums collected were $1. Some of the payments — those by highly profitable insurers  —  will be positive.  Those by highly unprofitable insurers will be negative. To do this I take the “expectation” of what I will call the “payment function” over a lognormal distribution characterized by having a mean of  μ and a standard deviation of  σ.  By payment function, I mean the relationship shown below and created by section 1342 of the ACA, 42 U.S.C. § 18062. This provision creates a formula for how much insurers pay the Secretary of HHS or the Secretary of HHS pays insurers depending on a proxy measure of the insurer’s profitability. The idea is to calculate a ratio of “allowable costs” (roughly expenses) to a “target amount” (roughly premiums).  If the ratio is significantly less than 1 (and outside a neutral “corridor”), the insurer makes money and pays the government a cut. If the result is significantly greater than 1 (and outside the neutral “corridor”), the insurer loses money and receives a “bailout”/”subsidy” from the government.  The program has been referred to with some justification as a kind of “derivative” of insurer profitability, the ultimate “Synthetic CDO.

The graphic below shows the relationship contained in the Risk Corridors provision of the ACA.  The blue line shows the net insurer payment (which could be negative) to the government as a function of this proxy measure of the insurer’s profitability. Ratios in the green zone represent profits for the insurer; ratios in the red zone represent losses. Results are stated as a fraction of  “the target amount,” which, as mentioned above, is, roughly speaking, premium revenue.

How much the insurer pays (positive) or receives (negative) under Risk Corridors as a function of  measurement of profitability
How much the insurer pays (positive) or receives (negative) under Risk Corridors as a function of a ratio-based measurement of profitability

When we do this computation, we get a ghastly (but closed form!) mathematical expression of which I set out just a part in small print below. (It won’t be on the exam). I’ll call this value the totalPaymentFactor. Just keep that variable in the back of your mind.

Excerpt of the formula for insurer total payout
Excerpt of the formula for insurer total payout

I next want to calculate the amount of payments profitable insurers will make to HHS. To do this, we truncate the lognormal distribution to include only situations where the ratio between premiums and expenses is greater than 1. Again, we get a pretty ghastly mathematical expression, a small excerpt of which is shown below. I will call it the expectedPositivePaymentFactor.

Formula for expected negative insurer payments under risk corridors over a truncated lognormal distribution
Formula for expected negative insurer payments under risk corridors over a truncated lognormal distribution

Finally, I want to calculate the amount of payments unprofitable insurers will receive from HHS. To do this, we truncate the lognormal distribution to include only situations where the ratio between premiums and expenses is less than 1. Again, we get a pretty ghastly mathematical expression, which, for those of you who can not get enough, I excerpt below. I will call it the expectedNegativePaymentFactor.

Formula for expected positive insurer payments under risk corridors over a truncated lognormal distribution
Formula for expected positive insurer payments under risk corridors over a truncated lognormal distribution

The CBO has told us in its recent report that the government will collect twice as much from profitable insurers (expectedPositivePaymentFactor) as it pays out to unprofitable ones (expectednegativePaymentFactor).  We can use numeric methods to find the set of μ, σ combinations for which that relationship exists.  The thick black line in the graphic below shows those combinations.

 

Black line shows combination of mu and sigma that result in the correct ratio of positive and negative insurer payouts under Risk Corridors
Black line shows combination of mu and sigma that result in the correct ratio of positive and negative insurer payouts under Risk Corridors

To determine which point on the black line above, which combination of the parameters μ, σ , is the actual distribution, we need to use our information about the totalPaymentFactor.  The idea is to realize that the totalPaymentFactor must be equal to the quotient of the CBO’s estimated $8 billion and the total premium collected by Risk Corridor plans over the next three years.  But we know that the total premium collected should be equal to the mean premium charged by the Exchanges multiplied by the number of people in Risk Corridor plans. Some math, discussed in the technical notes, suggests that the mean premium under the ACA is about $3,962. And the CBO accounts for 8 million people being in Risk Corridor plans in 2014, 15 million being in Risk Corridor plans in 2015 and 25 million being in Risk Corridor plans in 2016. This means that the total premiums collected by insurers under Risk Corridor plans over the next 3 years should be about $190.2 billion. And this in turn means that the totalPaymentFactor must be 0.042.

Ready?

It turns out that of all the infinite number of lognormal distributions there is only one that satisfies the requirements that (a) the government will collect twice as much from profitable insurers (expectedPositivePaymentFactor) as it pays out to unprofitable ones (expectednegativePaymentFactor) and (b) for which the totalPaymentFactor takes on a value of 0.042. It is a distribution in which the mean value is 0.923 and the standard deviation is 0.113.  I plot the distribution below. A dotted line marks the break even point for insurers.  Points to the left of the break even line correspond with profitable insurers; points to the right correspond with unprofitable insurers.

