• The ACA's risk mitigation mechanisms are reinsurance, risk adjustment and risk corridors

  • The ACA's risk mitigation mechanisms are necessary to stabilize the insurance market in 2014

Background

The 2010 Affordable Care Act (ACA) health reform law established state-based health insurance exchanges to provide an individual market for qualified health insurance plans. The state exchanges sell insurance plans to any citizen, regardless of health status. Enrollees who purchase plans through an exchange can receive federal premium subsidies if their household income falls between 100-400 percent of the federal poverty level. This primer provides an overview of the ACA’s risk mitigation provisions that apply to individual and/or small group market plans: reinsurance, risk corridors, and risk adjustment.

While the exchanges are implemented and administered by either the state or the federal government, the qualified health plans offered are sold by private insurance companies and designed to be in compliance with the ACA regulations. For insurers, offering a plan on the exchange is very different than offering a plan on the pre-ACA individual market or to a group purchaser such as a large company. For one, the issuer offering their first exchange plan in 2014 has no way of knowing the health status or previous claims history of the applicants; some exchange enrollees may have been uninsured for many years and have a long list of unmet medical needs. Secondly, the applicant must be charged the same premium as everyone else in their age band, and the oldest applicants cannot be charged more than 3 times the rate as the youngest. And finally insurance companies are selling a new insurance product, with newly mandated benefits, and limits on cost-sharing, but they have no control over how many, or how few, individuals enroll.

Issuers will price their products according to their best projections. However, for the reasons listed above uncertainty about risk pools is larger than for a mature market. In order to improve the incentives for insurers to participate, the ACA includes three risk spreading mechanisms: temporary reinsurance, temporary risk corridors, and permanent risk adjustment, all of which limit the amount an insurance company can lose on any plan. In order to fund reimbursement payments to insurers facing losses, the risk spreading mechanisms assess fees on all insurance plans and limit the amount an insurer can profit from any plan as well. These mechanisms allow insurance companies to price their 2014 products at a lower rate, as any significant losses will be partially offset by payments from the federal government.  

Reinsurance                                                                 

Reinsurance provides a safeguard against individuals classified as “high risk” in the first three years of the exchange, 2014-2016. All non-grandfathered plans on the individual market, both inside and outside the exchanges are eligible for reinsurance payments.[1] The legislative language leaves the determination of a high risk individual vague, noting that it could be based on diagnoses or another method. Through regulation, The Department of Health and Human Services (HHS) has determined that high risk will be based on the cost of actual medical claims. As of this writing the most recent proposed final rule (released in December, 2013) stated that the 2014 reinsurance provision would kick in when an enrollee reached medical costs of $45,000 (the so-called “attachment point”) which was adjusted downward from the previous proposed regulation of $60,000.[2] For 2015 the proposed reinsurance attachment point is $70,000.[3]

Once a plan enrollee’s medical claims top the attachment point of $45,000, the federal government will reimburse the plan for 80 percent of the claims costs beyond that limit. For example, if an enrollee incurred $55,000 of medical costs, the program would reimburse the plan for $8,000.

Reinsurance programs can be implemented by each state, using a non-profit entity to collect and distribute reinsurance funds. Or, states can defer implementation to the federal government.

The reinsurance program is funded through fees levied on all health insurance plans, including self-insured plans that may or may not be using a third-party administrator. The proposed rule released in 2013 would exempt self-insured plans not using third party benefits administrators from paying the fee in 2015 and 2016.[4] The reinsurance fee is statutorily required to equal a specific amount for reinsurance payments, a specific amount paid to the U.S. Treasury, and a variable amount for administrative expenses. Each insurer’s portion is calculated based on their enrollment. The reinsurance payments will total $10 billion in 2014, $6 billion in 2015 and $4 billion in 2016; additional payments to the U.S. Treasury will be $2 billion in 2014 and 2015 and drop to $1 billion in 2016. This translates to $63 per person in 2014 and $44 per person in 2015. The amount collected by the reinsurance fee is projected by The Congressional Budget Office (CBO) to cover the cost of reinsurance payments.

