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.
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.
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.
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.
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.