Stabilizing Forces

More than six years after its adoption and nearly three years since its insurance market reforms went into effect, the Affordable Care Act (ACA) remains intensely controversial in the United States. Although its achievements are undeniable—coverage of more than 20 million Americans and reduction of the level of uninsured to the lowest levels in history¹—the House of Representatives has voted to repeal it dozens of times, and the full Congress once, while scores of lawsuits have been filed challenging its provisions or implementation. Although premiums in the ACA marketplaces initially were set at lower rates than expected, premiums have grown rapidly in many markets, particularly for 2017, contributing to continued discontent.²

By contrast, Part D, the Medicare outpatient prescription drug benefit program, largely has been considered a success. Although its approach to covering prescription drugs was controversial at the time it was adopted by a Republican Congress, it quickly garnered bipartisan support. Congress has never voted to repeal Part D; in fact, a Democratic Congress expanded its coverage through the ACA. Part D premiums have remained largely stable, initially set at lower levels than expected and growing much more slowly than anticipated.

ACA Premium Stabilization Programs

Among the ACA’s most controversial provisions are those establishing its premium stabilization programs, the “3Rs”—risk adjustment, reinsurance and risk corridors. Each of these programs serves separate, although related, functions.³ The risk adjustment program collects assessments from insurers that enroll lower-risk individuals in the individual and small group markets, and transfers these funds to insurers that cover higher-risk individuals in those markets. Risk adjustment was intended to encourage insurers in the individual and small group markets to cover high-cost individuals, who often were excluded from coverage before the market reforms, and to discourage plans from engaging in risk selection to avoid these individuals.

The temporary reinsurance program, which is in place for the first three years of the market reforms (2014–2016), imposes per capita fees on group health plans and insurers in the individual and group market, and uses the funds raised through this fee to reinsure insurers that incur high-cost claims in the individual market. Like the risk adjustment program, it is intended to provide an incentive to insurers to enroll high-cost individuals. But it is also grounded in recognition that, in general, the ACA’s health insurance market reforms disproportionately will attract high-need individuals to the individual market in the early years of the reform, and it is intended to cushion the burden of these cases on insurers as the individual market stabilizes.

Finally, the temporary risk corridor program, also only in effect for the first three years of the market reforms, applies a statutory formula to collect funds from insurers that offer qualified health plans (QHPs) in the marketplace and enjoy excessively large profits, and to make payments to QHP insurers that suffer exceptionally large losses. The risk corridor program is intended to limit the risk faced by insurers that are willing to offer plans in the new and largely unknown guaranteed issue and modified community-rated individual marketplaces during the first three years of the program.

Controversies Surrounding the ACA Premium Stabilization Programs

Each ACA premium stabilization program has provoked controversy. The risk corridor program has been criticized as an insurer bailout and was crippled by legislation enacted by Congress in the program’s first year of operation that made the risk corridors revenue neutral. That is, the legislation limits program payouts to the amount collected from insurers.⁴ For 2014, the Department of Health and Human Services was only able to pay out 12.6 percent of the amount owed to insurers under the statutory formula because of this constraint. This in turn contributed to the insolvency of a number of insurers and has resulted in a number of lawsuits as insurers attempt to collect the full amount they claim they are due under the statute.

The reinsurance program, on the other hand, has been able to pay insurers the full amount owed under implementing regulations (indeed, at a higher coinsurance rate than initially projected), but only by directing the full amount of the fees collected under the ACA’s reinsurance provision to provide reinsurance and not paying out the full amount that also was supposed to be returned to the Treasury from program fees. This has provoked criticism from ACA opponents who claim the administration is robbing the Treasury by not making the repayment.⁵

Finally, the formula used by the risk adjustment program to redistribute funds has been criticized as favoring large, established insurers and penalizing smaller and newer insurers. Insurers who fared poorly under the risk adjustment program have filed a lawsuit challenging the risk adjustment formula. Insurers disfavored by the program also have appealed to state and federal regulators for relief.⁶

Medicare Prescription Drug Benefit Premium Stabilization Programs

Given the controversial nature of the ACA’s premium stabilization programs, it may surprise some that these programs were in fact modeled closely after premium stabilization programs that have been in effect for a decade under the Medicare Part D drug program. Medicare Part D, like the ACA, also has a risk adjustment program. Like the ACA’s risk adjustment program, the Part D program is based on the risk profile of enrollees, although the Part D program adjusts the premiums paid to insurers prospectively based on the projected risk scores of their enrollees rather than adjusting payments retrospectively based on their enrollees’ actual risk profiles.

