Risk Corridors

What's the issue?

In addition to creating health insurance Marketplaces (exchanges) and premium subsidies to make insurance more affordable, the Affordable Care Act (ACA) completely changed the way insurance is priced and sold in the individual market. As of 2014, insurers (both those participating in the exchanges and those selling on the individual market outside the exchanges) face a number of new restrictions.

Insurers must accept every applicant, regardless of health status or preexisting condition(s), and cannot charge more for customers based on their medical history, a process known as medical underwriting. Insurers are limited in how much they can vary premiums based on age and tobacco use. Insurers cannot charge women more than men for a comparable policy and must spend at least 80 percent of premiums on medical claims, known as the minimum medical loss ratio requirement. (Age, sex, tobacco use, and previous medical claims are highly predictive of future medical expenses and were routinely used by insurers to set premiums or reject applicants.)

Beyond the restrictions on how insurers treat applicants and set premiums, there was a great deal of uncertainty regarding who would purchase health insurance through the exchanges. A significant number of people buying an exchange plan may have been previously uninsured, some of whom may have untreated medical needs or chronic conditions requiring expensive immediate or ongoing medical care. Insurers do not have good data on the health status and medical costs of the uninsured. This uncertainty made it difficult for insurers to set their premiums and may discourage insurers from participating in exchanges.

If insurers set premiums too low, they may not have enough money to cover their enrollees' medical expenses and could become insolvent or would need to increase premiums substantially the following year to reflect new assumptions of a prospectively higher-cost risk pool, potentially losing market share. If they set premiums too high, insurers may find themselves at a competitive disadvantage compared to other insurers offering policies in the Marketplaces. (They may also be required to provide consumers with rebates or lower future premiums if they do not meet the 80 percent medical loss ratio described above.)

With the new restrictions on premium setting and the unpredictability of medical expenses from the newly insured, insurers faced a high level of uncertainty when setting their premiums. To buffer insurers from high losses in the initial years, keep premiums affordable, encourage insurers to participate in the exchanges, and minimize year-to-year premium fluctuations, the ACA authorized three premium stabilization programs: risk adjustment, reinsurance, and risk corridors.

At the time the ACA was passed, risk corridors were noncontroversial. Risk corridors were included in the now popular 2003 law establishing coverage of prescription drugs through Medicare Part D; at that time, they were implemented with little fanfare. So it is perhaps surprising that risk corridors have proven to be a lightning rod for critics of the ACA. Critics claim that risk corridors amount to an insurer bailout. This issue was highlighted when the administration allowed some noncompliant policies to be renewed following outcries over cancelled policies. If people who renew noncompliant policies are healthier on average than those who purchase insurance through the exchanges, risk corridor payments could be higher than initially projected.

What's the background?

Risk adjustment, reinsurance, and risk corridors (known collectively as the "three Rs") help keep premiums stable by providing a buffer for insurers whose enrollees are sicker than average, insurers that have enrollees with catastrophic medical expenses, and insurers that have not adequately priced their plans. Together the programs discourage insurers from avoiding unhealthy risks, encourage insurers to participate in the market and increase competition, and protect against inaccurate rate setting based on a lack of information on new enrollees.

Risk adjustment is a way of paying insurers based on their enrollees' predicted medical costs, which are estimated using various risk factors known to be associated with medical claims. Insurers that enroll a disproportionate share of high-risk people receive payment transfers from insurers with relatively low-risk people. Reinsurance partially compensates insurers when enrollees experience high medical costs due to a catastrophic illness or accident.

Under risk corridors, the government reduces insurers' risk by partially offsetting high losses and sharing in large profits. Risk corridors are based on how allowable costs compare with a target amount. Insurers whose ratio of allowable costs relative to the target amount is too high, meaning their premiums did not cover all their claims, will receive partial reimbursement for those losses. Insurers whose ratios are too low, meaning their premiums were much more than was needed to cover their expenses, will be charged an amount to partially offset their profits. By eliminating some of the pricing uncertainty associated with a new program and new population, risk corridors are intended to encourage insurers' participation in the new market.

What's in the law?