Lognormal distribution of insurer profitability consistent with CBO data
Lognormal distribution of insurer profitability consistent with CBO data

Here are some factoids about the uncovered distribution.  The  average insurer will have expenses that are 92.3% of premiums and the median insurer will have expenses that are only 91.6% of profits. In other words, they will be making 7.7 cent and  8.4 cents respectively on every dollar of premium they take in.  For reasons discussed below, this is a difficult figure to accept. It is particularly difficult in light of the pessimistic news that is emerging about things such as the age distribution of enrollees , reports from Deutsche Bank that one of the largest insurers in the Exchanges, Humana, expects to receive (not pay!) a lot of money under the Risk Corridors program, the hardly exuberant forecasts of other publicly traded insurers about the ACA, and the recent general downgrading of the insurance sector by Moody’s partly because of the ACA.

Implicit in my finding about the most likely distribution of profitability is an assertion by the CBO that 76% of insurers will be profitable under the ACA while 24% will be unprofitable. About 17% will be sufficiently unprofitable that they will receive subsidies (a/k/a bailouts) from the federal government and 9% will be sufficiently unprofitable that their marginal losses will be covered at 80%. Only 15% of insurers will be “inside” the risk corridor and neither pay nor receive under the program.

How could I be wrong?

I feel  confident that I’ve done the ” gory math part” of this blog post correctly. Mathematica, which is the software I’ve used to do the integral calculus and the numeric components involved just does not make mistakes.  I also feel pretty confident that I understand how the Risk Corridors program works under section 1342 of the ACA.  That’s kind of my day job. And so, readers who skipped down to this part, I do believe that if the CBO were right about the $8 billion, that could only happen if insurers were, on average, earning an implausible 8% in the Exchanges.

If I’m wrong, then, it is because, except for the little issue I will mention at the end, I have made bad assumptions about the total premiums insurers expect to collect over the next three years in policies covered by Risk Corridors. That error could come from two sources. I could have the mean premium per policy wrong or I could have the relevant enrollment wrong. Let’s look at each of these.

Could I be wrong about the mean premium?

I computed the mean premium in the computation above by using data collected by the Kaiser Family Foundation on the ratio of premiums by age under most insurance plans and the typical Silver plan premium for a 21 year old (non-smoker). I then used the original forecast about the age distribution of insureds to compute an expected premium.  I got $3,962.  And this number seems very much in line with earlier HHS estimates, which were that mean premiums would be $3,936. So, I think I have the mean premium correct.

Could I be wrong about the number of people in Risk Corridor plans?

I computed the number of people enrolled in policies covered by Risk Corridors by looking at the CBO’s own figures.  I’m not vouching that the CBO is right in its projections, but this is not the day to argue that point.  The CBO now says (Table B-3, p. 109) that individual enrollment in the Exchanges will be 6 million, 13 million and 22 million respectively over the next three years.   And it says that employment-based coverage purchased through Exchanges (which I assume are SHOP Exchanges) will be 2 million, 2 million and 3 million respectively.  So , by addition, that’s where the figures I used of 8 million,  15 million and 25 million come from.  I’m not aware of anyone else who would purchase a policy subject to Risk Corridors. Again, bottom line, I don’t think I’m doing anything wrong here.

The little issue at the end: Could ACA definitions be responsible for the incongruity?

The only other conceivable explanation of the divergence between the CBO figures and my analysis is that I am failing to take a subtlety of Risk Corridors into account.  Remember, careful readers, that sentence earlier up that started out: “The idea is to calculate a ratio of “allowable costs” (roughly expenses) to a “target amount” (roughly premiums).” I stuck in the “roughlies” because the “allowable costs” are not exactly expenses and the “target amount” is not exactly premiums. When you look at the statute and the regulations, you can see that both of these terms are tweaked: basically you subtract administrative costs from both values.  And you subtract reinsurance payments from expenses — but that makes sense because the insurer reduced premiums in anticipation of those reinsurance payments.

So, in the end, I don’t see why these subtleties should affect my analysis in any significant way. But I am not infallible. And I do pledge that if someone points out an error to me, I will dutifully assess it and report it.