Part D’s reinsurance program is much more generous than the reinsurance program established under the ACA. The program pays 80 percent of all covered costs incurred by an enrollee above a threshold amount $7,515 (in 2016).⁷ By contrast, the ACA program only covers, for 2015, 55.1 percent of claims costs exceeding $45,000 but less than $250,000.⁸ The ACA reinsurance program paid out $7.9 billion in 2015 for 2014 claims in its most generous year.⁹ This was less than a quarter of the estimated $32 billion paid out under the ACA for premium tax credit and cost-sharing expenditures for 2014.¹⁰ By contrast, the Part D reinsurance program paid out $31.2 billion in 2015 compared to $44.8 billion in direct, low-income, and retireesubsidies paid out by Part D.¹¹

For its first two years of operation, the Part D risk corridor program was more generous than the ACA program currently is.¹² A decade after it began, the Part D risk corridor program bears the same proportion of risk borne by the ACA program for plans that have exceptional losses, but the payments kick in when actual spending exceeds 5 percent of anticipated spending, as opposed to 3 percent under the temporary ACA program. Under the Part D program, however, Congress has not restricted payments to funds collected (although in every year since the program was adopted insurers have, for reasons I will explain, paid into the program rather than collected from it).

But the most remarkable feature of the Part D 3R programs is that they are permanent. Like the ACA’s premium stabilization programs, the Part D programs were intended to reduce and share the risk borne by insurers that were willing to enter a new market with unknown risks. While the ACA’s risk corridor and reinsurance programs will be eliminated after three years, the Part D programs have continued long after the risks of participating in the market have become quite knowable and manageable.

Moreover, the Part D programs have attracted very little controversy. No lawsuits have been filed over the Part D premium stabilization programs. Congress has never voted to repeal the Part D premium stabilization programs; in fact, the Part D premium stabilization programs rarely have been mentioned in congressional oversight hearings. The Part D reinsurance and risk corridor programs are not denounced as bailouts, even though they are just as, if not more, generous to insurers than the ACA programs. Year after year, the federal government has continued to subsidize private insurers through the Part D program with little controversy.

The Key Role of Premium Stabilization Programs and Subsidies in Part D

Although the Part D premium stabilization programs have not been controversial, they have played a major role in ensuring the success of the Part D program. Indeed, they have contributed much to the popularity of the program with insurers, enrollees and politicians. To understand why, one must understand how the Part D program works.

Each year, participating insurers submit bids for their Part D rates for the following year.¹³ These bids are based on each plan’s projected claims, administrative costs, and profits for the coverage year. Bids are based on enrollees of average health status. Bids do not include expected reinsurance payments.

Each month, the Centers for Medicare and Medicaid Services (CMS) pays Part D plans a prospective payment amount for each enrollee (the direct subsidy). The direct subsidy is a per enrollee amount based on a plan’s approved bid, which has been adjusted through the Part D risk adjustment program for the enrollee’s case mix. The payment amount is adjusted further to provide additional payments for low-income enrollees and for the long-term institutionalized status of enrollees.

Plan bid amounts are reduced by the premium amount paid by enrollees. Finally, CMS adds to direct subsidy prospective payment additional amounts for reinsurance covering 80 percent of costs greater than the catastrophic level. At the end of the year, CMS reconciles these prospective payments, taking into account actual levels of enrollment, risk factors, actual allowable drug costs, adjustments for rebates and other discounts, reinsurance, low-income subsidies, and risk corridor contributions or payments.

The premiums paid by Part D enrollees for prescription drug coverage consist of a “base premium” based on total national Part D per capita expenditures plus the difference between the amount bid by their plan and the national bid average, to which the charge for any benefits provided by the plan beyond those covered by Part D is added. The base premium is supposed to cover 25.5 percent of allowable program costs, with the federal government covering the remaining 74.5 percent. Part D premiums also are adjusted upward for higher-income enrollees. Most beneficiaries with incomes below 150 percent of the federal poverty level and with assets below specified levels do not need to pay a premium because the Medicare low-income subsidy (LIS) covers their premium up to a regional threshold amount, which is based on an enrollment-weighted average premium for each prescription drug plan region.

