Role of Reinsurance and Risk Adjustment in California’s Health Care Reform

1. Role of Reinsurance and Risk Adjustment inCalifornia’s Health Care Reform June 2008 William H. Dow, UC-Berkeley SPH Collaborators: Brent Fulton, UC-Berkeley Petris Center Kate Baicker, Harvard University Funding acknowledged from California Program on Access to Care

2. California’s 2007 Failed Health Insurance Reform Efforts • After year-long process: Governor and Democratic Assembly agreed on proposal, but Democratic Senate balked at cost. • Key features: • Employer pay-or-play mandate • “Pay” option to enroll employees in public pool. • Individual mandate • Subsidized public pool up to 400% FPL. • Hardship exemption if premium/income too high. • Non-group market reform • Adopt age-modified community rating + guaranteed issue.

3. CA Non-Group Market • Enrollees: • Now: ~2 million (vs. >6 million uninsured) • Under plan: some enrollees move to pool or employer insurance, some uninsured move to nongroup market • Community rating to address current concerns: • Equity/affordability: • 1% of market “uninsurable” (nationwide) • 12% applications rejected (AHIP, 2005) • 22% applications rated up (AHIP) • Efficiency: • Job-lock due to high premiums for chronically ill • Insurers compete not just on value, but on cream-skimming. Distortions such as excluding specialists from networks, poor coverage for chronic illness, etc.

4. Adverse Selection Concerns Under Non-Group Community Rating • If individual mandate is not binding, healthy may drop insurance, leading to adverse selection premium spiral. • Major insurer concern. • Compromise exemption: only ~100,000 persons might receive hardship exemptions from individual mandate, in market of ~2 million. Since small % of market, worst case scenario would yield only ~5% premium increase, so no spiral. • Exacerbated incentives for cream-skimming distortions. • Could lead to lack of “cadillac” plans for fear of attracting sick; higher deductibles than desired, poor networks, etc.

5. Expected Profit (or Loss) per Enrollee Under Community Rating, by Risk Group DRAFT - PRELIMINARY RESULTS Source: Based on 2003-2004 MEPS

6. Policies to Lessen Adverse Selection Under Community Rating • Regulate away cream-skimming: • e.g., require to sell 5 tiers of plans. But many distortions are not easily regulated; this regulation itself may be distortionary. • Put highest risks into state pool: • But if costs of high risks paid from general revenue, this decreases social risk pooling, by lowering premiums for healthy in nongroup market. • Social risk pooling could be maintained by partly paying cost of high risks in pool by taxing the nongroup market. But to determine size of tax, need to measure average risks in each market… e.g. by risk adjustment. • CA proposed: • Reinsurance • Risk adjustment

7. What is Reinsurance? • Reimburses insurer for a portion of the costs of the most expensive enrollees • E.g.: A common proposal would reinsure 75% of costs above the threshold for the top 1% of spenders. • The 1% threshold is $35k-50k. This group accounts for ~25% of health spending. • States that have public reinsurance programs include NY, AZ, CT, ID, MA, NH, NM.

8. Reinsurance rationale? • Mitigates dumping among top 1%. Doesn’t much help the other 20-30% who are high risks • In markets without community rating, it is a vehicle to help pool risks. • Vehicle for subsidizing premiums. But poorly targeted since not means tested. Not necessary for protecting insurance companies against risk: Private reinsurance already does that well.

9. Reinsurance Modeling • NHPF and others have argued that reinsurance would have little risk selection benefit. • We have estimated reinsurance effects on: • Decreased risk selection incentives • Premium reductions (subsidy) • Budgetary costs in CA

10. Methodology • Estimated models to predict 2004 expenditures using 2003 MEPS demographic characteristics and medical conditions • Used predictions to create four risk pools • Calculated reinsurance threshold levels using 2004 data • Calculated average subsidy for each risk pool based on actual expenditures • Subsidy amount was 75% of expenditures above reinsurance threshold

11. Expected Profit (or Loss) per Enrollee by Reinsurance Threshold and Risk Group DRAFT - PRELIMINARY RESULTS Source: Based on 2003-2004 MEPS

12. Budgetary Cost to Reinsure Non-Group Market in CA Source: 2003-2004 MEPS

13. Drawbacks of Typical Reinsurance • Still strong incentives to risk select. • Insurers have dulled cost containment incentives… for exactly the expensive cases we worry most about. • Large budgetary cost to lower premiums, inefficiently targeted by income. => But combining with diagnosis-based risk-adjustment could minimize these limitations.