Sensitivity Analysis

Out of an abundance of caution, however, I have rerun the numbers on the assumption that premium revenue from policies subject to Risk Corridors is 50% greater than my original estimate either because of an underestimate of per policy costs or a failure to understand that there is some additional group within Risk Corridors protection.  When I do that, though, I find that the ratio of expenses to premiums is 0.943, meaning that insurers are still earning a pretty substantial 5.6%.  Although that is more believable than the earlier figure of 7.7%, it is still pretty high. 

Conclusion

To be honest, it makes me very nervous to say that the CBO did its math wrong or, worse, to accuse it of bad faith.  These are intelligent, educated professionals and they have access to a lot more data and a lot more personnel than I do.  Here at acadeathspiral  it’s just me and my little computer along with some very powerful software.  On the other hand, it’s not as if the CBO hasn’t been wrong before. It assumed earlier that the government would reduce its deficit $70 billion over 10 years as a result of Title VIII of the ACA (the so-called CLASS Act on long term care insurance) when many independent sources believed — rightly as it turned out — that the now-repealed CLASS Act was obviously structured in a way that could never fly.  The CBO assumed in July 2012 that 9 million people would enroll in the Exchanges in 2014, a number that is now down to 6 million. And, while there are explanations for each of these changes, the bottom line is that CBO is fallible too.

So, if I might, I would strongly urge the CBO to double check its numbers and provide more information on the data it relied upon and the methodology it employed in getting to its results.  I’d ask Congress, which has ongoing oversight of the ACA, to insist that the Congressional Budget Office, which is exempt from Freedom of Information Act requests from ordinary citizens, provide further detail.  American healthcare is indeed too important to have policy decisions made on the basis of what could be some sort of mathematical error.

Really Technical Notes

  1. I’m using a reparameterized version of the lognormal distribution that permits direct inspection of its mean and standard deviation rather than the conventional one, which in my opinion is less informative.   The explanation for doing so and the formula for reparameterization is here.
  2. To compute the average premium, I took the premium ratios used by the Kaiser Family Foundation, calibrated it so that a 21 year old was paying the national average payment for a silver plan purchased by a 21 year old. I then computed the expected premium over the distribution of purchase ages originally assumed by those modeling the ACA.
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Could the “low” ACA premiums just be “the winner’s curse” in action?

Those optimistic about the success of the Affordable Care Act have been noting over the past several months that the premiums offered by insurers have been lower than those earlier forecast.  But if one looks carefully at the original rhetoric, the comparison tends to be between some of the lowest premiums offered within a jurisdiction and those originally forecast.  And this metric, according to ACA proponents, is appropriate because they expect consumers to focus purchases on the lowest cost policies.

But what if the lowest premiums are lower than expected not because the mix of purchasers is thought to be fine or because of cost cutting measures enabled by the ACA, but simply because all this metric exposes is the work of the insurers who priced their policies below actual risk?  The “winner’s curse” is the term economists and game theorists give to situations in which, in an atmosphere of uncertainty, people bid on an item in an auction environment. What will often happen is that the “winning” bidder will tend to be one that loses money.

It is quite possible that all we are seeing with “low” ACA pricing, as measured by ACA proponents, is “the winner’s curse” in action.  We may well be looking at insurers who (a) got it wrong or (b) thought the government would most greatly subsidize their losses or (c) for strategic reasons, decided to  sell a “loss leader” in the first year or so of the ACA in order to lock consumers into their networks and their doctors with the idea that they could substantially raise premiums in the future. If this hypothesis is correct, individual policies under the Exchange are a lot less stable than many ACA proponents are asserting.

To summarize the results of the computations shown below, if the mean premium charged by insurers selling a type of policy (Silver HMO Plans, for example ) in a given geographic region (Harris County, Texas, for example) reflects the true risk posed by ACA policy purchasers, about 20% of the low bidders — the ones that I suspect will get a disproportionate share of the business — stand to lose at least 20% on their policies before the Risk Corridor program bails them out.

The big story as the ACA unfolds may be that some insurers — the ones who ended up with the business — simply made an error of exuberance in a new market and priced their policies too low. While these insurers will, thanks to a federal subsidization program for losing insurers called Risk Corridors, not entirely lose their shirts in the first year of the program as a result, they do stand to lose a lot of money that they will likely want to make up in any subsequent years of the Affordable Care Act.

New data analysis finds significant dispersion in plan premiums

This post will contribute some new data analysis that suggests the likelihood of the winner’s curse materializing as well as the magnitude of such a curse. Basically, I have sucked into my computer official government data on the 78,000 plans sold on the federal marketplace and done a lot of number crunching.  The data shows a significant dispersion of prices offered by insurers for plans in the same geographic area,  of the same metal tier and offering the same form of coverage (PPO, POS, HMO, or EPO) .  While this dispersion does not prove that the low prices are outliers reflecting either miscalculation by some insurers or only-temporary use of low prices, it does  suggest a significant possibility that such is the case.

