Tag Archives: transitional reinsurance

How The Obama Administration Raided The Treasury To Pay Off Insurers

As discussed earlier, I have moved most of my blogging on the Affordable Care Act over to Forbes blog site: The Apothecary.  Here’s where you can find my latest entry.  It’s about Obama administration lawlessness in running the Transitional Reinsurance program.

Here are a few paragraphs to whet your interest.  To see more, go here.

This is about a raid conducted in the murky twilight of the Federal Register. It’s a scheme in which the Obama administration collected less in taxes from health insurers (mostly off the Exchanges) than they were required to do under the Affordable Care Act, created a plan to pay insurers selling policies on the Exchange considerably more than originally projected, and stiffed the United States Treasury on the money it was supposed to receive from the taxes. It’s a different bailout than the Risk Corridors program. That, at least, was originally authorized by statute.  This is about a diversion that took place in spite of a statute that explicitly prohibited it.  And the consequence of the diversion of funds was to enrich insurers and, probably, to keep more insurers selling policies on the Exchanges than would otherwise be the case.

The transitional reinsurance program as implemented, however, has become entirely unmoored from the statute that created it. It has instead embarked on a progressively stranger course in which two of the most recent diversions were  underassessing health insurers to pay for the program and then using the first $2 billion collected not to pay the United States Treasury as called for by the statute but instead to pay off insurers selling individual health insurance policies on the Exchange and, some times, off the Exchange.  Indeed, not only has $2 billion from the 2014 money been diverted from the Treasury to insurers but it looks as if at least an additional $800 million from the 2015 money is heading in the same direction.

By combining the two revisions of the original reinsurance parameters, the Obama administration made the program about 40% juicier for insurers . To the cynical eye, this could be seen as one of several administrative cures for the Obama administration’s politically understandable yet completely illegal decision to starve exchange insurers of potential customers who would now, by administrative fiat, often be permitted to keep those dreadful policies that the Affordable Care Act was supposed to eliminate. With foolish campaign promises as the motivation, one illegality begat another.

And now let’s take a closer look at the Obama administration’s legal justification for shoveling money to insurance companies on whose graces the success of Obamacare rests . You can read it above.  CMS contended that, because the statute was silent or ambiguous; it gave CMS discretion.  According to CMS, the statute used “shall” when it came to the $10 million to be collected for reinsurers in 2014 and used only “reflects” when it came to the $2 million for the Treasury, implying that the collection of money for reinsurers was more mandatory than collection of money for Treasury. Besides, argued CMS, the premium “stabilization” purpose of the ACA would be enhanced by funneling more money to insurance companies.

This reading of the statute makes no sense, however. The ambiguity exists only by virtue of ignoring a provision of the statute never even mentioned by CMS its legal analysis. By sending out a specific bill to health insurers and third party administrators to cover the Treasury payments, CMS had clearly collected money under the program in part pursuant to section 1341(b)(3)(B)(iv), the part that requires $5 billion for Treasury.  Look at paragraph (b)(4): “Notwithstanding the preceding sentence, any contribution amounts described in paragraph (3)(B)(iv) shall be deposited into the general fund of the Treasury of the United States and may not be used for the program established under this section.” But this diversion of funds collected for the Treasury into the hands of the insurers was precisely what CMS now purported to find justification for in the language of the statute.  CMS’s argument is particularly strange given the“miscellaneous receipts statute” which says that agencies generally can’t just keep money they collect; rather they must “deposit the money in the Treasury as soon as practicable without deduction for any charge or claim.”

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Prices rising, choice declining for 2016 Obamacare

Data released yesterday at healthcare.gov shows the beginnings of an adverse selection death spiral that threatens the stability of the system of insurance created by the Affordable Care Act.  The data shows that, on plans using the “federally facilitated marketplace” created under the ACA, PPO plans that continued from 2015 to 2016 increased gross premiums an average of 16% and Gold and Platinum plans increased 15% and 21% respectively.  HMO plans, by contrast, increased a lesser 8% and Bronze and Silver Plans increased a lesser 12% and 9% respectively.  We should thus expect to see in 2016 relatively fewer people purchasing plans that give them a greater choice in physicians or that provide greater protection against medical expenses.

The tables below summarize the big picture.  The first table shows the mean change in gross premiums between 2015 and 2016 for plans that persisted over that timespan when grouped by metal level.  As one can see the more generous Gold and Platinum plans increased at rates considerably higher than the less generous Catastrophic, Bronze and Silver plans.

MetalLevel percent change
1 Bronze 12.1
2 Catastrophic 8.1
3 Gold 15.2
4 Silver 9.4
5 Platinum 20.9
mean change in premiums between 2015 and 2016 for 6,699 persistent plans

The second table shows the mean change in premiums between 2015 and 2016 for plans that persisted over that timespan when grouped by plan type.  As one can see the PPO plan, which offers the greatest choice of doctor, increased at a higher rate than other types of plans.  EPOs, which are similar to HMOs but restrict visits to specialists less, increased in gross premiums at a rate far higher than HMOs.

PlanType percent change
1 POS 12.3
2 HMO 8.3
3 EPO 12.2
4 PPO 16.5
mean change in premiums between 2015 and 2016 for 6,699 persistent plans

The third table combines the first two and shows, for each combination of metal level and plan type, the mean percentage increase in gross premiums between 2015 and 2016.

MetalLevel HMO EPO POS PPO
1 Catastrophic 1.9 5.8 6.9 14.8
2 Bronze 11.2 10.9 12.0 16.2
3 Silver 5.8 8.8 12.5 14.5
4 Gold 9.4 16.6 17.1 19.7
5 Platinum 12.2 25.6 7.5 25.9
mean change in premiums between 2015 and 2016 for 6,699 persistent plans

Premium increases are only part of the story, however.  Some types of plans are not available at any price any longer.  The table below shows the percentage of rating areas in 2015 and 2016 containing each type of plan.  Notice that the percent of rating areas containing any PPO has dropped significantly between 2015 and 2016; HMOs and POS plans have dropped as well, though EPO plans have become more prevalent.

PlanType AVG2015 AVG2016
1 HMO 92.6 88.6
2 EPO 78.3 82.5
3 POS 83.7 75.4
4 PPO 92.5 76.7
percent of rating areas having at least one of these plan types

We can also consider the prevalence of competition. The table below shows the percentage of rating areas in 2015 and 2016 containing at least two of each type of plan. Notice that with PPOs, the percentage of rating areas with competition has declined, although it has increased somewhat for HMOs, EPOs and POS plans.

