"We can't really subsidize a marketplace that doesn't appear at the moment to be sustaining itself" —Stephen Hemsley, CEO, United Healthcare
It's a commonplace in American business that the difference between a brilliant statement and a stupid one usually depends on who is saying it. When Steve Hemsley asked his C-Suite crew why it looked like United Healthcare would be losing half a billion dollars on Obamacare in two years, I doubt anybody said "Gee, boss. I guess the marketplace must not be sustaining itself." Or if someone did, they're certainly not working there anymore.
Although the major insurers did not have to worry about many of the structural things I discussed in the first article, they did worry—a lot—about the overall riskiness of the population that Obamacare would bring into the market. They were very worried about this because they were partially responsible for creating it. Obamacare was designed to address the so-called "individual market" made up of people who for one reason or another had to buy insurance directly from insurance companies for themselves and their families rather than obtaining it through an employer. For decades, insurance companies had been denying most of these people coverage or looking for ways to get them off the rolls for existing or pre-existing conditions. Only the very healthiest could get and keep this insurance (and it was very, very expensive). The rest were, by definitions created by the insurance companies themselves, all high risk, although no one knew exactly how high.
The designers of Obamacare (and this includes people from both the Left and the Right who had input into it) were preoccupied and, I will argue, distracted by this risk. So they built into Obamacare risk control devices that came to be known as The 3 R's. These were reinsurance, risk adjustment, and risk corridors.
Reinsurance was very straightforward. Reinsurance is also known as catastrophic insurance is a special kind of insurance that insurance companies themselves purchase to cover the high end of the most expensive claims. Obamacare reinsurance was funded by an assessment on all the of the commercially insured in the United States, including those in large and self funded groups who did not have access to the benefits of the program itself. There was an expectation at the beginning that the people that would become members via Obamacare would be sicker and perhaps much sicker than the population at large. It was thought that these people, having previously been uninsured, had probably not been getting treatment for illnesses which had over time become severe and expensive to treat. The plan was to pay out the reinsurance at 100 percent of what the statute covered. If there were so many sick people that it developed that the program was underfunded, it would pay out some percentage of the 100 percent, depending on how much money was raised.
As it happened, despite expectations, the payout was not only at 100 percent, but there were additional unspent funds that were rollled over into the next year. There are several reasons for this, but an important one is that people were not quite as seriously sick as expected. Please note this for later in the discussion.
Risk adjustment was also straightforward, although it turned out to have a fatal unanticipated flaw. The risk that it meant to address was that some insurers for whatever reason, might attract a disproportionate number of the sicker people in the pool of applicants. So the Federal government built its own software (The Edge Server) to aggregate all claims from all insurance companies in each state and calculate a statewide average risk score. It would then compare the average score for the state to the actual scores of each insurance company. The idea assumed naturally, that the insurance companies that had fewer sick patients would pay out less in claims and would do better financially. So the Feds would reallocate money from these companies to the ones who had more than their share of sick people in order to create a totally level playing field. This program would fund itself and would not require any outside Federal funding, since it simply transferred funds from one entity to another.
But in order for this simple thing to work, several very complicated things had to happen perfectly. First, the Feds had to build their Edge Server from scratch perfectly and on time. Second, the Edge Server had to interface perfectly with all of the different insurance companies' claims systems which also had to be perfectly integrated with their other internal systems as described in the last article. Finally, the output (risk scores) from the Federal server had to be available to the insurance companies so they could use it to make their vital pricing decisions for the following year.
This is important. In my first article, I said that an insurance company needs to know its average provider discount in order to determine its premium prices. But an insurance company also has to know something about how its members use the providers, because the discounts must also be weighted by how they are being used. If insurance companies don't know this, they are likely to misprice their insurance. If they are risk adverse, they will price it too high and will not be able to sell it. If they are optimistic, they will price it too low and while they will pick up a lot of members, the premiums will not cover claims costs and they will lose money.