Let’s take an example. Here are the prices offered where I live, Harris County, Texas — mostly Houston — for an HMO Silver Policy to a couple with two kids. The couple has an average age of 50 years old.  We’ll call this hypothetical family “The Chandlers,” as a matter of convenience. The graphic shows the dispersion of premiums normalized so that the lowest price for a given policy is given a value of 1.

Dispersion plot for Harris County, Texas, Silver HMO policies sold to Couple, aged, 50 with two children
Dispersion plot for Harris County, Texas, Silver HMO policies sold to Couple, aged, 50 with two children

As one can see, for the Harris County, Texas policies shown here, although there are three policies that have premiums fairly close to the minimum, there are, however, two policies that have premiums  more than 30% more than the minimum. If the mean premium estimated by insurers is “correct,” the insurer selling a Silver HMO policy at the lowest price will lose about 17%. The implication, if the Harris County plan is representative and if the mean premium is closer to the true risk than the low premium, is that the insurers most likely to win business due to low prices are likely to lose a considerable amount of money.

There are several potential rejoinders to the suggested implication of the graphic.  Let me address each of them in turn.

Might Harris County, Texas be unusual?

One response is that the example for Harris County, Texas Chandlers is unrepresentative. Houston, for example, has some very fancy hospitals and some not so fancy hospitals; so maybe premium dispersion for Harris County simply reflects whether one has access to the fancier hospitals (and the doctors who have admitting privileges to them).  I have considered this possibility and find that, actually, the example I provide is pretty representative. Here, for example, are 20 randomly selected examples. For each plan, I show the amount the low bidder would lose if the average premium is “correct,” the dispersion of premiums, and the plan and purchaser randomly chosen. Of the ones in which there are any significant number of policies available, most of the premiums show a dispersion pattern qualitatively similar to that in Harris County for The Chandlers. Indeed, some of the random examples show dispersion considerably greater than that for the Harris County silver HMO policies. Except where there is little competition for plans and the low bidder is thus selling at the average price, the result presented above does not look like a fluke.

Dispersion Plot and potential losses of low bidder for 20 random plans and purchasers
Dispersion Plot and potential losses of low bidder for 20 random plans and purchasers

I can double check this result by computing for 5,000 random combinations of plans and purchasers the losses of the low bidder if the true risk was equal to the mean premium charged for policies and purchasers of that type. The graphic below shows the “survival function” (or “exceedance curve”) for the resulting distribution of these losses.  The value on the y-axis is the probability that the losses will exceed the value on the x-axis. The results shown below confirm that the situation for Harris County Silver HMO plans sold to The Chandlers is not all that unusual.  As one can see, losses of more than 10% take place more than 30% of the time and losses of more than 20% take place about 17% of the time. A rather scary picture.

Exceedance curve of the distribution of losses of low bidders for random plan-purchaser combinations on the assumption that the mean premium represents the true risk
Exceedance curve of the distribution of losses of low bidders for random plan-purchaser combinations on the assumption that the mean premium represents the true risk

In fact, however, the situation may be even worse than depicted in the graphic above. Sometimes the losses computed by this method are low because the low bidder is also the only bidder.  If we consider situations in which there is more than one bidder, here is the resulting survival function (exceedance curve) of the distribution. As one can see in the graphic below, the distribution of risks is shifted slightly to the right.  Now 40% of the low bidders stand to lose at least 10% and about 21% stand to lose at least 20%.

Exceedance curve of the distribution of losses of low bidders for random plan-purchaser combinations where at least two premiums exist on the assumption that the mean premium represents the true risk
Exceedance curve of the distribution of losses of low bidders for random plan-purchaser combinations where at least two premiums exist on the assumption that the mean premium represents the true risk

Maybe the higher priced policies are better?

Another potential explanation for price dispersion is that, even if the policies are priced differently, that does not mean that the cheapest policies are selling for too low a price.  All Silver HMO policies sold in Harris County, Texas to The Chandlers may not be the same.  Some may have different deductibles or different networks.

The first response to this rejoinder is that the actuarial value of the policy — the relationship between expected payments by the insurer and premiums — should be about the same for each metal tier of policies. Silver policies should all have actuarial values, for example, of 70%.  So it should not be the case that one silver policy has cost sharing different than the cost sharing of another silver policy in a way that would affect the premium charged for the policy. Moreover, the calculations underlying this post keep HMOs, PPOs, POS plans and EPOs apart; so it should not be the case that observed premiums differ because, perhaps, the cheaper plans are HMOs whereas the more expensive ones are PPOs.