PlanType AVG2015 AVG2016
1 HMO 71.3 72.5
2 EPO 66.5 74.0
3 POS 48.2 50.6
4 PPO 76.0 61.0
percent of rating areas having at least two of these plan types

The same analysis can be done on the metal levels of the plans available.  The table immediately below shows for 2015 and 2016  the percentage of rating areas in which there is at least one plan of the specified metal level.  Platinum plans have declined sharply in prevalence since 2015.  Now only just over half of the rating areas have even a single platinum plan available even if one were willing and able to pay the higher premiums.

MetalLevel AVG2015 AVG2016
1 Catastrophic 74.3 72.2
2 Bronze 91.8 88.1
3 Silver 91.1 89.7
4 Gold 90.9 88.5
5 Platinum 92.7 53.2
percent of rating areas having at least one of these metal levels

When it comes to competition, the picture is even worse for platinum plans.  In only about a third of the rating areas can one choose between platinum plans.

MetalLevel AVG2015 AVG2016
1 Catastrophic 33.5 30.3
2 Bronze 82.5 82.4
3 Silver 85.7 84.6
4 Gold 73.0 73.4
5 Platinum 44.9 34.6
percent of rating areas having at least two of these metal levels

Finally, since it seems to be the PPO plans whose prevalence is declining most, we can show the extent of that prevalence according to the metal level of the plan. The table below shows that the Platinum PPOs, the plan probably most helpful to the chronically ill that the ACA was supposed to help greatly, is diminish significantly in prevalence but that Gold and Silver PPOs are diminishing as well

PlanType MetalLevel AVG2015 AVG2016
1 PPO Catastrophic 85.8 71.1
2 PPO Bronze 94.9 81.6
3 PPO Silver 94.9 81.6
4 PPO Gold 94.9 81.6
5 PPO Platinum 89.5 53.5
percent of rating areas having at least one of these Platinum plan types

Conclusion

The data shows that platinum plans and PPO plans are shrinking in prevalence and that the gross premiums for such plans are going up. One might say that this development is not so awful since it leaves in place a market for more basic plans: HMO plans for example or silver and gold plans.  Perhaps the government should not be subsidizing individual’s choice of doctors or fostering plans, such as platinum plans, that fail to deter excess medical consumption.  Such is not, however, the promise of the ACA or, I suspect, the desires of many of its proponents.

Moreover, we are in a dynamic situation.  Think about next year when the insurer subsidies are supposed to disappear and when the chronically ill people who were in platinum and/or PPO plans migrate into the next best thing, a gold plan or, if one is available, a POS or EPO plan.  Suddenly those plans become vulnerable to adverse selection pressures.  And for 2017 we might thus expect to see yet further shrinkage of PPO and platinum plans and greater pressures on everything but the basic Bronze and Silver HMO plans.  When that happens, the adverse selection death spiral will not only start biting wealthier purchases or those with chronic conditions, but mainstream America. Private health insurance is fragile. It generally does not well withstand the sort of underwriting regulation imposed by the ACA.  The conceit of the ACA proponents was that they had engineered a system — the “three legged stool” so strong that it could resist the almost invariable pressures of adverse selection.  If I am right, and regardless what one thinks about the motives of those proponents, we are beginning to see that the engineering was just not good enough.

Caveats and further research

The computations shown above are based on the number of plans and not weighted by the number of enrollees.  This is largely of necessity since the federal government has not been releasing enrollment figure by plan in a clear way (although it may be possible to tease the figures out of rate review submissions filed and collated on healthcare.gov).  Although enrollment weighting will likely decrease the average mean premium (less expensive policies tend to be purchased more), it is not clear that enrollment weighting will have much effect on relative premium increases.

The figures are also not computed yet on a state-by-state basis, something that I hope to present in a later post.  They also contain only data for states whose plans are described in material available at healthcare.gov.  Data for states such as California and New York, which have their own exchanges, is not included here and might alter the numbers somewhat.

Finally, I present gross premiums here; as I have discussed at length elsewhere, net premium increases may well be higher, particularly where the purchaser wishes to retain a gold or platinum plan or a PPO plan whose premiums are rising even faster than those of the silver plans and the second lowest silver plan. The situation is worst where, due to some willingness on the part of a new entrant to take risk,  the second lowest silver plan drops in price, thereby decreasing subsidy levels, but other silver, gold and platinum plans increase in price.

Note

Programming for this work was done in R using data from data.healthcare.gov and is available on request from the author. Packages used include data.table, tidyR, htmlTable and dplyr. There is a lot more work to be done mining these databases.

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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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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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The ACA’s transitional reinsurance tax: the numbers are funny again

Most sellers of health insurance in the United States outside of health insurance Exchanges will be forced to add $63 per member on to premiums for 2014 to cover a new tax imposed by the Affordable Care Act on the sale of such policies. That tax revenue coupled with $2 billion out of the federal treasury will go to subsidize individual policies sold on the federal Exchanges, probably lowering their gross premiums by about $525 per person.  If, however, enrollment in the federal Exchanges remains considerably lower than projected and enrollment in non-grandfathered, non-Exchange plans does not compensate for the reduction, the revenue collected from the tax is likely to be in excess of that which needs to be paid to support the statutory subsidies.  The $63 per member tax, which has precipitated considerable protest, thus might end up being overly high. And if the Executive branch can exercise its discretion to delay or waive taxes for one part of the ACA based on alleged new developments, why not for another?

The Center for Medicare & Medicaid Services (CMS)  has many options for addressing the surplus.  It might choose to to use the surplus tax revenue either to cut similar taxes in the subsequent years of the program or to rebate the excessive tax back to health plans and others who paid it. CMS might, I suppose, inflame people from both ends of the ideological spectrum by gifting insurers with more generous reinsurance this year.  Or CMS might simply squirrel the surplus away to provide reinsurance after the normal sunset of the program in 2016. I suspect, however, that  CMS is likely to use the surplus to increase the generosity of reinsurance provided in subsequent years of the program such as next year. Doing so could mask problems of adverse selection that could otherwise result in large premium increases. Such a choice would not  necessarily be a bad thing: it just highlights yet again the expense of the ACA, the fragility of attempts prior to its passage to model its effects, and the problems with thinking about its interlocking web of provisions in a linear, reductionist manner.

Here’s a more detailed explanation.

The Affordable Care Act subsidizes both insurance purchases made on the individual Exchanges and  individual policies still sold off the Exchange that conform with various ACA rules.  Doing so lowers the price of insurance and decreases the systematic risk associated with selling policies in a new regulatory environment in which the population of insureds may have different (and worse) health profiles than those previously composing the insurance pool.  A key way that the ACA does this is through a program of “transitional reinsurance” provided free of charge to insurers willing to write policies in the individual market — so long as those policies haven’t been exempted from the requirements of the ACA by being “grandfathered.” The program is “transitional” because it is supposed to end after three years. One way of thinking about all this is that free reinsurance lowers both the mean and the standard deviation of the net claims distribution faced by eligible insurers.

Under section 1341 of the ACA and the regulations CMS has developed to implement it, the transitional reinsurance program is ultimately supposed to break even. If tax revenues that fund it are less than the expenditures it requires, CMS has provided in 45 C.F.R. § 153.230(d) that reinsurance payments are cut in that year in order to prevent a deficit. If tax revenues that fund the transitional reinsurance program are greater than the expenditures it requires, CMS has stated in 45 C.F.R. § 153.235(b) that the surplus will be spent in subsequent years of the program on reinsurance benefits.  The program also works with a one year lag: money is collected and paid in each year is for claims made the preceding year.

The Center for Medicare and Medicaid Services has funded the transitional reinsurance program this year by levying (with the help of its IRS friends)  a $63 per insured life tax on most (but not all) health insurance policies sold in the United States this year. (The payments are deductible for for-profit enterprises). CMS says it is planning an exception to the tax for self-funded plans that are also self-administered, a rule that, as shown in the graphic below, CMS previously said (correctly) it lacked statutory authority to issue and that will significantly benefit labor unions. This tax revenue, coupled with a required $2 billion from the United States Treasury, is estimated to yield $12 billion to be paid in 2015 for claims arising in 2014.  CMS will use the the money to provide a form of stop-loss reinsurance that attaches at $45,000 of claims per member and that provides 80% reimbursement for claims up to $250,000. In earlier versions of the regulation, the attachment point was a less generous $60,000.

Comparison of regulations: March 11, 2013 v. October 30, 2013
Comparison of regulations: March 11, 2013 v. October 30, 2013

How would you spend $12 billion?  Well, using the “continuance tables” (statistical claims distributions) contained in CMS’s “Actuarial Value Calculator,” one can show that the expected payments under the reinsurance system created by CMS for 2014 will range from about $433 per member for a bronze plan up to about $597 for a platinum plan. The weighted average expected payment will be about  about $525. The enhanced size of this subsidy, rather than other miracles of Obamacare, may explain in part, by the way, why premiums on the Exchanges came in somewhat lower than some had projected. If CMS is planning on spending about $12 billion on transitional reinsurance and it spends $525 per insured person, simple division shows that it takes about 23 million people who might trigger the reinsurance obligation in order to exhaust the fund.

The problem, however, is that, given recent developments, there are unlikely to be 23 million persons in 2014  (a) who might trigger the reinsurance obligation (“reinsurance triggering”) and (b) who are insured by reinsurance-eligible insurers (“reinsurance eligible”). You could just take my word on this point and skip to the end of this entry or, better yet, follow the accounting done here.

An accounting

Let me concede, temporarily and for the sake of discussion, that there will be 6 million people on average in 2014 who are paying premiums based on policies purchased in the individual Exchanges.  That’s hard to believe given (a) that the number with a month to go is probably about 3.2 million (President Obama’s alleged 4 million enrollment reduced by 20% shrinkage for nonpayment); (b) that the number of insured in the Exchanges would have to be 7 million post March for there to have been 6 million on average during all of 2014; and (c) Vice President Joe Biden’s augury that 5 million would be a “heck of a start.”  I will grumpily concede it nonetheless.

How many off-Exchange purchasers should we then add?  Here the numbers are slippery too.  I am indebted, however, to some careful work by the Kaiser Family Foundation on this point.  You can read it here. The highest estimate I have seen for the number of nonelderely persons covered by  a plan purchased directly from an insurer at any one time in a calendar year is 19 million.  But many of these 19 million will (a) not have insurance the entire year; (b) will have insurance that is secondary to other insurance and thus unlikely to accumulate the $45,000 attachment point in claims; and (c) will be in grandfathered policies not eligible for reinsurance and persisting through 2014 only by dint of President Obama’s magic waiver of the terms of the ACA.  When one looks at the situation at any given point in time — which is the proper basis for figuring out an average — it looks as if there might be 13-14 million who have some form of individual health insurance and 10-11 million who have primary health insurance coverage of the sort that might trigger a reinsurance obligation.

So, should I add 11 million to the 6 million and say that there are 17 million insureds that might trigger a reinsurance obligation?  No! That would ignore two substitution effects.  We know from various studies that a lot (perhaps 65% – 89%) of the people purchasing policies on the Exchanges simply swapped non-Exchange policies that would not be eligible for the other big federal subsidy — premium tax credits — for Exchange policies.  So, even if we assume, contrary to the evidence, that only half of the Exchange purchasers came from the ranks of the uninsured, that means there are really only 3 million new purchasers of policies eligible for reinsurance. Moreover, the 10-11 million figure isn’t right anymore either.  For 2014, individual insurers have to choose. They can stop selling their policy altogether, they can expand benefits to conform with the tougher requirements of the ACA and obtain a right to reinsurance or, at least in some instances, they may be able to grandfather their policy and avoid many ACA mandates but forfeit a right to reinsurance. I have not seen any good statistics on how many of the 11 million will persist into 2014, but I would be surprised if more than 80% did.  So, rather than 11 million, it seems to be the better upper bound on the number of extant non-Exchange, reinsurance eligible policies is 9 million.

It thus seems to me as if the better upper bound on  the number of policies that might trigger a reinsurance obligation is 12 million: 3 million genuinely new policies plus 9 million sold outside the Exchange but eligible for reinsurance. This means, however, that if CMS’s estimates of claims under the ACA are correct, a reasonable upper bound on reinsurance payments under section 1341 of the ACA are likely to be at most $6.3 billion ($525 x 12 million) rather than $12 billion.

Given all this, there are two aspects of CMS’ s behavior that are a bit puzzling.  Why is CMS not adjusting the reinsurance benefit for this year say to provide 100% coverage rather than 80% coverage and/or removing the $250,000 cap on claims triggering reinsurance? Or, given the belief of the President that he has discretion to waive taxes in light of changed circumstances, why is CMS not waiving, say, half of the taxes that would otherwise be owed.  (Not that I think this is constitutional).

The answer to the puzzler, I suspect, is either a cognitive failure or a very clever strategy. It is possible that it has not dawned on CMS that changing enrollment patterns means that it will not be able to exhaust the $12 billion it expects to receive pursuant to section 1341. More likely, however, someone at CMS has done the math and has been delighted to discover a slush fund that it can use the money to provide extra generous reinsurance next year and thus keep the price of premiums down.  How will we know? If we see an announcement from CMS in the next few months changing the parameters for the 2015 reinsurance plan to be considerably more generous, believe that it is the result of collecting “too much” in taxes in 2014. In the meantime, however, we have another example of ACA “details” that don’t seem to stand up under close scrutiny.

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The Two Million Scenario: What if the Affordable Care Act enrolls a lot fewer people in the Exchanges than predicted?

People can be blinded by dreams in many spheres
People can be blinded by dreams in many spheres

Many people who remain basically positive about the Affordable Care Act are viewing the enrollment statistics like the football fan whose team is 2-6 and who point out that the team could win 7 out of its 8 remaining games and still probably make the playoffs.  Yes, getting off to a really bad start doesn’t preclude a happy ending. Success may still be mathematically possible. But unless there’s good reason to think that the fundamental factors such as poor coaching,  poor game plans or unexpected injuries that have led to the bad start no longer apply, the more reasonable prediction is that things will continue more or less as they have.

It’s time to start thinking realistically about what happens if a core component of the Affordable Care Act, subsidized, non-underwritten health insurance available from private insurers, essentially fails to provide many with better access to medical care. This might not happen in every state — there might be a few whose Exchanges can be deemed “successful” — but it is looking more and more to me as if we are heading for enrollments in many states well, well short of that on which the arguments for the ACA were significantly premised. Indeed, some supporters of the ACA have started moving the goal posts, revising history to say that the real goal of the Act wasn’t to reduce the number of uninsureds but to have an actuarially sound pool. (So the purpose of the Act was to help insurance companies stay afloat?) And it hardly helps enrollment when President Obama urges his allies to hold back enrollment efforts so the insurance marketplace does not collapse this coming week under a crush of new users even after he earlier assured the nation  healthcare.gov  was supposed to be working much better by this time.

For purposes of this blog entry, I’m going to assume that enrollment in the Exchanges ends up being about 2 million for 2014 instead of the projected 7 million.  I can’t rigorously justify that number — but, of course, neither could the pundit who is now saying 4 million. And, if I had time and space I’d prefer to do this analysis under a variety of scenarios, but, for now, the 2 million figure feels about right. And if I were betting on which side of the 2 million we will fall, it would be the lower side. What are the consequences? I can’t address all of them in a single blog entry — and trying to predict matters past 2014 gets very treacherous — but here are some.

And, for those of you who don’t want to read further, here’s the headline:

Insurance sold through Exchanges without medical underwriting — a central promise of the Affordable Care Act — is likely to implode in a significant number of states by 2015 while limping along in several others but providing little net desired decrease in the number of people without quality health insurance.  The silver lining in this failure will be that the program will likely cost less than projected due to fewer number of people receiving subsidies, although this reduction will be partly offset by higher-than-projected subsidies to the insurance industry. Expect significant pressure to grow among supporters of the Affordable Care Act to use these net savings to increase the subsidies available to people buying coverage through the Exchanges and to lure insurers in the problem states back into the Exchanges.

1. The number of people without private health insurance may actually grow

This is so because, if 2 million obtain insurance through the Exchanges but more people (3.5 million is a prevailing estimate from sources ranging from Forbes to Jonathan Gruber) lose their current individual health insurance, that’s a net decrease in the number of insured.  And if we add in the loss of 100,000 or so people from the Pre-Existing Condition Insurance Plan that likewise is terminated or those who heretofore were in various state high risk pools, there is a serious risk that the Affordable Care Act will have decreased the number with private health insurance.

In fairness, I have not taken Medicaid expansion into account. Some may see it as unfair to count just the number of people with private health insurance rather than the number with access to health care through private insurance or public schemes such as Medicaid. And, indeed, in those states in which Medicaid has been expanded — one can’t blame President Obama too much if other states choose not to participate — enrollment has outpaced enrollment in private plans at about a 4-to-1 ratio. This suggests, by the way, that people are willing to use a web site, even some clunky ones, to sign up for health care if they think the price is right.

The rejoinder to the argument that we should consider Medicaid, however, is that an awful lot of political energy and an awful lot of monetary investment has been predicated on healthcare reform benefiting more than just the poor but the middle class too. If it turns out the middle class has, net, been hurt by the 2014 features of Affordable Care Act or has paid a large investment for the 2014 features of a law that, net, does provide little marginal benefit, it’s fair to criticize the 2014 features of the Act for their architectural shortcomings. And, yes, I know all about staying on your parents’ policy until you are 26 and limitations on rescissions, but none of those pre-2014 “achievements” should count in assessing the 2014 record.

2. The number of people with quality health insurance may stay about the same

Yes, there will be people who formerly had no health insurance or who had rotten health insurance who, thanks to the 2014 aspects of the ACA, now have health insurance that covers more.  There are many news accounts from pro-ACA forces providing evidence of this. Here’s one (although all the “success stories” are likely to have high medical claims); here’s another (notice again that the successes are likely to have high medical claims).

But it may well be that for every such success story apparently to be catalogued by paid grants from the government, there is another who had health insurance tailored to their needs (such as policies for the 50 and over set that did not cover maternity expenses) who now find themselves priced out of the health insurance market with its Essential Health Benefits requirement (section 1302 of the ACA). Here’s a website inviting people to post their cancellation notices.  Here are some anecdotes relating such problems (although one always have to be very careful about exaggerations in this arena; see here for a discussion of a particular case by Consumer Reports).  Here’s another.