At the beginning of Obamacare, no one had any utilization data at all, of course. They did to a greater or lesser degree have their own general discount data, and the established insurance companies had their own utilization data from their current membership in other products. But no one knew how to price for the Obamacare membership. So in general, they made the best guess they could given their business objectives. The most common business objective was to try to break even (and this was true even for the large insurers) while picking up as many members as they could. The most sophisticated insurance company out there, United Healthcare, decided to more or less opt out of Obamacare for its first year. Its thinking was that there would be a large backlog of people needed medical services and that this backlog would work through the system in the first year. This backlog would also likely break the backs of many of their competitors (especially the Co-Ops) and then United could come in the second year when the market had "stabilized." United did play in a couple of markets in the first year where they felt they could try things out and gain some direct information about the Obamacare population without taking on too much risk.
But they didn't get enough good information to price their product properly. No one did. And in the end, the risk adjustment numbers from the Feds came out late, too late to be used in pricing, which made things worse. Insurance companies have to form their prices and submit them to State regulatory agencies before the end of the first half of the year for the following year. This is why Steve Hemsley can confidently say that United will lose another quarter of a billion dollars in 2016.
What did the companies miss about the utilization? People continue to use more services than expected. The first year did not clear the high demand. There is also some evidence that Obamacare users are going to the higher priced (i.e. lower discount) providers in higher than average numbers. A reason for this might be that having had no insurance for years and therefore having had to pay for their medical services in cash, they became better "shoppers" than average insured members who didn't have to think about medical services in the same way. There is also some evidence that shows that the monopolization that is going on with insurance companies is also going on with providers as well. Larger richer providers are acquiring the smaller poorer ones. And the larger richer ones tend to have the lowest discounts with the insurance companies. When they acquire a smaller cheaper hospital (for example) they typically apply their more expensive contracts to it. This is happening now.
The reaction of the insurance companies has been consistent between the old school commercial ones and the start-ups. The insurance companies are narrowing their networks (to try to exclude the more expensive providers as much as possible) and are changing their product lines to eliminate the ones that may be providing incentives for people to use more services. They are also increasing co-pays and co-insurance as much as they can get away with. And in many cases, they are blaming it on Obamacare because, why not?
The third R of the three R's, which has been getting a lot of play in the media, is not, I believe, very important. This R was the Risk Corridor. The risk corridor calculation is a bit complicated and I won't reproduce it here, but the general idea was to cap profits and put a floor on losses. If an insurance company went above a certain stated profit percentage, it had to surrender this money to the Treasury. In theory, this money would then be reallocated to companies that made serious pricing mistakes in order to reduce their losses. While there was occasional lose talk at the beginning that this would be a revenue neutral exercise, with the winners being able to offset the losers, in fact the program was never properly funded. The insurance companies knew very early on that not many companies were going to exceed the profit ceiling and that excess profits would not be a source of funding for the many losers. As the Nashco Conference in Washington DC in February of 2015, (Nashco being the Co-Op's general organization), the talk among the CFOs was that almost no one was expecting much if any risk corridor money. However, in November of 2014 and again explicitly at the conference in Washington (via a presentation from a top actuarial firm) CMS told the world that there would be a 100 percent payout. No one believed it at the time, including the actuary actually making the presentation, but as time went on and the Co-Ops began to realize that they were in bad shape, it became a hoped for Hail Mary pass that Congress would somehow find money to fund the program. It didn't, of course. So the public whining began by the damaged and destroyed Co-Ops. However, it should be remembered that even had the risk corridor money been fully paid out, it would not have gotten the companies to break even levels. It was not designed to do that. The detractors of the risk corridor see it as a simple bail out, which it was. Some also think that its mere existence provided an incentive for insurers to underprice their insurance knowing that the bail out was coming. This I can tell you was not true. Not because there weren't people who would have liked to do it, but that in order to do it, the various insurance companies would have had to know far more about their risk, discount levels, and patient utilization then they in fact ever did or could have.
Now what's the point of this rather sound thrashing I have given to the Co-Ops and insurance companies?
We start with a number of things that Obamacare did produce that were excellent and which are not going away. This includes the covering of pre-existing conditions and a standard group of basic treatments that have to be part of any insurance plan. We have to hold onto these. But we also have to fix the system. Obamacare was the latest attempt to take a crack at this and as you can see it has had problems for everyone. But I believe that in order to advance and to fix things; to really discuss the practical options, we have to see how things actually worked or didn't work. So I have tried to lay down a base for the last article. What to do. You may find my base too simple if you are an insurance expert and it is true that I even left out other issues that have to be dealt with. But I want to set here a common ground.