Of course, cost sharing is not the only way in which policies within a given location, of the same metal tier and sold to the same purchaser could vary.  One policy might offer richer benefits than another.  It could have a richer network with more doctors available or more prestigious and expensive hospitals inside the network. Could that be responsible for a substantial part of the premium dispersion we see?  It’s impossible to tell for sure — the data published by HHS does not attempt to quantify the richness of the network being offered.  I do find it difficult to believe, however, that such differences are responsible for the entirety of differences in excess of 20% between the low bidder and the mean bid, or, for that matter, differences in excess of 40% that sometimes occur between the low bidder and the higher bidders.

Maybe the average premium is meaningless; the low bidder got it right

Of all the potential rejoinders I have considered, the one now forthcoming is the one that is most troubling. There is nothing the data standing by itself can tell us whether most of the insurers have it right and the low insurers are about to lose their shirts or whether the low insurers have been more insightful or have managed to keep costs down such that they will break even (or even make money) selling their policies at low premiums.  And, yet, I am doubtful. One can view the mean or median of the premiums as an “ensemble model” of the true cost of providing care under the Affordable Care Act. And there is research (examples here, here and here) suggesting that ensemble models predict better in many open-textured situations than individual models.  So, while it’s possible, I suppose, that in every jurisdiction the low bidder is predicting more accurately than the group of insurance companies as a whole, such a result would be surprising.  A far simpler explanation is that the low bidder — the one who is likely to win business from price sensitive insureds — is succumbing to “the winner’s curse.”

Maybe the disaggregation of plans is misleading

This is a very technical objection, but consider carefully what I have done.  I have looked at all policies of a given metal tier and a given plan type in a given geographic location sold to a certain family type such as “all silver policies in Harris County, Texas, sold to The Chandlers.”  But, really, plans are sold not to just to The Chandlers but to all family types. So, it could conceivably be that while the plans sold to the family type I am looking at are highly dispersed, the average premiums over all family types (weighted by prevalence of the family type) are far less dispersed.  This strikes me as unlikely — why would an insurer be overcharging one family type relative to another — but you can not rule it out a priori.  Maybe — just maybe — the dispersion we are observing is not real; it is just an artifact of my disaggregation of the data.

I would, of course, love to aggregate the data and see if the high degree of dispersion persists. The difficulty with this cure comes with the problem of weighting the data.  We don’t know the distribution of policies sold among family types.  We don’t know, for example, whether The Chandlers constitute 2% of policies sold or 5% of policies sold. So, I can’t  perform a perfect aggregation of the data. One way to get a feel for the objection, however, is to simply take an unweighted average of the premiums for all the family types identified in the database and aggregate it that way.  This is far from perfect, and we could spend a lot of time refining it, but it should provide a clue as to whether the disaggregation of plans is significantly responsible for the high degree of observed dispersion.

The graphic below shows the exceedance curve for losses of the low bidder assuming the mean premium is the true risk based on an unweighted average of family types purchasing the policies.  One can see that 20% of the low bidders will lose at least 20% if it turns out that the mean premium charged for similar policies reflected the true risk. Upwards of 35% will lose more than 10%. A quick comparison of this curve with those above shows that it is essentially the same.  There is nothing that I can see suggesting that the fundamental result shown in this blog entry — high dispersion of premiums among what should be similar policies and the potential for significant losses by low bidders — is an artifact of the methodology I have employed.

Exceedance curve for losses of low bidder assuming mean premium is true risk for aggregated purchaser types
Exceedance curve for losses of low bidder assuming mean premium is true risk for aggregated purchaser types

Conclusion

In the end, even the extensive data that the government is put out is insufficient to determine definitively whether the lower priced insurers in the individual Exchanges are about to lose money. There are more optimistic interpretations of the observed premium dispersions: maybe it is the low bidders who are “getting it right” or maybe the low bidders have just found ways to keep costs down through better negotiating or cheaper care networks. But if these optimistic explanations prove insufficient, what this post shows is that while some insurers will likely do just fine there are a substantial minority of insurers who are about to get bitten by the “winner’s curse” and get a large volume of purchasers for whom the premiums charged will be insufficient to defray the expenses incurred.

 Technical Notes

The data used here was taken directly from the United States Department of Health and Human Services. It was analyzed using Mathematica software, which was also used to produce the graphics shown here.

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