The Part D program is highly competitive. Enrollees have 19–29 Part D insurers from which to choose (plus, typically, nine Medicare Advantage plans with drug benefits).¹⁴ Insurers have a strong incentive, therefore, to keep their premiums low. By underestimating the cost of their high-cost enrollees in calculating their bids, insurers can lower their premiums.¹⁵ They can do so confidently, with the assurance that the reinsurance program will bail them out at the time of reconciliation if they incur high claims costs. By overestimating to some extent the cost of their enrollees with costs below the catastrophic level in their bids, insurers can increase their direct subsidy payments relative to their non-catastrophic coverage expenses, and thus their profits. Of course, if Part D insurers make too much from their premiums, direct subsidies and reinsurance payments relative to their claims costs, they may need to return some of their profits through the risk corridor program.

Part D reinsurance payments have dramatically increased in recent years, while premiums have grown more slowly. Moreover, a higher percentage of insurers over the years—78 percent in 2013—have paid into the risk corridor program from their excess profits.¹⁶ This data suggests Part D insurers are in fact actively manipulating the bidding process and the reinsurance and risk corridor programs to maximize profits and keep premiums low.

All of this is to say that the Part D premium stabilization programs have played a key role in allowing insurers to keep premiums low and profits high, even though insurers have had to return some of the profits to the program. Low premiums (and premium increases) and high profits have made the program popular both with consumers and insurers. The Part D 3Rs have thus supported the stability of the program, both politically and in terms of insurer participation.

ACA Premium Stabilization Programs and Subsidies: Less Generous and Phase Out Too Quickly

By contrast, although the ACA reinsurance program significantly reduced premiums in the first three years following the implementation of the market reforms, it was phased out quickly and will cease to exist as of 2017. The risk corridor program, which was supposed to stabilize premiums as insurers got their sea legs in the new market, was cut dramatically by Congress and also will be gone at the end of 2017. Whereas the Part D reinsurance and risk corridor programs have helped to reduce and stabilize premiums for almost a decade, the ACA premium stabilization programs hardly had a chance to do so before they were eliminated.

The Part D program also has remained affordable and popular because of the large subsidies the program enjoys. As already noted, federal subsidies cover 74.5 percent of program costs for individuals with incomes up to $85,000 and $170,000 for couples. This has made Part D affordable for almost all moderate and higher-income eligible enrollees.

The LIS offers free coverage to 12 million enrollees without cost sharing.¹⁷ Because this low-income population tends to suffer worse health problems than the general population and because both insurers and low-income consumers face reduced incentives to control drug spending for those who receive low-income subsidies eligible, low-income subsidy recipients, who make up about 30 percent of Part D enrollees, account for 37 percent of Part D spending.¹⁸

Although ACA subsidies also are quite generous for very low-income individuals (whose incomes exceed 100 percent of poverty, the lower-end cutoff), they phase out quickly and only reduce cost sharing for individuals with incomes below 250 percent of the poverty level and premiums for individuals with incomes below 400 percent of the poverty level. Individuals with incomes above these levels receive no help at all with their premiums or with their cost-sharing obligations. Many of them have remained uninsured.¹⁹

Lessons to be Learned

There is a clear lesson to be gained from our experience with Part D and the ACA. Reinsurance and risk adjustment programs can be designed to encourage insurers to cover high-cost individuals. Reinsurance programs can be designed to keep premiums—and premium increases—low. Risk corridor programs can be designed to reduce the risk of an insurer participating in a new market and to recapture excessive profits while cushioning excessive losses. Stable premiums and insurer participation—and generous subsidies—result in consumer satisfaction and political support. We know this because they have worked for Medicare Part D.

Of course, there are other reasons why Medicare Part D enjoys broader public and political support than the ACA. It is part of the popular Medicare program and primarily covers senior citizens, a politically engaged and active group. Its benefits are enjoyed broadly by all economic classes and are not focused primarily on the poor. It covers only a small subset of medical expenses, and thus is less costly than the broad coverage offered by the ACA. But in the end, Part D’s generous premium stabilization programs and subsidies explain much of its success, while the limits placed on the ACA 3Rs and subsidies undoubtedly have contributed to many of the program’s problems.