On balance, though, it’s quite believable that, many of the gains due to subsidization may be offset due to government offering only products that have more “features” than many people are willing to pay for.  To analogize, consider a law that prohibited people from owning either a clunker car (defined somehow) or a car without four-wheel drive. The theory behind the law was that clunkers were unsafe and that four-wheel drive is sometimes useful: even if you don’t need it right now, you might need it or have needed it at some point.  Fair enough. But such a law might not actually increase the number of people driving quality cars that fit their needs. Some people just can’t afford a new car.  And others, who could afford a respectable car without four wheel drive and didn’t think they needed it right then (urban Floridians, for example), might simply decide not to get a car rather than use scarce marginal dollars for cars with features they don’t need. While such a result need not occur — it depends on all sorts of factors — my sense is that this is where we are heading with the Affordable Care Act and its fairly demanding and undifferentiated requirements for coverage in policies sold on the Exchanges.

3.  Federal mandate tax payments may be a little bit bigger than expected for 2014

The Congressional Budget Office estimates this spring that the United States Treasury would receive about 2 billion dollars as a result of the individual mandate tax (26 U.S.C. § 5000A). That figure was premised, however, on a belief that 7 million people would enroll in the Exchanges.  If only 2 million people get insurance through the Exchange that’s roughly 5 million fewer than anticipated who will not. There thus could be as many as 5 million more people who will have to pay the individual mandate (26 U.S.C. §5000A) and could lead to something like another $500 million in revenue next year.

Before we spend the money of 5 million more Americans who might have to pay extra in tax, however,  we need to we need to subtract off two categories of people.  (1) We should subtract off those who acquire faux-grandfathered policies created by President Obama’s recent turnabout to let people who like their (potentially cruddy) coverage keep it under some circumstances and not have to pay the individual mandate.  (2) We should subtract off the small number of people who were projected to purchase policies on the Exchange but, because of poverty or otherwise, would not have had to pay the mandate tax had they failed to do so.

So, let’s say on balance that 3 million fewer people than projected pay the tax under 26 U.S.C. 5000A. It’s hard to know exactly what sort of tax revenue would be involved, but it is likely in excess of $285 million per year because each such person would have been responsible for at least a $95 per person penalty. (I know, I know, there are lots of complications because the penalty is difficult to enforce and because you only have to pay half for children, but then there are complications the other way in that $95 is a floor and one may have to pay 1% of household income). Why don’t we use round numbers, though, and say that the government might get about $300 million more in tax revenue for 2014 (although they may not get the money until 2015) due to lower-than-projected enrollments in the Exchanges.

4. Before the federal government subsidizes them, insurers in the Exchange will lose billions

4. Before consideration of various subsidies (a/k/a bailouts) of the insurance industry created by the Affordable Care Act, insurers could lose $2 billion as a result of having gambled that the Exchanges would be successful.  Here’s how I get that figure. No one knows for sure but, if the experience under the PCIP plan is any guide, when about 1/3 of the projected number of people apply to a plan that is not medically underwritten, expenses per person can be more than double that originally expected.  Even if we assume that experience under the PCIP is not fully applicable, given an enrollment 1/3 of that projected, it would shock me if covered claims were not at least 125% of that expected. If so, on balance that means that losses per insured could total roughly $1,000. If we multiply $1,000 per insured by 2 million insureds, we get about $2 billion. If the Exchanges lose money at the same rate as the PCIP, insurer losses could be upwards of  $7 billion. Again, I make no pretense of precision here. I am simply trying to get a sense of the order of magnitude.

5. The federal government will subsidize insurers more than expected but insurers will still lose money

The Affordable Care Act creates several methods heralded as protecting insurers writing in the Exchanges from claims that were greater than they expected.  One such method, Risk Corridors under section 1342 of the ACA, could end up helping insurers in the Exchanges significantly. But, if, as discussed here, enrollment in the Exchanges for 2014 is 2 million persons, the cost of helping the insurance industry in this fashion will be another $500 million for 2014. Risk Corridors, which have recently been aptly analogized to synthetic collateralized debt obligations (CDOs), requires the government to reimburse insurers for up to 80% of any losses they suffer on the Exchanges.  It also imposes what amounts to a special tax (again of up to 80%) on profits that insurers may make on the Exchanges. The system was supposed to be budget neutral but, as I and others have observed, will in fact require the federal government to pay money in the event that insurer losses on the Exchange outweigh insurer gains. The basis for my $500 million computation is set forth extensively in a prior blog entry. It will only be more if, as discussed in another prior blog entry, the Obama administration modifies Risk Corridors to indemnify insurers for additional losses they suffer as a result of President Obama’s decision to let those with recently cancelled medically underwritten health insurance policies stay out of the Exchanges.

If claims are, as I have suggested 25% higher as a result of enrollment of 2 million, insurers will lose, after Risk Corridors are taken into account, about 9% on their policies. It would thus not surprise me to see insurers put in for at least a 9 or 10% increase on their policies for 2015 simply as a result of enrollment in the pools being smaller than expected.

The relatively modest 9% figure masks a far more significant problem, however.  It is just a national average. Consider states such as Texas in which only 2,991 out of the 774,662 projected have enrolled thus far.  If, say, Texas ends up enrolling “only” increasing its enrollment by a factor of 16 and gets to 50,000 enrollees, I would not be surprised to see claims be double of what was projected.  Even with Risk Corridors, insurers could still lose about 24% on their policies. A compensating 24% gross premium increase, even if experienced only by that portion of the insurance market paying gross premiums, could well be enough to set off an adverse selection death spiral.

Footnote: For reasons I have addressed in an earlier blog entry, one of those methods, transitional reinsurance under section 1341 of the ACA is best thought of as a premium subsidy that induces insurers to write in the Exchanges. Because the government’s payment obligations are capped, however, the provision is unlikely to help them significantly if the cost per insured ends up being particularly high throughout the nation.

6. The federal government might save $19 billion in premium subsidies

The Congressional Budget Office assumed that premium subsidies would be $26 billion in 2014, representing a payment of about $3,700 per projected enrollee.  If the distribution of policies purchased and the income levels of purchasers are as projected, but only 2 million people apply, that would reduce subsidy payments down to $7.5 billion.  And if the policies sold in 2014 cost a little less than projected, that might further reduce subsidy payments.  I think it would be fair, then, to estimate that low enrollment could save the federal government something like $19 billion in premium subsidies in 2014. This savings coupled with heightened tax revenue under 26 U.S.C. §5000A — could we round it to $20 billion — would be more than enough to cover insurer losses resulting from the pool being smaller and less healthy than projected.

