Risk Corridors

 

Update: 12/18/15

 

Language in the 2016 omnibus package prohibits risk corridor bailouts.

 

Another Bailout?

Tucked away in the Affordable Care Act are three measures that would buffer and cover risk assumed by insurance companies. A combination of risk adjustment, reinsurance, and risk corridor provisions would operate effectively as bailouts for insurers if the law begins to fail. While these measures were intended to be budget neutral, all signs point to a “blank check” policy where taxpayers would be on the hook to rescue insurers. This “Obamacare Bailout” must be corrected and reformed to provide fairness to taxpayers and place responsibility for a potential death spiral firmly on the administration’s tab.

 

Understanding the Three R’s

The first thing to realize is that risk insurance programs are by no means unprecedented. Consider the 2003 Medicare Advantage and Prescription Drug programs that included similar mechanisms. They are intended to protect insurers and offset their costs from unpredictable consumer behavior such as lower-than-expected participation or revenue. In the case of the ACA, risk mechanisms exist to stabilize premiums and keep insurers in the new exchanges.

 

For example, if enrollment were to fall short of the 7-million figure or the composition of the pools end up being mostly sick people, then the feared ‘death spiral’ goes into effect. Because the insurers have already invested in the new programs with the expectation of profits from new customers and federal subsidies, anything short of those investments would generate financial losses for those companies. The three risk insurance programs establish a series of financial transfers among the government and insurers to keep premiums artificially low. Without these mechanisms, insurers would have to increase prices to offset higher than expected costs as what would occur under normal market conditions. Under that scenario, new customers would flee the exchanges and many insurers would pull out of the program, thus threatening to dismantle the ACA.

 

It’s important to understand the specifics of each risk program. Below are brief explanations of each:

 

1. Risk Adjustment

This program operates as a regulation that spreads risk among insurance companies. Because the ACA mandates coverage regardless of pre-existing conditions, the possibility to pay more for already sick policyholders is quite high. If one insurer gains a new pool of customers that is unhealthier than average, that company would ultimately lose money. In order to prevent bias against the sick and to ensure that every American be covered, the risk adjustment mechanism forces those companies with healthier-than-average pools to pay insurers with the unhealthier pools. Risk adjustment is intended to offset the losses from accepting unhealthy customers by removing the gains from healthy pools. This program is financed solely by cash transfers among companies, and will be triggered depending on the distributional balance of pools going forward. This is a permanent program that affects individual and small group plans in and outside of the exchanges.

 

2. Reinsurance

This risk mechanism buffers insurance companies from individual enrollees who accumulate higher than average medical expenses in the first few years of the law. Because insurers must accept customers regardless of pre-existing conditions, expensive treatments for chronic diseases and other high-risk procedures will rise. If medical costs for an individual go above $60,000 in 2014, the federal government will reimburse the insurer up to 80% over that cap. However,  lower reimbursement rates are anticipated for 2015-2016.

 

The reinsurance program is financed by  a $63 flat fee collected from every insured and self-funded plan. These charges have accumulated into a fund between $10 and $20 billion that will be expended over three years to partially offset an insurer’s expenses for taking on a larger volume of high-cost cases, and will stabilize average premiums for all policyholders. This is a temporary program that applies to individual plans in and outside of the exchanges.

 

3. Risk Corridors

Because insurers do not know how many people will sign up for the exchanges or what the diversity of the pools will be, they will have a hard time setting prices for new policies. Risk corridors provide a cushion for setting premium prices that don’t cover all medical expenses. In a nutshell, insurers who participate in the exchanges set a “target amount” of premium dollars they will need to cover expected medical costs for new enrollees. Let’s set the target at 100% meaning an insurer perfectly calculated this arrangement. If costs exceed the target between 103% and 108% then the insurer can receive up to a 50% reimbursement. If costs rise above 108% there can be an 80% reimbursement. Basically, if the insurance company guessed wrong on premium pricing then the government helps them smooth out the transition.

 

However, the risk corridors work in the opposite direction as well. If costs are below the target amount between 92% and 97% then the insurer pays the government a 50% reimbursement. Any shortfall below 92% of the target means the government will receive up to 80% of those costs. In this case, if the premium rate is set too high then the insurers will pay back what was overcharged. The risk corridor mechanism only applies to individual plans purchased through the exchanges.

