July 26, 2016—This issue brief has been slightly revised to clarify that the Mercatus Center report excluded reinsurance, risk adjustment, and risk corridor payments only from its calculation of medical loss ratios but did separately discuss payments under these programs.
Starting in 2014, the Affordable Care Act transformed the market for individual health insurance by changing how insurance is sold and by subsidizing coverage for millions of new purchasers. Insurers, who had no previous experience under these market conditions, competed actively but faced uncertainty in how to price their products. This issue brief uses newly available data to understand how health insurers fared financially during the ACA’s first year of full reforms. Overall, health insurers’ financial performance began to show some strain in 2014, but the ACA’s reinsurance program substantially buffered the negative effects for most insurers. Although a quarter of insurers did substantially worse than others, experience under the new market rules could improve the accuracy of pricing decisions in subsequent years.
The Affordable Care Act (ACA) created a dramatically different marketplace for individual health insurance through three key reforms: prohibiting insurers from considering subscribers’ health status or risk; providing substantial subsidies for millions of people to purchase individual coverage, many for the first time in their lives; and creating an “exchange” structure that facilitates comparison shopping. In addition, the ACA limits the percentage of premiums that insurers can devote to profit and administrative expense and requires state or federal regulators to evaluate the basis for rate increases.
Until recently, reports about the financial impact of these reforms on insurers had been largely positive. Stock values increased substantially ahead of broad market indices.1 A large number of participating insurers created strong competition, both on and off the ACA exchanges.2 Finally, the full, unsubsidized prices in the individual insurance market have been favorable to subscribers, compared with the price of similarly comprehensive products in the group markets.3
Recently, however, we are hearing more troubling financial news from health insurers in the individual market.4 Premium rates have increased more than expected.5 Several newly established insurers that focused on the individual market have failed or are in financial distress.6 And the nation’s largest insurer, United Healthcare, announced it would be withdrawing from most of the ACA’s exchange markets, based in part on its significant losses.7
This issue brief analyzes newly available data sources to better understand the financial performance of health insurers under the ACA during 2014, the first year of full reforms. It is important to analyze financial performance comprehensively because isolated reports can be misleading: losses from one insurer can fail to reflect better-performing insurers. In addition, adverse reports based on preliminary data can overlook the offsetting effects of reinsurance and other buffering mechanisms that the ACA included to protect insurers from excessive losses.8
Using rate data from the Centers for Medicare and Medicaid Services (CMS), this study compares actual to projected 2014 medical claims from ACA-compliant health plans. On average, we find that medical claims were only 2 percent higher than insurers first projected, after taking into account reinsurance payments.
We also examine CMS’s medical loss ratio data, which reflects financial performance related to compliant and noncompliant plans, including payments from three risk-adjustment programs and advance cost-sharing. Using this information, we can summarize the financial performance of health insurers in the individual and group markets. Overall, within the individual market, health insurers incurred losses amounting to 4 percent of premiums while group insurers earned a profit of almost 2.5 percent.
In addition, we evaluate changes in profitability of 144 credible insurers (i.e., those with more than 1,000 members) prior to and after one year of full ACA reforms. We find that more than a third of them had either improved or remained profitable from 2013 to 2014; for the remainder, financial performance worsened.
Actual vs. Projected Claims
We begin by analyzing how insurers’ financial performance in the individual market compares with their original projections for 2014. Many insurers were eager to offer competitive rates in this newly subsidized market to benefit from the substantial growth in enrollment and premium revenues that was expected—and that, in fact, occurred, as further documented below. However, establishing initial rates under the newly reformed and greatly expanded individual market was particularly challenging for the first year, because insurers lacked actuarial experience under the ACA’s market conditions. Therefore, actuaries had to make various assumptions based on judgment and a certain amount of guesswork.9 In addition, after insurers filed their rates, President Obama changed the market conditions by allowing insurers to continue to offer noncompliant policies to existing policyholders rather than requiring them to switch to new ACA policies.
