Obamacare's Risk Corridors Won't Be A 'Bailout' Of Insurers

2013 was abysmal for Obamacare. The federal exchange website had a botched rollout, to put it mildly, and enrollment was a fraction of what the administration expected for 2013. The first month of 2014 isn’t looking great either. Young Invincibles" – the 18 to 34-year old group often thought to be critical to Obamacare’s success comprised only 24 percent of the 2.2 million enrollees. Yet this group makes up over 40 percent of the nation’s uninsured population. While health status is certainly more important to the law’s success than age distribution (insurers want healthy 40-year olds as well because they pay higher premiums but might not use as much health services), an unbalanced age distribution will increase premiums (as well as the likelihood of a death-spiral) by as much as 3.5 percent in the worst-case scenario.

Given the state of the law thus far, conservatives are certainly justified in pointing its failures. But criticism should be reserved for the parts of the law that truly are broken – adjusted community rating, expansive minimum benefit requirements, and mandates that penalize full-time work. One part of the law that’s come under fire recently are the risk corridors" – which are essentially a system of profit/loss sharing to help balance risk between insurers for the first three years of the law. Conservative opposition is based on the belief that these risk corridors will lead to a bailout" of insurance companies. Indeed, a bill sponsored by Senator Marco Rubio would completely repeal the provision. However, this not only distracts from the bigger issues facing Obamacare, but it also makes it difficult for conservatives to offer a replacement plan of their own.

What are risk corridors?

To understand what risk corridors actually are, it’s best to ask the guys who actually price insurance plans. Three Milliman actuaries explained it this way in 2013:

Under this program, if an insurer’s allowable costs" are 103 percent of their target amount," the government shares these losses with insurers 50/50 up to 108 percent – after that, the insurer is responsible only for 20 percent of the losses. The reverse applies if an insurer has lower costs, and thus higher profits. The symmetrical" nature of the program makes it look budget neutral (and CBO has scored it as such). This is unlikely however, especially given the skewed enrollment numbers. In fact, it is reasonable to think that on balance, the program will be a net subsidy" to insurers.

The main reason the program exists is because insurers generally have less experience in how to accurately price policies in the individual market than the group market, and have virtually no experience pricing policies for the new demographics under Obamacare. Risk corridors serve as a bridge over troubled waters," as the Milliman actuaries point out – they help smooth some of the uncertainties that come with pricing plans under a new regulatory landscape.

Are risk corridors a taxpayer-funded bailout?

Because of the risk corridors’ uncapped nature, conservative commentators and analysts have begun railing against the provision. Ramesh Ponnuru at Bloomberg View writes:

Certainly, the program’s uncapped nature is problematic from a fiscal standpoint. Insurers have likely underpriced their policies on the exchanges with the understanding that risk corridors (as well as transitional reinsurance and risk adjustment) would help mitigate some of their losses. If this is true across most plans, then there will be a net outlay to insurers. And to fiscal hawks, this most definitely smells like a bailout.

But this criticism misses several important points.

For starters, risk corridors are temporary. They are slated to run through 2016, and terminate by 2017. So at most, we’re looking at three years of payments to insurers. And while it might be tempting to underprice plans all three years, doing so would result in a significant spike in premiums for 2017, which would make it more difficult to attract new customers.

Second, Medicare’s successful prescription drug coverage program (Part D) also uses risk corridors – and if the most recent trustees report is to believed (see Table IV.B11), Part D’s risk corridors are far from a bailout for insurers. (An important note here is that Part D uses back-door" risk adjustment for its plans – that is, its premiums are community-rated, meaning everyone pays the same premium regardless of age or health status, but plans are reimbursed on a risk-adjusted basis.)

But perhaps the most important point here is this: any conservative reform plan for universal coverage will have to use similar methods of risk adjustment. The point here is simple – if you want insurers to participate more broadly in the individual market, you’ll need to offer a carrot to offset the unavoidable uncertainties. And railing against risk corridors now will make them a hard sell further down the road. Risk adjustment mechanisms get you the buy-in of insurers, but they also helps keep premiums at manageable levels while insurers develop enough experience to properly price plans on their own. This helps encourage people to enroll in these plans, which in turn helps insurers develop the necessary pricing experience – resulting in a virtuous cycle.

Better ways

Conservatives don’t have to simply sit idly by, however. Fiscally-minded politicians could help mitigate the size of risk-sharing payments by working to deregulate Obamacare’s exchanges – decompressing the age-rating bands and repealing many of the benefit requirements, for instance, would help lower premiums, and make it easier to price policies under the law, leading to less uncertainty. Simply put, fewer regulations mean fewer risk-sharing payments.

Moreover, it is important to remember that the size of a potential bailout" under Obamacare is likely small relative to the massive subsidy given to employers to provide health insurance – over $250 billion annually. While reducing the employer tax exclusion might be more disruptive than repealing risk corridors, it isn’t accurate to call what will likely be a relatively small subsidy a bailout," while ignoring a tax expenditure that amounts to 7.1 percent of the federal budget. Chipping away at our unique system of employer-sponsored insurance would also likely increase the size of the individual market, further helping to stabilize premiums (by virtue of having more enrollees off of which to base experience).

While Obamacare undoubtedly adds to our growing entitlement spending, the law is far from a bailout" of insurers. There are more important changes that conservatives should focus on than repealing the risk corridors, especially when these changes can form the foundation of a conservative health reform plan.

This piece originally appeared in Forbes

This piece originally appeared in Forbes