 

Health Insurance “Bailout” in a Death Spiral

The reinsurance and risk corridor mechanisms are the most controversial of the three because they establish a direct “bailout” operation between the government and the insurance companies. Reinsurance taxed every policy a flat rate to create a multi-billion-dollar pot that is intended to cover a three-year transition for all players to grow accustomed to the law, and more importantly to not lose money. Yet no one can tell if the reinsurance fund can pay for all three years or if an emergency mechanism is in place.

 

Similarly, the risk corridor program has no finite balance from which to reimburse, thus raising the potential for a “blank check bailout” if the collected premiums can’t cover all the new expenses. This provision was written to be budget neutral, but section 1342 in the ACA states that, “Regardless of the balance of payments and receipts, HHS will remit payments as required.”

 

Moreover, the President’s numerous changes and delays to the law have increased the likelihood that a “bailout” will occur. Although enrollment numbers finally topped 11 million at the beginning of 2016, the potential for a death spiral still exists, particularly as website problems and the President’s unilateral delay of the individual and employer mandates deteriorate the need to sign up. In a “death spiral” situation, the bailout mechanisms in the ACA must be aggressively used to prevent insurers from leaving the market. The cost for each risk program could rise substantially in that scenario.

 

So what should we do about these risk programs?

The key question is whether the insurance companies can make enough money in premiums to cover the increased costs for plans in and outside the exchanges. From one perspective, it seems wrong to hang the insurance companies out to dry for a law they were forced to comply with. However, insurers have been highly compliant and cooperative throughout the creation and implementation of the law. Despite countless setbacks and poor federal management in attracting enough folks to the exchanges (and undermining the mechanisms that would have forced them on), it’s probably  time to reap what they sowed.

 

Does Responsible Action Exist?

Using the motivators of reducing spending, protecting taxpayers, and  reforming the ACA, we should restrict or outright repeal the risk provisions. At the very least (1) the reinsurance program should be modified to spend no more than what is in the fund (2) the risk corridor mechanism should explicitly demand budget neutrality. With a top reimbursement rate of 80% for a plan that exceeds the target amount, the insurer is not fully compensated anyway so they need to plan on absorbing that extra cushion.

 

If the provision is stated to be budget neutral, then the reimbursement percentage can be less and operate under the same constraints, except that taxpayers are not asked to indefinitely pay for a poor performing law for three years. If all these risk provisions are minor in cost (as the White House contends) then the insurance companies should be able to absorb these marginal expenses. But if not, the law keeps its promises to taxpayers and forces insurers to realize the worthwhile commitment to this program.

 

The ideal action would be to repeal the risk corridor provision entirely, and then reimburse taxpayers the $63 charge from a repealed reinsurance program. The risk adjustment mechanism could stay in place because funds are transferred between insurers and could act as a partial hedge if one company ends up with a large share of unhealthy customers. But even that measure won’t help if the other two are repealed. Lacking a bailout, the insurers would react to actual market forces and raise prices for those already with plans. It is also likely, that in such a scenario the federal subsidies would have to be increased to cover those costs. That would be an entirely new spending issue in its own right. But without a guarantee for limited risk, insurers participating in the exchanges will likely pull out of the program and prevent new signups. The health care experiment at that point would probably collapse.

 

Framing the risk programs as a “bailout” is for all purposes accurate and potentially potent as an issue early in 2014. If an anti-bailout bill is passed on its own or attached to a debt ceiling increase, it puts supporters of the health law in a tight spot. They would have to choose between passing an unlimited bailout for health insurance companies to keep the law alive, or eliminate the bailout measures to the ultimate demise of the ACA. Members of Congress have introduced several variations of such bills.

 

Any action on this front should be paired with replacement mechanism should the law fail. The President will not voluntarily replace his health law, but if the death spiral occurs, he will need alternatives. A responsible, free-market alternative should be prepared in that event because, in the end, the goal is to ensure a better-functioning healthcare system, not have the law collapse and be replaced with more government spending. An anti-bailout measure is a step in achieving that objective.