A CMS regulatory impact analysis estimates that the reinsurance protection allowed insurers to price their premiums 10-15 percent lower than what prices would have been otherwise.[5]

Table 1: Reinsurance Program Funds Collected 2014-2016

Year

Reinsurance Payments

Payments to the US Treasury

Administrative Expenses

Per-Enrollee Cost Levied on Each Insurer*

2014

$10 Billion

$2 Billion

Variable

$63/ per person (HHS Estimate)

2015

$6 Billion

$2 Billion

Variable

$44/ per person (HHS Estimate)

2016

$4 Billion

$1 Billion

Variable

$26.25 Buck Consultants Estimate[6]

*All self insured plans would contribute in 2014, the latest proposed rule exempts self-insured plans that do not use a third party administrator from the reinsurance fee in 2015 and 2016.

Risk Corridor

The risk corridor program is similar to reinsurance in that it is a temporary program from 2014-2016 that redistributes funds from insurers to stabilize the insurance market and the payments are distributed based on the insurers’ actual costs. Unlike the reinsurance payments, the risk corridors apply to qualified small group health plans in addition to the individual market. This mechanism requires that each plan issuer calculate, for each specific plan[7], their allowable costs as well as a target amount. Allowable costs include claims and money spent on quality improvement and the target costs include premiums collected minus a limited percentage of administrative costs.

Allowable Costs = Medical Claims + Quality Improvement Costs

Target= Premiums Collected – Administrative Costs

Risk Corridor Score= Allowable Costs / Target

If the costs are below 97 percent of the target, the insurance issuer presumably made a profit on that plan, and must share a portion of that profit with HHS. If the costs are above 103 percent of the target amount, the insurance issuer presumably took a loss on the plan, and HHS will cover some of that loss.

When a plan’s costs are 92-97 percent, or 103-108 percent of the allowable amount 50 percent of the plan’s gain or loss is shared with HHS. If the costs are below 92 percent of above 108 percent, 20 percent of that gain or loss is shared.

Because the target costs and allowable costs are calculated via a specific formula, with caps on the administrative expenses, the risk corridor calculation is not necessarily reflective of the plan’s true profit or loss; a ratio of 100 percent does not mean the plan broke even. CBO projects that the receipts from plans whose score falls below 97 percent will equal outlays to plans whose score is above 103 percent.

Risk Adjustment

The risk adjustment provision in the ACA applies to both the individual and small group insurance market (both on and off the exchanges), but unlike the previously described two mechanisms, will be permanent. Like the reinsurance provision, states can operate their own risk adjustment, using either their exchange or another entity, or defer to HHS. Beginning in 2014, HHS, the exchanges, or contracted risk adjustment entity will assess the actuarial risk of the insurance pool within each plan and compare it to the average actuarial risk of all plans in the state, including the large group plans. The provision works similarly to risk corridors and reinsurance as funds are transferred from plans attracting a lower-risk pool of enrollees to plans with a higher risk pool and are operated in each state. However, it is important to note this is the only risk mitigation strategy that is determined by enrollee projections, not actual costs incurred by the plans.

Although the details of how each state will conduct their risk assessment program is not yet available, it can be assumed that if a state’s average risk score is set at 1.00, than plans whose enrollees average out to be over 1.00 will receive risk adjustment payments and plans with enrollees averaging below 1.00 will have to pay into the program.

The risk adjustment provision can be implemented and administered either by the state or by HHS. However states that are operating their own risk adjustment must either use the federal methodology or develop the method of adjustment in accordance with HHS.[8] Like the previous two mechanisms, risk adjustment is also assumed by CBO to be budget neutral.

Table 2: Overview of the Reinsurance, Risk Corridors and Risk Adjustment Provision

Program

Established by

Administered

Time Span

Costs Involved

Plans Paying In:

Protects Against

Reinsurance, PPACA Section 1341

State or Federal

Third Party entity, required to be a non-profit.

2014-2016

2014: $10 billion ($12b including admin costs) 2015: $6 billion ($8b including admin costs) 2016: $4 billion ($5b including admin costs)

All health plans, third party administers for self-insured plans

Having “high risk individuals.” HHS definition: over $45k in claims

Risk Corridors, PPACA Section 1342

Secretary of HHS

Secretary of HHS

2014-2016

Per CBO Score: funds coming in will equal funds paid

Qualified health plans in the individual and small group market

Costs exceeding 103 % of premiums minus administrative costs

Risk Adjustment, PPACA Section 1343

States who established exchanges, Federal runs the others

States who established exchanges, Federal runs the others (but methods for all are developed by HHS Secretary)

2014 and beyond

Per CBO Score: funds coming in will equal funds paid out

All health plans on the individual and small group market

High risk pool of enrollees, relative to average actuarial pool of all plans (including large group) in the state

 

Budgetary Impact

The Congressional Budget Office (CBO) originally projected these provisions to be budget neutral. In their most recent Budget Outlook report in February 2014 CBO estimated net receipts of 8 billion over the 2014-2023 budget window. 

