The “Rs”: Understanding the Death Spiral in the Obamacare Exchanges

One month after the worst product launch in modern history (yes, worse than “New Coke”), the big question is: Will the federal government be able to rescue health insurers who will lose lots of money in the Obamacare exchanges?

At the beginning of the Obamacare negotiations, insurers recognized that their actuaries would have trouble pricing the policies in the exchanges, which opened for enrollment on October 1. So, the law included “three R’s” in order to backstop their risk. Two of the three “R’s” are critical to insurers’ ability to survive the exchanges through the end of 2016. Both of these persist only through the first three years of Obamacare, by the end of which they believed that risk in the exchanges will have stabilized.

The first “R” is reinsurance. Each year, Obamacare levies a special premium tax on all insurers (whether participating in exchanges or not) as well as self-insured (so-called ERISA) plans (in which employers bear the risk of medical costs and insurers or administrators only process claims). This tax revenue is supplemented by a little extra from the U.S. Treasury. In total, the reinsurance sums are: $12 billion for 2014, $8 billion for 2015, and $5 billion for 2016.  (Readers wishing more details, but still in laypersons’ language, are referred to this analysis by actuaries from the Wakely Consulting Group.)

For each of the three years, the U.S. Department of Health & Human Services (HHS) must publish a notice explaining how it will distribute this money. The notice must be published by the end of March the previous year. Last March, HHS issued its notice of payment parameters for 2014. The attachment point for reinsurance is $60,000, with a co-insurance rate of 80 percent, capped at $250,000.

For example, if a patient has medical claims of $200,000, the insurer will be compensated $112,000 [($200,000-$60,000) X 80%] by the reinsurance fund. If the patient has medical claims of $500,000, the insurer will claim the maximum of $152,000 [($250,000-$60,000) X 80%]. If reinsurance claims are greater than $12 billion, HHS will prorate the claims.

Of course, health insurers also have access to the commercial reinsurance market for claims above $250,000. Nevertheless, they priced their policies based on an anticipated smooth enrollment, not the fiasco we’ve seen so far.

The second “R” that operates for three years is “risk corridors”. This is an unlimited taxpayer liability that compensates insurers in the exchanges for medical costs in excess of 103 percent of the target costs for each plan. For costs between 103 percent and 108 percent of target, taxpayers compensate the insurers half the excess loss. For costs above 108 percent of target, taxpayers will compensate plans 2.5 percent of the target medical cost plus 80 percent of the excess over 108 percent.

So, while Congress put significant amounts of taxpayers’ money at risk to induce insurers to participate in the exchanges, it did not fully immunize them from getting creamed if they underpriced their policies.

After one month, there are signs that insurers got their pricing significantly wrong. Because it is so hard to enroll in the Obamacare exchanges, only the most persistent (that is, those who expect the highest medical claims) are wasting hours navigating the website to sign up.

The Wall Street Journal reported on November 4 that young people are avoiding the exchanges in droves (C. Weaver & T.W. Martin, “Young Avoid New Health Plans,” Wall Street Journal, November 4, 2013). Priority Health, a Michigan insurer, reported that the average age of new applicants is 51, versus 41 in the previous individual market.

It certainly looks like health insurers’ Obamacare exchange adventure will be very expensive. By 2015, they will likely be asking the federal government for a bailout. The Administration has no flexibility in this regard. Finally, the initiative will fall to the House of Representatives, which has pledged to repeal Obamacare. It will be an interesting negotiation.

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