March 6, 2017

Risk Adjustment at Heart of “Incredibly Complex” Health Care Reform

Seth J. Chandler

Visiting Scholar
Summary

If the Trump Administration can't do a better job determining how much risk the insured really carry—while still rightly insisting that all Americans deserve a variety of affordable health insurance choices—then massive transfers funneled through the risk adjustment system will just create even more massive instability.

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President Donald Trump's core principles for health care include ensuring that Americans with pre-existing conditions have access to coverage, and that Americans should be able to purchase the health insurance plan they want, not one forced on them by the government. Each of these goals is laudable and achievable, taken separately. But President Trump and others are about to confront what others have learned the hard way: Achieving both goals simultaneously is extremely challenging.

Those attempting to implement the Affordable Care Act (ACA) have faced the dilemma under easier conditions and, even after years of trying, have not solved it. Unless President Trump's technocrats can fix something known as "risk adjustment" that has bedeviled the Obama administration, his dual principles cannot coexist.

The problem arises from the peculiarities of insurance markets. If insurance policies can vary greatly in their coverages and networks, people will tend to sort themselves into the coverages and networks that fit them best.

On the surface, this sounds great: Americans get the plans they want, not uniform plans put together by some government bureaucrat who knows best or is attempting to use insurance to achieve political goals. But in the unique case of insurance markets, there are adverse consequences.

With a great diversity of plans available, people who believe themselves to be high-risk usually purchase policies that have great coverages and broad networks. People who believe themselves to be low-risk usually purchase policies with lesser coverages and narrower networks. This separation means that the policies with great coverages are going to start to get really expensive, because they are full of higher-risk policyholders.

Neither Democrats nor Donald Trump want to let insurers charge people buying the same policy different rates based on their health conditions. And they don't want to let insurers impose pre-existing condition limits that would make the more generous policies less expensive for insurers to service. The result, under these constraints, is that only one group of people will buy the premium policies: People with really, really expensive medical conditions.  The price of these policies go up until they essentially no one can afford them.

In the end, almost everyone else would migrate to lesser policies, and we would end up with an unstable environment in which only policies with poor coverages and narrow networks are really able to survive. So, yes, insureds and insurers on paper have freedom to design policies that they actually want, but the market this freedom produces is fatally unstable.

This predicament might have dissuaded anyone from trying to preserve both insurance plan freedom of choice and prohibitions on underwriting. But the ACA’s sponsors remembered a complex concept used in some European insurance markets and, in a different way, in American Medicare: stop basing the amount an insurer receives for insuring a person on the amount that person pays.

In short, have the government funnel extra money to insurers covering those high-risk people. With this "risk adjustment," an insurer with generous policies doesn't have to raise prices and a stable market with diverse insurance policies can form.

But there is a second way to avoid instability: Don't let the separation between premium plans (purchased by the sick) and cheap plans (purchased by the healthy) form in the first place. To prevent risk adjustment from bearing too heavy a load, don't let insurers vary their policies too much in quality. That way, the separation of insureds won't be so bad.

The ACA attempted both. It sacrificed some flexibility in insurance plans to avoid too heavy a risk adjustment burden. Section 1302 of the law does not permit, for example, plans that cover 98 percent of medical expenses, or, on the other hand, plans that cover only 40 percent of expenses. Emergency policies that cost little but only protect someone when their health care expenses exceed, say, $20,000, are not allowed either.

Every plan must have "Essential Health Benefits." This means, for example, that insurers cannot attract low-risk 30-year-old men by selling a policy that fails to contain pregnancy/maternity benefits.

Even so, risk adjustment ends up paying some insurance companies a lot of money, which has to come from somewhere. It's a zero sum game: The ACA makes insurers who cover less risky individuals pay extra amounts into the system, and these costs are ultimately passed on to healthy insureds, or even born by those now priced out of the insurance market.

Despite the ACA’s mechanisms to keep risk adjustment under control, it has largely failed to do so. Often, its assessment doesn’t reflect actual medical risk. At other times, it appears to have exaggerated the differences in risk posed by individuals. As a result, risk adjustment has added its own element of instability to the market—particularly for smaller insurers.

Indeed, the practical failure of risk adjustment is partly responsible for the exit of insurers from the marketplace and the mess in which the ACA finds itself. Last year the Obama Administration made changes long requested by the insurance industry, but it may be too little too late. Many insurers have left town and more are likely to follow.

President Trump's experts will have an even harder job than did President Obama's. As more variation is permitted in insurance policies, and as the disparity in risk levels among insurance buyers increases, risk adjustment becomes more necessary and difficult.

If the Trump Administration can't do a better job determining how much risk the insured really carry—while still rightly insisting that all Americans deserve a variety of affordable health insurance choices—then massive transfers funneled through the risk adjustment system will just create even more massive instability.