The Bottom Line

I suspect my conclusion will make absolutist ideologues on the left and right equally uncomfortable.  What I am wondering is if the Affordable Care Act might not die in 2015 with a giant imploding bang but rather limp on with a whimper. On balance, what we may well see if only 2 million enroll in Exchanges pursuant to the Affordable Care Act is a system that fails to function in some states and remains fragile and expensive elsewhere. On the one hand, it will be an expensive system because of the enormous overhead incurred in creating a highly regulated industry that provides assistance to a relatively small number of people. On the other hand, precisely because it will be helping far fewer people than projected, it might well cost significantly less  than anticipated. I would expect this departure from what was projected to lead to two sorts of pressures:

(1) There will be a claim from ACA supporters that we can use the savings to increase subsidies or the domain of the subsidies beyond the 400% of Federal Poverty Line cutoff  and thereby reduce the adverse selection problem that will already be manifesting itself.

(2) There will be a claim from ACA detractors that all of this confirms that, apart from ideological considerations, the bill is an expensive turkey and that, if  the only way to save it is to impose more and more regulation and spend more and more money, it ought simply to be repealed.

Complicating factors

Rules

There are many factors that could result in the estimates provided in this entry being quite wrong.  I do not want to fall into the same trap as others who have ventured into this field and claim that there are not very large error bars around all of these numbers.  And I do not believe the system is necessarily linear. It may be that small changes have cascading effects. Here are several reasons my estimates might be wrong.

1. The rules change in 2015. There are at least three significant rule changes in 2015.

a. The tax under 26 U.S.C. 5000A for not having government-approved health insurance increases significantly, going from the greater of $95 per person or 1% of household income to the greater $295 per person or 2% of household income. Insurers may therefore assume that enrollment will be greater in 2015 than in 2014.  Some people will be pushed over the edge by the higher tax rate into purchasing health insurance. If so, insurers may feel less pressure to increase prices because they believe their experience in 2014 will not be repeated in 2015.

b. The employer mandate will presumably not be delayed again by executive order which may have two offsetting events: employers reducing the number of full time employees thereby adding more to the Exchanges or employers maintaining health insurance thereby reducing the potential pool for the Exchanges.

c. As discussed in an earlier blog entry, there will be a decline in transitional reinsurance now provided free to insurers in the Exchange which, in and of itself, will put significant pressure on premiums

Realities

Finally, this is a field where events just frequently overtake predictions.  All of these predictions go out the window, for example:

a. if there is a major security breach in the government computer systems and people’s personal information is disclosed;

b. healthcare.gov continues to seriously malfunction during the critical pre-December 23 sign up period

c. if the yet-to-be-built payment system for insurers does not function and people become dissatisfied as a result;

d. if people find, as some are projecting (here and here), that the set of medical providers available in the Exchange policies is drastically reduced over what they expected; and

e. there is a major sea change in legislative power in Washington.

f. other

 

 

 

 

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Can its reinsurance and risk adjustment provisions salvage the Affordable Care Act?

The Problem

Let us suppose, for the moment, that enrollment in the Exchanges increases as healthcare.gov becomes less dysfunctional and as we get closer to the January 1, 2014 and March 1, 2014 deadlines. It is, after all, unrealistic to think that enrollment will remain at the pathetic/paltry/miserable levels recounted by today’s testimony from Kathleen Sebelius,  notwithstanding her counting of people who merely put a plan in their shopping cart.  But it does seem likely to many , including me, that

  1. sticker shock,
  2. the small and difficult-to-enforce penalties for 2014,
  3. President Obama’s decision to let insurers “uncancel” ungrandfatherable policies and let some of those insureds stay out the Exchanges,
  4. the website debacle, and
  5. whatever short-sightedness or financial liquidity issues led to most of even the sickest uninsured Americans not enrolling in the Pre-existing Condition Insurance Plan

will likewise lead the enrollment in the Exchanges to be considerably smaller than projected. This is particularly likely to remain true, I believe, in states such as Texas in which institutional forces and political culture often do not encourage participation and in which fewer than 3,000 out the estimated 3,000,000 eligible to do so have enrolled thus far.

The key question is how resilient are the Exchanges to low enrollments in which, one would expect, the enrollees are — even more than they were projected to be — disproportionately older and disproportionately less healthy. And have the Exchanges been rendered yet more fragile by what many cheered as the surprisingly low premiums charged by many insurers? Could those insurers, who are likely to swoop up most of the business in a price sensitive market, in fact be about to face the winners curse? The answer to these questions may lie deep in the details of one of the least studied and yet one of the most important set of provisions in the Affordable Care Act: the reinsurance and risk adjustment provisions contained in sections 1341-1343 of that Act and now codified at 42 U.S.C. §§ 18061-18063.

Here’s the (long) paragraph-length explanation of how these reinsurance and risk adjustment provisions work. 42 U.S.C. § 18061 basically creates a transitional (2014-16) government operated stop-loss reinsurance program funded out of a special tax on other health plans ($63 per covered life). The reinsurance attaches when a person covered by a plan in an Exchange incurs $60,000 or more in claims per year.  After that point, the reinsurer pays for 80% of the claims up to a cap of $250,000.  Thus, if an individual had claims of $180,000 in a year, the government would reimburse the insurer for $96,000, which is 80% of the difference between $180,000 and $60,000. What this provision appears to do is make insurer profit and loss less sensitive to attracting high claims insureds. 42 U.S.C. § 18062 basically redistributes money in a complex way from insurers whose Exchange plans profit to insurers whose Exchange plans lose money. Again, the idea is to reduce the insurer anxiety either that their plan and their marketing (if any) happens to attract an unhealthy pool or that they selected a premium too low for the actual risk that materializes.  Finally, 42 U.S.C. § 18063, the only program that is supposed to persist past 2016, imagines an incredibly complex system in which the risk posed by an insurer’s pool is assessed and the states or, in their default, the federal government (see 42 U.S.C. 18041(c)(1)(B)(ii)(II)), transfers at least some money from those with the riskiest pools to those with the least.

Will these provisions really rescue the insurers?