Section 1342 of the ACA requires the Department of Health and Human Services (HHS) to set up a temporary risk corridor program to help reduce pricing uncertainty in the new health insurance exchanges. The risk corridor program is for plan years 2014-16. Combined with the other premium stabilization programs, it encourages insurers to participate in the exchanges by eliminating some of the unpredictability of newly insured enrollees.

The risk corridor program compares allowable costs to a target amount (see Exhibit 1). The target amount is equal to the premium charged after administrative costs are subtracted. Allowable administrative costs include taxes and regulatory fees, administrative costs, and profit. Allowable costs are the same as those used in the medical loss ratio calculation and include medical claims, quality improvement efforts, and health information technology. In addition, payments and charges from the risk adjustment and reinsurance programs are included in the risk corridor calculation to adjust the allowed costs and/or target amount.

Exhibit 1
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The law specifies that insurers that have a ratio of allowable costs to the target amount that is within 3 percentage points in either direction (97-103 percent) will keep all of their profits and be responsible for all of their losses. Insurers with actual costs between 92 percent and 97 percent of the target amount would pay HHS half of their gains within that range, while insurers with costs between 103 percent and 108 percent would be reimbursed half of their losses within that range. Insurers with actual spending below 92 percent of the target amount would refund the federal government 80 percent of those gains within that range.

Conversely, insurers with actual spending above 108 percent would be reimbursed 80 percent of those losses within that range by the government. While the risk corridors are symmetric, the ACA does not require the program to be budget neutral. As a whole, if the market suffers from adverse selection and premiums are inadequate, more payments will go out than are collected. On the other hand, if the market is priced too high, the government will receive more payments than it will spend on reimbursements (see discussion under "What's the debate?" on budget neutrality).

The amount insurers pay to the government for higher-than-expected gains and the reimbursements insurers receive for higher-than-expected losses are cumulative. For example, if the target amount was $500, but an insurer had actual spending of $550, its ratio would be 110 percent. The insurer would receive no reimbursement for the first $15 of loss, 50 percent for its losses between 103 percent and 108 percent, and 80 percent for expenses over 108 percent, for a total reimbursement of $20.50 (see Exhibit 2).

Exhibit 2
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Much of the detail of the risk corridor program was not in the ACA and was left to regulation. In March of 2012, 2013, and 2014, HHS issued regulations implementing risk corridors, and in May 2014, it finalized regulations implementing the 2015 and 2016 risk corridors. Additional policy guidance has been provided through several frequently asked questions fact sheets. The risk corridor program has evolved somewhat since the March 2012 regulations, both arising from and resulting in concerns from both political opponents and insurers (see "What's the debate?").

What's The Debate?

PREMIUM STABILIZATION OR INSURER BAILOUT?: The risk corridor program has proven to be one of the more controversial aspects of the ACA with critics, including a number of Republicans in Congress, characterizing the program as an insurer bailout. They argue that as a result of HHS and state officials putting pressure on insurers to keep premiums low in the exchanges, the federal government will end up picking up the tab to bail out insurers if they underpriced.

Critics also claim that the program encourages insurers to underprice their plans in order to gain market share, knowing the government will offset their losses. As noted in Exhibit 2, however, the risk corridor program does not reimburse all of an insurer's losses (or recapture all of an insurer's gains). An insurer would have its loss reduced under the above scenario but would still lose money. It is worth noting that the medical loss ratio requirement also limits insurer profits but does not limit their losses.

In fact, risk corridors have broad support from economists, health policy experts, insurance companies, and regulators. The ACA risk corridor was modeled after a similar program in Medicare Part D signed by President George W. Bush. The risk corridors in Medicare Part D began with the program in 2006 and are still in effect, with the amount of risk held by plans increasing over time. During this period the federal government has collected more money than it paid throughout the program.

In the first year about 80 percent of insurers made payments back to Medicare, and only 20 percent of insurers received money, according to a report from the HHS Office of Inspector General. Based on the Medicare Part D experience, the Congressional Budget Office (CBO) at one point projected $8 billion in revenue from risk corridors. When HHS subsequently stated the intention to implement risk corridors in a budget neutral way, CBO eliminated its revenue projection from the risk corridor program.

The decision by HHS to enforce budget neutrality in the risk corridor program was disconcerting to insurers because of the possibility that receipts in a given year would not be sufficient to cover risk corridor payments. HHS first raised the aim of budget neutrality in the 2015 proposed rule and expanded on it in policy guidance issued through a series of frequently asked questions (FAQs). In the FAQs, HHS said it anticipated that receipts from insurers would be sufficient to fully make all payments due under risk corridors, but if they were not, all payments would be reduced on a pro rata basis. Any shortfalls would first be made whole the following year using receipts from insurers before making that year's payments. Any receipts in excess of those needed would be held in the event of a shortfall in future years.

In the final regulations released in May 2014, responding to concerns from insurers that a potential shortfall in risk corridor payments introduces additional uncertainty in their rate setting, HHS clarified that the ACA requires full risk corridor payments to be made, regardless of any shortfall, and says that it will find other sources of funding for risk corridor payments, subject to the availability of appropriations. Given the current political environment around the ACA, and risk corridors in particular, noting that other sources of funding are subject to "available appropriations" may do little to assuage the concerns of insurers.

THE MONEY TRAIL: There is some question as to the source for payments made to insurers under the risk corridor program and how collections received from insurers can be used. Logically, it makes sense that collections made under risk corridors from high-profit insurers would be used to reimburse insurers with high losses. As mentioned previously, under Medicare Part D collections in the first years of the program were more than enough to offset requests for reimbursement. This type of "revolving fund" would allow HHS to deposit receipts into a fund, rather than the Treasury, and use the money to make payments required under the risk corridor program.

A memo from the Congressional Research Service (CRS) to the House Energy and Commerce Committee questions whether HHS has the authority to operate a revolving fund under the ACA. The CRS memo states that any collections from the risk corridor program would go to the general Treasury and would not be available to distribute to other insurers without additional legislative authority. CRS's interpretation is that a revolving fund must be created statutorily, and although the ACA authorizes HHS to make risk corridor payments, it does not specify a source of funding. As a result, CRS claims an appropriation is needed before risk corridor payments can be made to insurers or additional legislative authority given to HHS to create a revolving fund.

In response to questions from the Government Accountability Office (GAO) on its budget authority for risk corridor payments, HHS cites section 1342 of the ACA, which establishes the payment methodology and requires HHS to collect payments from and make payments to certain qualified health plans. HHS says that the fees collected and the payments made under the risk corridor program are consistent with the definition of user fees. The 2014 appropriation gives the Centers for Medicare and Medicaid Services (CMS) the authority to collect user fees and keep the fees available for use through the 2019 fiscal year. HHS states that this appropriation along with section 1342 gives CMS the authority to collect and distribute risk corridor payments.

THE DEVIL IS IN THE DETAILS: HHS has proposed a number of changes to the risk corridor program over time. As a result of the public outcry over cancelled policies, the Obama administration changed course and let insurers renew--at states' discretion--previously cancelled policies that were not ACA-complaint. It is likely that the people who took advantage of this option are healthier than average, and by renewing their policies, they stayed out of the exchange risk pool.

Taking into account these potential changes to the risk pool, HHS increased the profit margin floor from 3 percent to 5 percent and increased the allowable administrative costs from 20 percent to 22 percent. For 2014 these adjustments are available only in states that allowed insurers to renew otherwise noncompliant plans. For 2015 and 2016 these changes to the profit margin floor and allowable administrative costs were adopted for all plans in all states.

There are several justifications for making these changes in all states. First, the phase-out of the preexisting condition insurance plan (PCIP) has been extended several times, giving insurers little data from these high-cost enrollees on which to base their 2015 premiums. Originally, the federal PCIP (as well as many state-based high-risk pools) was scheduled to terminate on December 31, 2013, because insurers would no longer be able to impose preexisting condition exclusions or use medical underwriting to set premiums, and people in the PCIP would be able to shop for new policies on the exchanges. Because healthcare.gov was not functional for much of the first few months of open enrollment, during the time in which people would need to choose a plan in order for coverage to begin on January 1, 2014, the PCIP phase-out was delayed, and the program finally terminated on April 30, 2014. Plans must submit their rates this summer, giving plans limited claims data from people previously enrolled in the PCIP.

In addition, the six-month open enrollment period for 2014 gives plans fewer months of claims data on which to base their 2015 rates. Finally, there is uncertainty and additional administrative expense associated with estimating the number of people in plans eligible for reinsurance. Increasing both the profit margin floor and the allowable administrative expenses will result in a more expensive program than under the original rules.

What's next?

As a controversial topic among Republicans, the risk corridor program will be a likely target for elimination. In fact, bills have been introduced in both chambers of Congress to eliminate the program. The opinion by CRS that the program requires an appropriation in order to make payments to plans is concerning in this political environment. Rep. Fred Upton (R-MI), chair of the House Energy and Commerce Committee, and Sen. Jeff Sessions (R-AL), ranking member of the Senate Budget Committee, sent a letter to HHS Secretary Sylvia Burwell asking about her authority to distribute risk corridor payments. Secretary Burwell referred them to the letter HHS sent to the GAO on user fees, but Rep. Upton and Sen. Sessions reject the characterization of risk corridor payments as user fees. It is clear that this issue is unresolved.

The changes to the risk corridor program may have an effect on insurers' decisions to participate in the exchanges and their ability to set premiums. Insurers must factor into their rates the possibility that the risk corridor program could incur a shortfall and payments may not be fully made in a given year. This would weaken the protection of the risk corridor program.

Resources

American Academy of Actuaries. "Fact Sheet: ACA Risk-Sharing Mechanisms: The 3Rs (Risk Adjustment, Risk Corridors, and Reinsurance) Explained." 2013.

Centers for Medicare and Medicaid Services. "Patient Protection and Affordable Care Act: Exchange and Insurance Market Standards for 2015 and Beyond." May 16, 2014.

Congressional Research Service. "Funding of Risk Corridor Program under ACA §1342." Memorandum to House Energy and Commerce Committee, January 23, 2014.

Department of Health and Human Services, Office of Inspector General. "Medicare Part D Sponsors: Estimated Reconciliation Amounts for 2006." October 2007.

Department of Health and Human Services. "Patient Protection and Affordable Care Act: HHS Notice of Benefit and Payment Parameters for 2014 and Amendments to HHS Notice of Benefit and Payment Parameters for 2014; Final Rule." Federal Register 78, no. 47, (March 11, 2013).

Department of Health and Human Services. "Patient Protection and Affordable Care Act: HHS Notice of Benefit and Payment Parameters for 2015; Final Rule." Federal Register, 79, no. 47, (March 11, 2014).

Department of Health and Human Services. "Patient Protection and Affordable Care Act: Standards Related to Reinsurance, Risk Corridors, and Risk Adjustment; Final Rule." Federal Register 77, no. 57, (March 23, 2012).

Kaiser Family Foundation. "Explaining Health Care Reform: Risk Adjustment, Reinsurance, and Risk Corridors." January 22, 2014.

Doug Norris, Mary van der Heijde, and Hans Leida. "Risk Corridors under the Affordable Care Act--Bridge Over Troubled Waters, but the Devil's in the Details." Health Watch 73, (October 2013).

William B. Schultz, General Counsel. Letter to Julia C. Matta, Assistant General Counsel for Appropriations Law, U.S. Government Accountability Office. Department of Health and Human Services, May 20, 2014.

About Health Policy Briefs

Written by
Sarah Goodell
Health Policy Consultant

Editorial review by
Cori Uccello
Senior Health Fellow
American Academy of Actuaries

Erin Trish
Schaeffer Center for Health Policy and Economics
University of Southern California

Rob Lott
Deputy Editor
Health Affairs

Tracy Gnadinger
Assistant Editor
Health Affairs

Health Policy Briefs are produced under a partnership of Health Affairsand the Robert Wood Johnson Foundation.

Cite as: "Health Policy Brief: Risk Corridors," Health Affairs, June 26, 2014.

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