The Three R's of Health Insurance
For some, the Three R’s evoke the smell of chalk dust and sepia-tinged images of children’s heads bent over multiplication and long division problems. Mastery of reading, ’riting and ’rithmetic, however, in no way guarantees you’ll grasp the intricate web of regulations underlying the Affordable Care Act (ACA), where the Three R’s refer to something very different: risk corridors, reinsurance, and risk adjustment.
Together, these interdependent programs help protect health insurance companies against unpredictable losses or unmanageable risk selection, and keep consumer’s premiums from spiraling out of control in the early years of the law’s coverage provisions. A recent conference of leading actuaries, insurance company officials, and economists sponsored by The Commonwealth Fund confirmed that the ACA’s Three R’s are having the intended effect of keeping premiums down in 2014 and moderating likely increases in 2015. Risk corridors and reinsurance provisions last from 2014 to 2016. Risk adjustment is permanent.
The Three R’s would likely have remained invisible to the public if the law’s critics hadn’t labeled them taxpayer bailouts of the health insurance industry. Even a cursory glance at the evidence shows they’re no such thing.
Risk adjustment is a process that deters insurance plans from trying to attract healthy enrollees (“cherry picking”), and protects companies that may—by chance or because of their particular benefits—attract sicker than average customers (“adverse risk selection”). Though the Affordable Care Act bans carriers from turning people down or charging them more based on their health, the incentive to attract healthier enrollees remains because healthier customers increase profits by reducing companies’ payouts. With healthier enrollees, plans can also reduce premiums while maintaining profit margins. This tends to reinforce their advantage with healthy customers, who are often most price-sensitive.
The result is an unstable market in which some plans experience a favorable cycle, attracting more and more good risks, and other plans, a vicious cycle, in which their higher-risk enrollees and higher premiums make them less and less competitive. If this pattern unfolds in new ACA marketplaces, where people receive federal subsidies, costs will go up for both consumers and the federal government and endanger the most vulnerable Americans’ ability to obtain affordable private insurance.
Risk adjustment interrupts these cycles by doing exactly what its name implies. It adjusts for differences in the health of plans’ enrollees by redistributing funds from companies with healthier-than-average customers to plans with sicker-than-average customers. Such transfers could occur within or across health plan tiers in the exchanges (bronze, silver, gold, platinum). All the redistributed monies come from insurance companies in the marketplaces. No taxpayer bailout here.
Reinsurance is a technique for making sure that health plans are protected against really bad luck in the form of relatively rare customers who experience truly catastrophic illnesses that result in huge expenditures. In the ACA’s individual markets, where companies have to take all comers, regardless of health status, such random occurrences can make the difference between success and failure, and between being able to keep premiums down, or raising them dramatically.
Reinsurance manages this risk by literally insuring insurance companies against it. Using fees collected from all the nation’s health insurance companies (essentially, insurance premiums paid by insurers), the federal government proposes to pay nongrandfathered insurance plans 80 percent of the costs between $45,000 and $250,000 experienced by any of its enrollees in 2014. In 2015, the terms may change to 70 percent coverage for costs between $70,000 and $250,000. Reinsurance disappears in 2016, at which time plans will presumably have a good sense of how frequently these rare events occur, and how to manage them. The plan is budget neutral: when the funds collected from insurers run out, the government stops paying. No taxpayer bailout here either.
Risk corridors are perhaps the most complicated of the Three R’s, but far from costing the taxpayers any money, the Congressional Budget Office (CBO) projects that this program could actually make the Treasury a tidy $8 billion profit. Because the ACA marketplaces are so new and the health risks of new enrollees uncertain, some insurance companies could make a windfall or lose their shirts in the early years of the rollout. This could encourage companies to set premiums higher than necessary just to make sure they aren’t among the losers.
To prevent this, the federal government has created a program under which it will collect money from plans sold in the new marketplaces with unexpectedly high gains and redistribute them to plans with unexpectedly high losses. If plans make or lose up to 3 percent more than expected, they keep the gains or eat the losses. However, if they make or lose 3 percent to 8 percent more than predicted, they give up 50 percent of the winnings or are compensated for 50 percent of their shortfalls above 3 percent. If losses or gains exceed 8 percent, the insurers give up or get back 80 percent of gains or losses exceeding 8 percent of the predicted amount. If the government collects more from winners than it has to pay out to losers, it keeps the balance. CBO thinks that’s likely—thus, the predicted profit for the federal government.
At no projected cost to the federal government, the Three R’s correct some problems that have long crippled the individual and small-group insurance markets. They also temporarily ease the entry of private health insurance companies into new, more genuinely competitive marketplaces. And most critically, the programs will help insure lower premiums for consumers. Sometimes a little regulation is just what the doctor ordered to make competition work in the real world.