All of this might seem a comfort to insurers that might permit them to survive and continue in the Exchanges even if the pools are, on average, considerably more expensive than originally projected. But to get a better handle on the degree of solace these provisions might provide, we need to look at some of the limitations of these programs and the actual numbers.

Stop-loss reinsurance under 42 U.S.C.  § 18061

First, let’s look at how much risk the transitional reinsurance provided by 42 U.S.C. § 18061 really slurps up. What I contend is that while this provision should — and probably did — lower the premiums the insurer would otherwise need to charge to avoid losing money, it does less to rescue insurers if the pool is less healthy than they foresaw.  While to really see this, we need to get deep into the weeds and do some math, I’m going to hold off on that fun for now. We have to save some things, such as the Actuarial Value Calculator, for other blog entries. I believe I have developed a plain English explanation that gets us most of the way there.

The key concept is to recognize that sophisticated insurers (are there other kinds?) took the free reinsurance into account when they priced their policies.  They computed an expected value of the reinsurance reimbursements and lowered their rates by something approximating that amount. They were able to charge lower rates than they otherwise would because some of the claims bill would be picked up by the government. But this does not mean that the insurers end up having profits that are insensitive to the actual claims incurred by their pool.  Unless all of the higher-than-expected claims are stuffed into the zone in which the reinsurance kicks in ($60,000 to $250,000), the insurers will be hurt when the pool has higher claims than expected.  But such an assumption is incredibly implausible.  If the insurer assumed that only, say, 2% of its insureds would have claims between $20,000 and $25,000 but, as it turns out, 4% of its insureds have such claims, nothing in 42 U.S.C. § 18061 will help such an insurer with that unanticipated loss. Moreover, because the reinsurance even within the relevant zone is incomplete, the insurer will lose money if claims between $60,000 and $250,000 are higher than expected.  The effect of the transitional stop-loss reinsurance on reducing the consequences of adverse selection is thus likely to be small.

In the end, what this transitional reinsurance mostly does is mostly to tax non-Exchange policies $63 per covered life in order to make policies within the Exchange more attractive to policyholders.  And, yes, that fact should make Exchange-based policies cheaper and reduce the problem of adverse selection.  After all, if the insurance were free presumably there would be little adverse selection — everyone would get it. But the reinsurance fails to reduce insurer vulnerability to adverse selection much more than, say, providing more generous tax credits and cost sharing reductions would have done. If the pool ends up being less healthy than the insurer anticipated — an almost certain consequence of lower-than-expected enrollments, 42 U.S.C. § 18061 is hardly going to end up relieving the insurer of most of the unhappy consequences of having written policies in that environment.

Footnote: There is one more wrinkle, but it only means that the transitional reinsurance is a yet weaker rescue vehicle: the government’s obligations under the transitional reinsurance provisions are limited.  There’s “only” $12 billion in 2014 and this ramps down to $4 billion in 2015.  If those amounts aren’t adequate to pay reinsurance claims, each claim gets reduced pro rata.  The reason I relegate this point to a “footnote,” however, is that if the pools are really small then even if claims per person are way higher than expected, the aggregate amount of claims in the reinsured zone of $60,000 to $250,000 aren’t going to be that big. My back-of-the-envelope computation suggests that the $12 billion allocated for transitional reinsurance should not be insufficient unless at least 2 million people enroll on the exchanges; since right now we are almost certainly at less than 100,000, 2 million seems a lot of insureds away.

“Risk Corridors” under 42 U.S.C. § 18062

The biggie in this field is the “Risk Corridors” provisions contained in 42 U.S.C. § 18062. It essentially creates this massive transfer scheme, taking money from insurers who had profitable pools and giving it to those who did not.  In some sense, it converts insurers from entities bearing risk to mere fronts for government funded health insurance.  If I were prone to accuse the Affordable Care Act of creating “socialized medicine,”  my Exhibit A would be the stealth “Risk Corridors” provision of 42 U.S.C. § 18062.

The graphic below shows how the scheme works. The x-axis of the graph shows hypothetical aggregate net premiums (what 18062 calls “the target amount”) an insurer might receive for some plan in some state.  The y-axis shows the profits the insurer receives as a function of those aggregate net premiums assuming that claims (a/k/a “allowable costs”) are $11.4 million. The purple line shows what profits would have been as a function of premiums if 42 U.S.C. sec. 18062 did not exist. The blue line shows what profits will be after the payments required by 42 U.S.C. 18062 are taken into account.  The khaki-shaded zone shows the payments insurers are supposed to receive (and the Secretary of HHS supposed to pay) under the statute. The green zone shows the payments insurers are supposed to make (and the Secretary of HHS supposed to receive) under the statute.

Profit as a function of premiums before and after 42 USC 18062
Profit as a function of premiums before and after 42 USC 18062

We can create a similar graphic in which the role of claims and premiums is reversed. The x-axis of the graph shows hypothetical aggregate claims costs (what 18062 calls “the allowable costs”) an insurer might receive for some plan in some state.  The y-axis shows the profits the insurer receives as a function of those aggregate claims costs assuming that net premiums are $8.6 million. The purple line again shows what profits would have been as a function of premiums if 42 U.S.C. sec. 18062 did not exist. The blue line again shows what profits will be after the payments required by 42 U.S.C. 18062 are taken into account.  The khaki-shaded zone again shows the payments insurers are supposed to receive (and the Secretary of HHS supposed to pay) under the statute. The green zone again shows the payments insurers are supposed to make (and the Secretary of HHS supposed to receive) under the statute.

Insurers profits as a function of claims before and after 42 USC 18062
Insurers profits as a function of claims before and after 42 USC 18062

If one looks at the slope of the blue lines — the ones that show profits after 18062 risk corridors are taken into account — they are much less steep for most of the domain than the purple lines — the one that show profits before 18062 risk corridors are taken into account.  What this means is that, in some sense, it doesn’t matter to insurers all that much whether they price too low or too high, whether claims are lower than they thought or — due to adverse selection or otherwise — higher than they thought.  Either they are going to pay money to the government or they are going to get money from the government.  The risk of writing policies in the Exchange is greatly diminished.

