The “3 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: Reinsurance, risk corridors, and risk adjustment. Two of these 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 amount 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 4th that young people are avoiding the exchanges in droves (C. Weaver & T.W. Martin, “Young Avoid New Health Plans,” Wall Street Journal, November 4th, 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 bail out. 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.

Comments (19)

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  1. Jackson says:

    “yes, worse than New Coke”

    Surely not THAT bad.

  2. Billy says:

    “there are signs that insurers got their pricing significantly wrong.”

    The government was wrong?! Say it isn’t so!

  3. Wilbur says:

    It all sounds like an enormous Ponzi scheme.

  4. Mark says:

    “So, while Congress put significant amount 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.”

    Damned if you do, damned if you don’t. Immunize them and they screw around, keep them vulnerable and they can’t sustain themselves.

  5. Perry says:

    If I didn’t dislike the cold so much I’d consider moving to Canada.

  6. John Fembup says:

    Urgent message for Ron Williams. Ron Williams? Please call Kathleen Sebelius for further instructions. Over.

  7. Jardinero1 says:

    There can only be a death spiral if people actually obtain coverage. There is more than a remote chance that the carriers will enroll so few that what losses they suffer, in year one, will be very small in the aggregate. I believe that all bets are off for year two.

  8. Jack Towarnicky says:

    I guess I don’t understand the adverse selection concern.

    We know those who have/anticipate significant medical expense and who do not have access to coverage from another source will enroll in the public exchanges – whether or not they qualify for taxpayer financial support. And, we know that the only other folks who are likely to enroll (once the rates spike because of adverse selection), are those who qualify for taxpayer subsidies. That is, almost everyone who enrolls will be those whose contributions ARE NOT a function of the cost of coverage, but whose contributions ARE based on their income (who typically never see/experience the adverse selection).

    So, in the aggregate, would taxpayers (as a group) be better off or worse off if there were fewer individuals participating in the exchanges who received taxpayer subsidized coverage?

    • John R. Graham says:

      I don’t want to disagree strongly, because this thing is so confused we can’t really predict what will happen.

      However, the young and healthy who remain uninsured currently (by definition) have a premium of zero. Therefore, any subsidy (tax credit) that does not cover 100 percent of their Obamacare premiums will be more expensive than they used to pay. So, there is a risk that they will still not sign up.

      Yes, many will qualify for “free” (zero premium) Obamacare policies. But they are not “free” to the beneficiary if he has to spend four hours a day for ten weeks signing up for the policy!

      And, the main point of my article is that if the people do sign up for subsidized plans, that makes the problem of selection that we are seeing worse. It doesn’t matter how much the subsidy is if the total premium is $100 and the costs are $130. The insurers still need a bailout. And it’s not all there under PPACA.

  9. Trixie says:

    Now that the Obama Administration has exempted unions from the Reinsurance “tax”, the fund numbers/formulas will likely have to be modified.

  10. Bob Hertz says:

    I sense that after about 2 years of the ACA, we will be right back to where we were in 2008……

    i.e. that about 4 million persons need a high risk pool, and another 15 million need Medicaid.

    I was saying back in 2008 or so that if we would dedicate $80 billon to high risk pools and $80 billion to Medicaid, that would have been better than the massive regulations of the ACA.

    Still true.

    Bob Hertz, The Health Care Crusade

  11. Craig Graham says:

    As a history major from my college days, I cannot help thinking how this entire healthcare dilemma coupled with this new ACA Obamacare ressembles the last desperate gambles of the parade of Roman ’emporers’ just prior to the Fall of the Empire in 476. Many of these ‘Roman’ emporers promised the people of Rome ‘bread and wine on every table’. Our president claims that if we like or current insurance and doctors we can keep them. Anyone see the parallels? Perhaps this healthcare quandary will not only be a record failure but perhaps, just perhaps, coupled with all the other financial and geo-political challenges the US is facing . . . it could be a catalyst for even greater disasters to come? I certainly hope not but one must admit that true leadership does not seem to e rising to the surface. With President Clinton’s recent comment and the state of the Republican leadership, if there is any . . . could this trigger a major change or even end our two party system?