14. Risk Adjustmentfor Stabilizing Risk Pools • Simple version: • Predict expenditure risk based on diagnoses: • Mr. Diabetic $5k and Mr. Healthy $1k => Average $3k • Compensate insurers for risk selection: • Insurer A only insures Mr. Healthy. • Insurer B specializes in diabetes and insures Mr. Diabetic. • Insurer A contributes $2k to risk stabilization pool, and the pool pays $2k to insurer B. • If risk adjustment is accurate: • Premiums: each charged same $3k (less tax-funded subsidies), same as with community rating. • Reduced cream-skimming incentives: Each enrollee equally profitable, so insurers compete on efficiency.

15. Risk Adjustment Ameliorates Reinsurance Drawbacks • Reinsurance: still strong incentives to risk select • Risk adjustment mitigates by rewarding insurers for taking on anyone above average risk, not just top 1%. • Reinsurance: insurers have dulled cost containment incentives. • Risk adjustment uses diagnosis-based measures, maybe from prior year, so less moral hazard. • Reinsurance: large budgetary cost to lower premiums, inefficiently targeted by income. • The risk adjustment mechanism can be used to proportionately assess insurers that cream skim the healthiest enrollees. (Potentially without any taxes.)

16. Hybrid Models are Already Being Successfully Used • Techniques have improved greatly for diagnosis-based risk-adjustment (e.g., hybrid ex-ante / ex-post). • Comprehensive review in van de Ven and Ellis (2000), much literature since then. • IS politically feasible: • Medicare Advantage, part D • State Medicaid HMO contracts • Internationally used (e.g., Netherlands) • Though challenges remain: • Complexity requires good governance, extensive data • Difficult balance to avoid moral hazard and care skimping • If tax subsidized, insurers can capture subsidies if they have market powe. Need guaranteed issue in public plans too?

17. Governor’s Proposal (October) • Phase-in community rating over 6 years: • 1st 3 years: +/- 20% rate bands on health • Next 3 years: +/- 10% rate bands on health • Immediate reinsurance mechanism to backstop market, phased out by year 7. • Develop risk adjustment mechanism to “normalize risk” across guarantee issue plans.

18. Next round of reform proposals:risk adjustment for other concerns too • Uninsured entering nongroup market may be sicker than average • Adverse selection of sicker employee groups into pay-or-play’s “pay” pool • Age-modified community rating leads to too high premiums for older groups

19. Adverse selection of uninsured into non-group market • Concern: • New nongroup entrants (now uninsured) may be unusually unhealthy. • It would be unfair to other non-group enrollees if this new group were only cross-subsidized by existing non-group enrollees. • Risk adjustment approach: • If risk adjustment data is collected for group markets and the public pool also, it can provide a metric for distributing costs across market pools • This would allow for more equitable risk pooling cross-subsidies across markets.

20. Employer adverse selection into pay-or-play pool • Firms opting into pool will have workforces that are sicker. Because: • “pay” amount is % payroll, independent of health and age; pool premiums are also not age-rated. • In contrast, small group private premiums may vary substantially by age and health. • So healthier small groups will pay for private insurance, thus diminishing risk pooling in small group market, and requiring increased public subsidies for the pool. • Potential solution: risk adjustment across pool and small group market. • Would allow healthier small groups to be “taxed” to cross-subsidize sicker small groups. Result would move net premiums back towards level with full risk pooling.

21. Age variation in premiums • CA proposed modified community rating, allowing different non-group premiums by age. • Keeps down premiums for younger enrollees. • But AARP concerned about high cost for older enrollees. • CA compromise: cap ratio of premiums for 60-64 relative to 30-34 age groups. But allows distorted age non-linearities, and problems from differential marketing/enrollment by age. • Risk adjustment approach: • Risk adjustment age-weights can be adjusted to more finely achieve desired age distribution of premiums.

22. Summary • California reform stakeholders worried about many forms of adverse selection. • Reinsurance was originally envisioned as a fix, but its effect may be limited. • By the end of reform negotiations, key actors embraced the concept of risk adjustment to stabilize the individual market under community rating. • Discussions now on-going about a broader role for risk adjustment in future reform proposals.