- - Tuesday, September 15, 2020

While Americans navigate the widespread social and economic disruption caused by the COVID-19 public health emergency, one thing is clear: Access to affordable health care is critical to mounting a meaningful national response.

Businesses across the country have laid off millions of American workers who relied on employer-sponsored health insurance to cover themselves and their families, and these newly-unemployed Americans are turning to their state’s individual insurance marketplaces. Now, more than ever, we must ensure that these markets remain stable and strong, and offer affordable options. 

One simple and important action the federal government can take to help consumers is to eliminate the opportunity for large insurance companies to game the Affordable Care Act’s (ACA) individual marketplace system. Unfortunately, big insurers have been able to use a little-known program call risk adjustment to harm smaller insurers and gain market power.

The formula underpinning the risk adjustment program includes a feature that insurance companies with high administrative costs may exploit to generate significant windfalls at the expense of more efficient companies. This harms consumers by reducing competition and raising premiums. The Centers for Medicare & Medicaid Services (CMS) has an opportunity to take a major step to correct this by reforming the risk adjustment program. 

The sheer impact of this relatively obscure program was recently documented in a paper written by Brian Blase, a former health economics adviser to President Trump. In his paper, Mr. Blase documents the “massive transfers” from most insurers offering ACA plans in the individual and small group markets to larger plans, often Blue Cross Blue Shield plans. According to Mr. Blase, “in 2018, these large companies reaped a windfall of $3.09 billion through risk adjustment, with $2.50 billion in individual market risk adjustment transfers and $0.60 billion in small group market risk adjustment transfers.”  

Risk adjustment is a poorly understood, but fundamental component, of the ACA’s convoluted design to ensure that insurers design products that appeal to both the healthy and the less healthy to promote a balanced risk pool. In addition to various “carrot and stick” incentives to induce healthy individuals to seek coverage on the ACA marketplace, the risk adjustment program requires that insurers covering relatively low-risk beneficiaries (the young and healthy) make payments to companies covering relatively high-risk individuals (older and less healthy patients). This is because the designers of the ACA were concerned that insurance companies might only attempt to avoid less healthy enrollees.   

Under ideal circumstances, insurers would be agnostic on enrollees’ health and instead compete on premium price and consumer benefits and services. However, in implementing the program, the Obama administration included a curious element in the risk adjustment formula in order to determine how much money insurance companies must pay one another: administrative costs. 

Rather than relying on medical claims data, which shows the actual costs incurred for medical expenses, the program multiplies a plan’s overall risk score by a premium amount that is too-easily distorted by high administrative costs. Insurance plans with higher administrative costs, therefore, will likely charge higher premiums, which in turn will improve their chances to receive transfer payments from insurers with lower administrative costs. 

Because the transfers are based, in part, on administrative costs unrelated to the actuarial risk, larger insurers that are receiving risk adjustment transfers lack incentives to reduce their often bloated administrative costs. Instead, under the current system, plans receiving risk adjustment transfers can be rewarded for their inefficiencies, and can be effectively subsidized for administrative costs over a certain level.

Smaller, more efficient, insurers are effectively subsidizing large plans for reasons that have nothing to do with the level of risk they incur. Moreover, transferring funds based on something other than actual risk undercuts insurers’ ability to balance a risk pool with younger, healthier members. It also has a secondary effect of incenting higher administrative costs and increasing premiums. 

The plain language of the ACA says nothing about using plan premiums – which invite the potential to over-inflate administrative costs – to determine risk transfers, yet, the CMS’ complex formula does exactly that. The CMS should instead follow the statutory language as it is written and use actual claims data in order to evaluate a plan’s actuarial risk in the risk adjustment program. Claims data, which captures an enrollee’s actual health care utilization, is the most accurate way to measure risk. 

The CMS can take meaningful steps to address this issue by adjusting the formula so that it is based on actual claims, not premiums. Adjusting the formula would be particularly timely as we face this time of unprecedented economic and health uncertainty. 

• Joe Grogan is a non-resident fellow at the USC Schaefer School of Public Policy, and was formerly assistant to President Trump for Domestic Policy. 

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