Despite CBO projections, there is a concern that more plans may need payment from the risk mitigation provisions and, as a result, the amount paid out to plans will exceed the amount paid into the programs. If more plans than projected enroll higher-risk pools of individuals and there are not enough plans with lower than anticipated costs, then the reinsurance and risk corridor payments would have to be paid from general revenue. The administration’s decision to allow reinstatement of 2013 plans, plans that would have otherwise been cancelled, may limit the number of healthy people signing up on the exchanges and make the new exchange pools disproportionately sicker. However, the recent announcement that state-based high risk pools will continue through the exchanges’ open enrollment period until March 31st (effectively keeping some of the sickest potential exchange enrollees on other plans for the first quarter of the year) will have the opposite effect on the risk pools and overall 2014 medical claims.

In addition, it is worth noting that the provisions keeping premiums lower will also reduce federal spending on the exchange subsidies. In the absence of the risk mechanisms, higher health insurance premiums would result in more households qualifying for subsidies and increased cost for those who are subsidized. So while it is possible that payments may need to come from general revenue to make up any funding deficits, repealing these provisions would not to be budget neutral.

History of Risk-Mitigation Provisions

The ACA’s exchanges are not the first federal entitlement program to use risk-spreading mechanisms to protect participating health insurance issuers. When the Medicare Part D drug benefit launched in 2006 participating insurers were pricing plans with a high degree of uncertainty. Similar to the exchange environment, plans did not know who would enroll and what their prescription drug needs would be. From 2006-2011 risk corridors were used and the Centers for Medicare and Medicaid Services shared in gains or losses outside that corridor.[10] Currently, the subsidies paid to Part D plans are risk adjusted based on patient characteristics, and no additional risk spreading exists.[11]  

Other programs like Medicaid Managed Care and Medicare Advantage also use risk adjustment to determine payments from the entitlement program to the private insurance plans, but these calculations are based on the risk projections of the population, rather than actual costs incurred.

Conclusion

The ACA brings a tremendous amount of uncertainty to the private insurance market. The risk spreading provisions were designed to stabilize the individual and small group market and allow companies to compete on the exchanges without excessive risk. Certainly entering the new market is not without risk; the reinsurance and risk corridors only partially reimburse plans for their costs above specific points. In 2015, health policy researchers will know whether these mechanisms were budget neutral, as is projected, or whether taxpayer funded general revenue was needed to make up excessive losses sustained by the insurers in the first year of exchange implementation.



[2] http://www.cms.gov/CCIIO/Resources/Fact-Sheets-and-FAQs/proposed-2015-payment-notice.html

[3] http://www.cms.gov/CCIIO/Resources/Fact-Sheets-and-FAQs/proposed-2015-payment-notice.html

[4] http://www.cms.gov/CCIIO/Resources/Fact-Sheets-and-FAQs/proposed-2015-payment-notice.html

[5] http://www.cms.gov/CCIIO/Resources/Files/Downloads/hie3r-ria-032012.pdf

[6] http://www.buckconsultants.com/portals/0/publications/fyi/2012/fyi-2012-1206-Transitional-reinsurance-program-results-in-new-costs.pdf

[7] The Robert Wood Johnson Foundation’s “Analysis of HHS Final Rules On Reinsurance, Risk Corridors And Risk Adjustment.” Released April, 2012 specifies that risk corridors will be calculated on a plan-specific level rather than looking at the insurer’s entire book of business in each state. (http://www.rwjf.org/content/dam/farm/reports/issue_briefs/2012/rwjf72568). The Health Affairs Blog also notes that it will be done at the plan benefit level (http://healthaffairs.org/blog/2012/03/16/implementing-health-reform-the-reinsurnace-risk-adjustment-and-risk-corridor-final-rule/). However, CMS documents use plan and insurance issuer interchangeably when referring to risk corridor calculations. (http://www.cms.gov/cciio/resources/files/downloads/3rs-final-rule.pdf)

[10] http://content.healthaffairs.org/content/28/1/215.full

[11] http://content.healthaffairs.org/content/28/1/215.full