Exhibit 1 compares insurers’ projected per-member-per-month (pmpm) medical expenses with actual medical claims for ACA-compliant individual coverage in 2014.10 Across the market, medical claims were 5.7 percent higher than projected ($429 vs. $406 pmpm). Some insurers did considerably worse than others. The quartile of insurers with the highest claims (75th percentile) underestimated their claims by an average of 35 percent, whereas the lowest-claim quartile projected their claims much more accurately, within 4 percent, on average, similar to the average claims underestimate of 6 percent marketwide. This indicates that serious adverse experience was concentrated among a minority of insurers. We can expect the accuracy of insurers’ claims projections to improve in subsequent years, as insurers gain more actuarial experience with the new market dynamics.
Most of insurers’ underestimated claims in 2014 were offset by $7.9 billion in reinsurance payments for high-cost patients from the federal government. The reinsurance program helps insurers transition to the new market rules, using federal funds collected through an earmarked fee on all health insurance, included self-funded plans, to pay a large portion of high-cost claims incurred in the individual market.11
Insurance actuaries knew the reinsurance program would cover some of their companies’ claims, but they lacked precise data about how much they should expect to receive from the program. Ultimately, the reinsurance credits to insurers (net of fees that insurers paid) were almost 50 percent higher than insurers had originally estimated ($43 vs. $29 pmpm). These greater payments resulted in part because enrollees in ACA-compliant plans had more high-cost claims than first anticipated, but also because the federal government modified the reinsurance payment formula in mid-2014 to be more favorable to insurers.
Altogether, taking into account the higher reinsurance payments, insurers’ net medical claims for ACA-compliant individual coverage were only 2.4 percent higher than they originally projected ($386 vs. $377 pmpm). Although gross claims were $23 greater than expected per member per month, reinsurance credits of $43—$14 higher than expected—made up over half this underestimate. This resulted in net medical claims being only $9 per member per month more than insurers originally projected for ACA-compliant coverage in the 2014 individual market. However, overall performance net of reinsurance credits remained substantially lower in the worst (75th) quartile of the market. These insurers had an average $121 per member per month in underestimated claims expenses.
In subsequent years, reinsurance payments are scheduled to decrease, because reinsurance is a transitional program designed to acclimate insurers to the new market environment. As insurers develop more relevant actuarial data on which to base rating projections, they may have less of a need to rely on reinsurance to buffer uncertain projections.
Profits and Overhead
Medical claims reveal only part of the picture of insurers’ financial performance. Also relevant is how the ACA affected their administrative expenses and premiums, as well as their resulting profit margins. To show this, we include data from insurers’ medical loss ratio (MLR) reports. The MLR is the percentage of premium that an insurer pays out in medical claims or devotes to quality improvement versus overhead administrative costs and profits. The ACA requires health insurers to maintain an MLR of at least 80 percent in the individual and small-group markets and of at least 85 percent in the large-group market. As part of this regulation, insurers are required to submit annual reports on their MLRs.
Based on MLR data, Exhibit 2 shows health insurers’ 2014 financial performance overall and also by individual versus group markets, compared with the two previous years prior to full ACA market reforms.12 These data include all regulated health insurance, both ACA-compliant and “grandfathered” noncompliant coverage. There are several noteworthy points.
First, the ACA almost doubled insurers’ premium revenue in the individual market, which increased by 97 percent, reflecting the considerable increase in enrollment brought about by the law’s subsidies and market reforms. Overall, health insurers’ premium revenues increased 6.2 percent, including group enrollment. This indicates that employer sponsorship of health insurance did not drop substantially in 2014.13
Second, medical claims increased somewhat more than premiums, reflected in the unadjusted MLR increase of 1.1 percent overall. Administrative costs (including broker commissions) rose only slightly (0.6%) as a percentage of total premiums overall. In the individual market, administrative expense decreased as a percentage of premiums because the modest increase in administrative costs was offset by a more substantial increase in premiums. This indicates that insurers were able to expand coverage efficiently in 2014.
Because both medical claims and administrative expenses increased more than premiums in 2014, health insurers’ overall operating profits (known as underwriting gain) diminished noticeably from previous years. This was especially pronounced in the individual market, where the 4.2 percent underwriting loss was three points greater than the underwriting loss two years earlier. Insurers overall showed a small profit margin in 2014 of 1 percent, aided by offsetting gains in the group market, but this was well less than half of the profit margin in prior years. This does not include any additional, nonoperating profits that insurers earned from investments, which are not reported in this brief.
Variability in Financial Performance
Some insurers fared much better than others in the individual market. Exhibit 3 divides credible insurers (i.e., those with more than 1,000 members) into three groups, based on quartiles of underwriting gains or losses.14 For each group (top quartile, bottom quartile, and median), Exhibit 3 shows the mean financial performance per member per month, weighted by enrollment.
The best-performing quartile of insurers in the individual market had an 8.5 percent profit margin overall in 2014, compared with a 21.8 percent loss by the worst-performing quartile. Net medical claims exceeded premiums by 5 percent for insurers in the bottom quartile, whereas in the top quartile, medical claims averaged 20 percent less than premiums. Clearly, one insurer’s experience does not reflect the others, or the industry, as a whole.
To further understand how the ACA affected insurers in its first full year, we grouped insurers according to whether their profit margins in the individual market increased or decreased from 2013 to 2014. Restricting the sample to credible insurers with primarily ACA-compliant membership resulted in a sample of 144 insurers across different states. Exhibit 4 indicates how many of these made profits both years, suffered losses both years, or switched between profit and loss.
Over a third of the total sample (53 insurers, groups 1 and 2) were profitable in 2014; these insurers accounted for 41 percent of the total members in this sample (data not shown). The remainder were either unprofitable both years or moved from profit to loss. Medical claims, rather than administrative costs, were the main driver of the negative financial experiences.
Insurers that turned profitable in 2014 (group 1) saw their medical costs decrease by almost 12 percentage points as a percentage of premium—that is, their MLR decreased. Coupled with a 1.4 point decline in the mean administrative cost ratio, these changes resulted in a substantial (13.2-point) rise in their overall profit margin to 7.6 percent, from a loss of 5.6 percent. In contrast, insurers that reported losses (groups 3 and 4) had substantially higher mean MLRs. Although they managed to reduce their administrative costs significantly, their MLR increased even more, producing a mean loss greater than 10 percent.
By subsidizing coverage, establishing insurance exchanges, and making insurance available to people with preexisting conditions, the ACA’s reforms changed market conditions in ways that insurers had difficulty predicting, at least initially. In 2014, the ACA’s reinsurance program offset much of insurers’ underestimated medical claims in the individual market. Also, despite overall losses in the individual market, the insurance industry as a whole earned modest operating profits (in addition to profits from investments).
Only some insurers fared especially poorly. One-quarter of insurers underestimated medical claims in the individual market to a much greater extent than the rest. A fifth of insurers in the individual market substantially improved their financial performance between 2013 and 2014.
All well-functioning markets have winners and losers, so it should be no surprise that some health insurers failed to succeed in the ACA’s reformed market, especially during the first year. As insurers gain greater experience with these new conditions, it can be expected that their actuarial precision will improve and that large differences in financial performance will diminish. Moreover, additional market stabilization can be expected as more previously insured people move out of grandfathered and transitional plans and into ACA-compliant coverage.
However, improved financial performance will require increased premiums, especially as the ACA’s reinsurance component phases out, starting in 2017. This reinsurance has played a crucial role in helping insurers transition. Because this has taken longer than initially expected, policymakers should consider extending the ACA’s reinsurance program until the reformed market has matured.