In some sense, then, if section 18062 (1342) is fully implemented — an issue to which I will shortly return — insurers don’t act very much as profit-making enterprises within the Exchange making or losing money on the spread between premiums and claims.  (This is even more true after the corporate income tax is taken into account) Instead, they are almost fronting for the government, providing their license, their claims processing abilities and their credibility to a scheme in which the government really bears the risk associated with the new Exchange-based system of providing insurance.  A cynic might term the Exchanges as having gone 80% of the way towards a single payor system in which there is but minor variation in the benefits offered by insurance policies and claims processing contracted out to various insurance companies with the experience to do so.

The incentives issue

There are several implications of this consideration of 42 U.S.C. 18062. The first is to consider what incentives the system sets up for insurers.  My tentative belief is that it incentivizes insurers to offer a low premium if they want to go into the Exchanges and this statutory provision may explain in substantial part why insurers priced their policies at rates lower than most expected. Let me see if I can sketch out the argument.  If the insurer prices high, they are going to get very little business.  Other insurers will take their business away by going low.  If they price low, they will get a lot of the business.  Sure, they may lose money if they price too low, but, if so, the government will reimburse them for most of their losses.  And if they price right or still too high, they can make some money.

The graphic below illustrates this concept.  The x-axis shows possible premiums the insurer might charge. The y-axis shows the profit of the insurer associated with that profit.  As one can see, before section 18062, the insurer does best to charge about $2,840 in premiums; after 18062, the insurer does best to charge about $2,677 in premiums.  Although the assumptions chosen to produce this graphic were somewhat arbitrary, it is interesting and suggestive to me that the magnitude of the reduction in premiums is roughly similar to that observed in the actual market place in which premiums came in several hundred dollars below that originally projected.

Profit as a function of premiums in a competitive market before and after 42 USC 18062
Profit as a function of premiums in a competitive market before and after 42 USC 18062

The imbalance issue

There’s a second issue suggested by the two graphics above (the ones with the shading) showing the effect of premiums and claims on profitability.  They highlight that there is is no reason to think that the amount the Secretary receives will be equal to the amount the Secretary takes in.  That would be true only if insurers happen, in aggregate, to price the policies just right. If insurers have underpriced the policies because they expected a larger — and correlatively healthier — pool, the graphics may quite accurately reflect what occurs and the Secretary will be obligated to pay out far more than the Secretary takes in.  I have found no one who has written on this problem, no one who can explain where the money will come from to make the needed payments, or what mechanism will be used to reduce payments in the event, as I suspect, there will be an imbalance between the money collected and the money the Secretary is supposed to pay out.

 And one final thing

Extra credit: Can anyone spot the uncorrected typo in 42 U.S.C. 18062? For answer, look here.

Risk Adjustment Under 42 U.S.C. §18063

The transitional reinsurance and risk corridors provisions only last until 2016. After that, assuming the Affordable Care Act survives in something like its present form for that long, insurers are protected from adverse selection only by the  sleeping giant among the trio of protection measures: the “risk adjustment” provisions in ACA section 1343, codified at 42 U.S.C. §18063. The idea here is to equalize the playing field for insurers not based on the amount they actually pay out in claims (stop-loss reinsurance) or their actual profits (risk corridors) but on the risk they took in accepting insureds.  It thus envisions this massive bureaucratic scheme whereby each individual purchasing a policy on an Exchange is scored (based on a complex federal methodology involving “Hierarchical Condition Codes“) and then, the insurers with high scores get paid by the insurers with low scores with the Secretary of HHS figuring out exactly how it works. To do this, the Secretary will need masses of sensitive information, including fairly granular accounts of the medical conditions of each person enrolled on an Exchange.  The idea in the end, though, is to calm insurer fears that because of peculiarities of their plans, bad luck, or other factors, they tend up with a worse than average pool.

This provision will not save the Affordable Care Act from an adverse selection death spiral if enrollment stays low.  This is because Risk Adjustment simply protects insurers from worse-than-average draws from the pool of insureds purchasing Exchange policies.  It does nothing to protect insurers from having an overall pool of insureds purchasing Exchange policies that is higher risk than anticipated. If that larger pool is high risk on average, however, insurers will need to price their policies high, which will lead the lesser risk insureds to drop out, which will result in prices being raised again — the death spiral story.

The Bottom Line

The bottom line here is that two of the provisions (18061 and 18063) that purport to protect insurers from adverse selection really do little to protect insurers from the sort of adverse selection that is now appearing quite likely to develop: lower risk persons staying out of the Exchanges, period. The remaining provision, 18062, “Risk Corridors” in theory could give insurers some confidence that they will not lose their shirts if the pool stays small and high risk.  But this is only true to the extent that insurers believe the Secretary of HHS will find some currently unknown pot of money with which to make payments when the number of insurer losers in the Exchanges far outstrips the number of insurer winners. If insurers doubt that the Secretary will be able to find the money and may simply resort to some pro-rata reduction in payouts under 18062(b)(1), they will have be less pacified in what must be their growing fears that the pool of insureds inside the Exchanges will, on balance, be far higher risk than they anticipated. And, if the Secretary finds money with which to honor the promises in section 18062, look for protests from those who were told that the Affordable Care Act would not have all that large a price tag.

Late Breaking News

As it turns out, the reinsurance and risk adjustment provisions are in the news today in an elliptical remark made at the end of a letter sent by the Center for Consumer Information & Insurance Oversight (CCIIO) that implements President Obama’s transitional “fix” with respect to canceled nongroup policies. He states:

Though this transitional policy was not anticipated by health insurance issuers when setting rates for 2014, the risk corridor program should help ameliorate unanticipated changes in premium revenue. We intend to explore ways to modify the risk corridor program final rules to provide additional assistance.

I believe this passage amounts to recognition by the President that providing a non-Exchange insurance substitute for generally healthy people who otherwise likely would have gone into the Exchanges will end up making adverse selection worse and further increase likely losses by insurers writing in the Exchanges.  This, by the way, is why insurers are apparently furious about the President’s “fix.”  The question, though, is where is the money going to come from to make the insurer’s whole.  The statute appears to envision a zero sum game in which the winners compensate the losers.  It does not appear to contemplate what seems ever more likely to occur: a game in which the only winning move is not to play.

Acknowledgements

If you are interesting in this topic, you should read the articles by Professor Mark Hall. I don’t alway agree with Professor Hall, but I have tremendous respect for his analysis.  He is, in my view, one of the leading scholars with a generally positive view about the Affordable Care Act. You can find the articles here and here.

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The aim of this blog

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

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

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

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

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

 

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