Thursday, October 10, 2013

Why insurance premia on the new exchanges are not comparable to existing policies

Are prices for health insurance on the new insurance exchanges lower than what was available before? A number of articles have suggested that prices are at least lower than expected -- see for example here and here.

What I have not seen noted anywhere is that the Affordable Care Act creates extensive loss-protection subsidies for insurers on the exchanges.  Because of these loss-protection measures, it is extremely difficult if not impossible to compare prices on the exchanges to prices that existed before.  

Indeed, if prices were not lower, it would be very surprising.   

There are three loss-protection measures for insurers offering policies on the exchanges; two are temporary (two years) and one is permanent.

The one that I think is most significant in regard to pricing is known as Risk Corridors.  Insurers compare their premium income less administrative cost to their actual claims payments.  If that difference is negative (claims exceed premiums less admin costs) the government (aka you and me) bears up to 80% of the loss.  Symmetry prevails, so the government will also tax any "excess" profits.

With problems of adverse selection and with expected stickiness of consumer choices, this policy has to induce lowball pricing for the two years that it will be in force.  Why not price low and lock in consumers?

The second major risk reduction policy for the exchanges is known as Reinsurance.  Insurers that have high-claim individuals will be eligible for reimbursement of losses.  Who pays for this?  Self-funded plans (again, aka you and me) pay a tax to fund this reinsurance scheme.  This policy also obviously encourages low prices for insurance policies while the reinsurance scheme is in effect.

The third risk reduction scheme is permanent and is known as Risk Adjustment.  Insurers compare the risk of their insured populations; insurers with higher risk individuals receive payments from insurers with lower risk individuals.  The technical details of this are very important and I expect some good careers for previous bankers who can figure out how to game the risk-adjustment formulae.  I agree that in principle risk adjustment is good, as it reduces the problem of adverse selection on the exchanges.  Also, this policy does not have any net inflow of government funds, so if the policy reduces prices on average there can be little argument that the policy is efficient.

Where else has anyone read about the risk reduction policies built into ACA and how those policies invalidate the debate over whether prices are lower on the exchanges relative to prior individual health insurance policies?

No comments: