The Insider: The Boogeyman Under the Bed: Adverse Selection in the ACA and other Dysfunctional Fantasies

  ·  Health Policy Hub   ·   Michael Miller

I kept thinking I wouldn't have to write this blog because people would figure out that all the hand wringing about adverse selection in the Marketplaces was just a tempest in a teapot. The press has been so bad on this that even estimable Kaiser Health News (KHN) wrote, "Getting enough young adults to sign up for coverage is critical to keeping the marketplaces financially viable by subsidizing the older and sicker people who are gaining coverage because insurers can no longer turn people away for pre-existing illnesses or charge them higher rates. If too many sick people buy insurance, it could lead to higher rates in future years that could eventually compromise the market." Shortly after the Kaiser Family Foundation (KHN’s patron organization) released a report showing fears of a death spiral were greatly exaggerated.

I guess the key word here is “eventually.” We are years away from needing to worry about this, but even if enrollment of young adults is only half of what was originally anticipated, the Kaiser Foundation study shows that the impact on premiums will only amount to a couple of percentage points. Hardly a disaster.

The light does seem to be slowly breaking on the mainstream media (not that I expect any mea culpas any time soon from all the reporters who hyped this story line). For example, a recent Washington Post editorial says, "Failing to reach that goal [40 percent of enrollees between the ages of 18-34] could — but is not guaranteed to — encourage insurance companies to raise premiums next year, deterring even more healthy people from signing up. " (Emphasis added.) Progress of a sort, I suppose.

As tempting as it would be to lay the blame for perpetuating this misleading narrative on bad reporting or (even better) on the critics of the ACA, the truth is proponents bear much of the blame. In particular, the palpable anxiety of the White House concerning the composition of the Marketplace risk pools has only served to validate the perception that we have a problem (or might have a problem if some magic number of young invincibles don’t sign up for coverage right away). This has led not only to bad press coverage, but also to bad policy decisions that have harmed the ACA and may have done lasting damage to the President’s credibility.

The source of all of this angst is the misapplication of what we know about how unreformed insurance markets operate in the radically different environment post-ACA. Let’s start by looking at how things worked in the bad old days and then look at how the ACA changes things to prevent an insurance death spiral.

Old rules of the game

The way insurance worked prior to the ACA, if you started a new insurance pool that attracted initial high risk participants it would be, in all probability, doomed. The high initial price would discourage healthier people from enrolling in year two. Insurer expectations that future enrollees would be sicker than average would prompt them to raise premiums higher still. The result: a continuous self-reinforcing cycle of bad expectations leading to bad results, leading to still more bad expectations. In other words, a death spiral.

New rules of the game

Fortunately, for many reasons, this sad story bears no resemblance to life under the ACA. Let’s take a look at why.

It’s the tax credits, stupid

At this point, it appears that about 80 percent of Marketplace enrollees are coming in with a subsidy. That means that what they pay is totally a function of their income, not the underlying risk pool. Whether the other insureds are all age 28 and healthy or age 62 and sickly makes no difference to what I will pay if my income is under 400 percent Federal Poverty Level.

Past performance is not an indication of future results

As we said, under old rules a bad start likely means a short unhappy life to the new pool. But under the ACA, things are completely different. The key is no new enrollees can enroll in non-ACA compliant plans. Once the old plans are closed to new enrollees, they will die a natural death because every year there will be fewer enrollees and those enrollees will be sicker. Over time, this will erase the incentive to remain outside the Marketplace insurance pool. With other options foreclosed, future incoming Marketplace enrollees will include the healthy as well as the sick. In other words, under the new rules bad risk in year one means better risk is coming in year two.

It's the penalties, stupid

Part of what drives that healthier risk into the market is that that the penalty for being uninsured goes up over time. Starting at the greater of $95 or 1 percent of income above the tax filing threshold in year one, and increasing to 2.5 percent of income by 2016. As the penalties become more substantial, so too does the incentive to enroll.

The American Action Forum’s recently released study showing that the majority of young people will get back less in benefits than they pay out in premiums and cost sharing, is irrelevant. It indicates only that either they don’t understand how insurance works or they are hoping that other people don’t. In the world according to the AAF, if you pay premiums and don't file a claim that is more than the premiums you pay in, you are a “loser”. Someone needs to tell these guys it's not like the lottery. You have insurance to cover you in case something bad happens. If you never file a claim, that makes you a winner (and very lucky). The AAF study just shows that young people are less likely than older people to have significant health claims (let’s see, how do I spell “duh”). I’m sure the Koch brothers will be happy to pay the health claims for those young people who gamble on going bare and get stuck with a catastrophic bill.

Built in stabilizers: Comes with training wheels

But wait, there’s more. The ACA contains provisions to help stabilize the new insurance market as it gets off the ground. These include a reinsurance mechanism to limit insurers liability for any individual enrollee and a “risk corridor” to protect insurers against substantial losses if they under-estimated the health needs of their enrollees as a whole. In any likely scenario, the risk corridor limits insurers losses to a quarter of what they would otherwise be while, according to a recent Milliman study, the reinsurance provision in particular makes it more profitable for health plans to enroll older adults than younger ones.

Rate regulation

It is possible that insurers might respond to higher than expected health claims in year one by baking an unreasonably high trend factor into their year two rates. That is where regulators (and consumer advocates) have to be vigilant. But because the built-in stabilizers will attenuate any losses and because they are competing for market share, insurers will be reluctant to jack up rates in year two. What if regulators don’t do their job? The minimum Medical Loss Ratio will force insurers to pay rebates if they overestimate claims trend.

The dog that didn’t bark

Here is the real kicker—the whole adverse selection story line is based on the assumption that insurers made the same enrollment assumptions about the risk pool in year one that White House did, but there is actually no evidence I know of that they did. In fact, the opposite appears to be true. I haven't seen any stories about insurers sharing their actuarial assumptions and comparing them to enrollment data, and I don’t expect to. At this early stage, any such comparison would be totally meaningless, but don't hold your breath for that story after open enrollment closes either.

While pundits and politicians fret, the insurers are remaining quite calm about enrollment and selection. The CEO of Wellpoint describes himself as cautiously optimistic while the CEO of Aetna recently said the demographics are looking better than he expected. Maybe this is because they are comfortable that they made a reasonably accurate bet on first year demographics, or maybe it is because they anticipate doing well on older adults per the Milliman study. But, in any event, the fact that insurers are not squawking should tell you something.

Recap: Much ado about (literally) nothing

So, even if initial selection is not all that some have hoped for, there will be no impact on the 80 percent who are subsidized; the increasing penalties, natural turnover and deteriorating risk pool in the closed books will sweep in the others over time. Also, the built-in stabilizers and insurers’ desire to retain market share (and not pay rebates) will keep premiums from spiking while the kinks are worked out over a period of the next several years.  

The damage done

Now for the bad news. Fear of adverse selection is what seems to have driven administration policy on the kind of chintzy grandfathering provision that led to many plan cancellations. While I think Politifact went way overboard in calling it the “lie of the year”, certainly the public had no idea of all the asterisks that were attached to “if you like your plan you can keep it.” The administration made it unnecessarily difficult for plans to keep their grandfather status because they wanted those healthy enrollees in the new Marketplace right away. That in turn led to the whole plan cancellation debacle (which of course was made much worse by the massive tech fail).

Even though the website is working much better now and a lot of people who got cancellation notices are able to find alternative, and often better and cheaper, coverage, the whole thing left a bad taste in the public's mouth. That could influence political races down the line that could turn on the public’s perception of the ACA.

So what now?

Unfortunately, we don't get a do over. The main thing we can do, in addition to working to helping implement the ACA as best we can and tell the story of its successes, is to fire back hard whenever someone raises the red herring of death spiral. There’s no shortage of ammunition.