How The Affordable Care Act’s Risk Adjustment, Reinsurance, and Risk Corridor Provisions Protect Consumers

Lately, the media have been covering three provisions—risk adjustment, reinsurance, and risk corridors—that were created by the Affordable Care Act. The new health law’s opponents have been highly critical of these provisions (risk corridors in particular), characterizing them as federal bailouts to insurance companies. Also known as the “three Rs,” these provisions allow insurance companies to manage the financial risk that they incurred when the Affordable Care Act prevented insurers from denying coverage or charging higher premiums to individuals with pre-existing conditions. Collectively, the “three Rs” seek to balance out the risk that sicker individuals bring to the insurance market as a whole. The provisions do this by redistributing funds from insurance groups (pools) that have healthier enrollees to those that have sicker individuals. And they limit significantly high profits—or losses—incurred by insurers.

Why do the “three Rs” programs exist?

Because health insurers must now accept people who are in less-than-perfect health, insurers are raising legitimate questions about how high or low to set premiums rates: should insurers set high rates, in case they end up with sicker-than-average enrollees? Or should they set low rates, hoping that healthier individuals will enroll? The first few years of the Affordable Care Act have been the hardest for insurers, as they can’t rely on past experience to help them determine rates that now include groups of individuals who may be in poor health. The “three Rs” help to balance the risks among insurance companies so that monthly premiums stay at reasonable rates.

The “three Rs” provisions also help to guarantee that insurance companies do not try to “cherry pick” by trying to attract healthier enrollees and discouraging less healthy applicants to join a plan. Reputable and competitive insurers make money by efficiently providing needed coverage. However, less reputable insurers may choose to advertise only in neighborhoods where young people are more likely to live, or on websites that young people tend to visit. These insurers may offer a gym membership as part of covered services (an attractive benefit for younger people), but then charge higher copays for certain drugs or services (those that someone in worse health might need). Some insurers also omit specialists who might tend to serve older or sicker patients (for example, geriatric specialists or oncologists) from their provider network.

The February 2014 Congressional Budget Office’s federal budget and economic outlook update reaffirmed that the “three Rs” programs taken together are not “insurance company bailouts,” but actually help to reduce the federal budget deficit while helping lower premiums for consumers.

What are the “three Rs”?

Risk adjustment 

• How it works: Risk adjustment collects funds from insurers in the health insurance markets that cover healthier people and redistributes those funds to plans that have sicker enrollees
• Plans that benefit: All non-grandfathered plans in the individual and small group markets in and outside the new state marketplaces
• Funding mechanism: Collects and redistributes funds from insurers in these markets that cover healthier people with plans that have sicker enrollees
• Sunset date: None
• Cost to the federal government: Zero

Reinsurance

• How it works: Reinsurance funds are collected from individual, small and large group, and self-funded employer plans, and then redistributed to insurers in the individual market to help cover the costs of enrollees with high insurance claims.
• Plans that benefit: All non-grandfathered plans in the individual market in and outside the new state marketplaces
• Funding mechanism: $63 annual fee per enrollee collected from individual, small group, large group, and self-funded employer plans (in 2015 the proposed fee is $44)
• Sunset date: 2014-2016—designed to stabilize new market during a period of transition
• Cost to the federal government: Zero

Risk corridors

• How it works: Risk corridors limit insurance plans’ unexpectedly high profits or significant losses.
• Plans that benefit: Individual and small group qualified health plans (QHPs) that are sold in the new state marketplaces (and may also be sold outside the marketplaces)
• Funding mechanism: Insurers set monthly premiums based on a predicted amount of claims. If claims are lower than predicted, the insurers reimburse the federal government. If the claims are higher, the federal government reimburses insurers for some of the money
• Sunset date: 2014-2016—designed to help insurers who have no past years of claims experience when setting monthly premiums
• Cost to the federal government: The Congressional Budget Office (CB0) estimatesthat over the three years of the program, the federal government will take in approximately $16 billion from insurers who guessed wrong and over-estimated claims but only pay out $8 billion to those with higher claims than expected in the new marketplaces. Thus, the CBO estimates that repealing the provision would increase the federal deficit by $8 billion dollars. No one should label this program an “insurance company bailout.” (See pages 114-115 of the report.)

Why are the “three Rs” important for consumers?

Insurance is supposed to be about spreading the risk among people of unpredictable and costly health problems. It’s also about spreading the cost of serious health problems over a person’s lifetime (you pay for insurance when you are young and healthy so that it’s there when you need it as you grow older or sicker).

The “three Rs” work together to distribute or balance risks fairly across insurance companies so that those that end up with healthier enrollees help those that end up with sicker enrollees. It helps to keep insurance companies focused on a good product rather than a “good enrollee.” And it makes the insurance market work properly.

Opponents have particularly argued against the risk corridors. Yet ironically, many of those critics supported a similar permanent program in the Medicare Part D drug benefit law to give insurers confidence to enter a new market. The basic concept then and now is that a new insurance market is unpredictable, and therefore insurance companies tend to set monthly premiums higher to cover themselves from expenses that may or may not occur.

With the Affordable Care Act, the individual market has been transformed into a new and better functioning market—one in which pre-existing condition discrimination is prohibited, and in which new, robust premium subsidies are available to many people. Since insurers don’t really know who will enroll or how sick they will be in these new marketplaces, the risk corridors give them confidence to participate and offer lower monthly premiums in the first couple years of the Affordable Care Act’s implementation, until they have more claims experience.

An October 2013 Health Section article by The Society of Actuaries (the experts who set premiums at insurance companies) explained the need for risk corridors this way:

“….Unless you have a vintage DeLorean (with time machine capability), you were likely intimidated by the amount of uncertainty in your pricing assumptions [for quality health plans in the new individual markets]…. [the risk corridor program] provides a strong incentive for issuers to participate in the health insurance exchanges set up by the Affordable Care Act….[and] provides an incentive for issuers to manage their administrative costs optimally.”

Translation: the risk corridor program is about making health insurers operate efficiently and keeping monthly premiums low for people in a consumer-friendly, albeit very new, marketplace of individual insurance.