Wednesday, October 30, 2013

How PPACA's Risk Adjustment, Reinsurance, and Risk Corridors Could Melt Down the Federal Budget

This is from Megan McArdle writing at Bloomberg

[T]here are deep-in-the-weeds protections baked into the Affordable Care Act: risk adjustment, reinsurance, and risk corridors.

These programs -- collectively called the “three Rs” -- aid insurers if they wind up enrolling a population that is sicker and more expensive than projected. They do a crucial bit of policy work: we want plans competing on efficiency and quality, not their ability to attract the healthiest patients.
The programs have related functions, but risk corridors will play the biggest role if the individual mandate does get delayed. Their entire purpose is to stabilize premiums during the first three years of Obamacare, when it’s especially difficult for insurers to price plans.

Here’s how it works: exchange plans (QHPs) projected how much their risk pool would cost overall in 2014, their “target” cost. If they’ve significantly miscalculated -- or, say, if a mandate delay causes adverse selection that they couldn’t have predicted -- HHS will take action:

"The risk corridor mechanism compares the total allowable medical costs for each QHP (excluding non-medical or administrative costs) to those projected or targeted by the QHP. If the actual allowable costs are less than 97 percent of the QHP’s target amount, a percentage of these savings will be remitted to HHS (limiting gain). Similarly if the actual allowable cost is more than 103 percent of the QHP’s target amount, a percentage of the difference will be paid back to the QHP (limiting loss)."

Total transfer depends on how badly the insurer miscalculated:

Basically, today’s worst-case scenario is that takes months to fix and the mandate is delayed until 2015, resulting in widespread adverse selection. Insurers wouldn’t recoup all losses, but the risk corridor program provides their bottom line with a substantial buffer. Importantly, it doesn’t need to be budget neutral; if the math demands it, the government can pay out more than it collects through the program. This could be expensive -- the CBO scored the health law as though risk corridors were budget neutral -- but it could also be offset by foregone subsidies.

I don’t find this reassuring. These mechanisms were not put in place to prevent a death spiral, and they aren’t designed to do that. Rather, they were put in place to prevent an entirely different problem: insurers trying to cherry-pick healthy people out of the pool (by, say, offering a policy that comes with a free gym membership). The idea is that there’s a huge tax on excess profits -- and a subsidy for losses -- so that it doesn’t make sense to expend a lot of energy trying to get a better patient mix. 

...The Affordable Care Act’s insurance market reforms have created a system prone to what Charles Perrow dubbed “Normal Accidents.” By "normal," he didn’t mean “minor” -- the lead exhibit was Three Mile Island. Rather, he meant something like “hard to avoid.” The system is both complex and tightly coupled: All the pieces are interdependent, so a failure in one part is apt to cascade throughout the market. This is not a system where you want to start pulling out one piece to see how well the rest can get along without it.

The administration clearly understood this -- right up to the point where a major component failed. Now it's apparently planning to keep the reactor running with as many pieces as possible in the hopes that none of it will unexpectedly blow up. This is not sound policy thinking, or even sound political thinking, and I think that all of us who care about keeping insurance available for ordinary Americans should try to talk them out of it -- for their good, as well as our own. ...