The Agenda

Revisiting Reinsurance

Though I recognize that it will be difficult to craft an alternative to the Affordable Care Act that is both fiscally sustainable and political appealing, I’ve become somewhat more optimistic recently.

Paul Howard’s carefully designed Medicaid block grant proposal strikes me as a good starting point, and I think we might even be able to build a consensus around federalizing the aged and disabled components of Medicaid, which might control costs.

Though Medicare reform remains politically contentious, conservatives seem to have rallied around Yuval Levin’s “confident market solution.” By setting Medicare capitation payments (or premium support) at the level of the second-lowest bid to provide the Medicare benefit in a given insurance market, the confident market solution aims to use price competition rather than administrative price controls to drive productivity-enhancing business model innovation. There is no guarantee that this approach will prove successful. Some have suggested that the preservation of a Medicare FFS public option will create serious adverse selection problems, and that (implicitly) a Medicare 2.0 without a public option might actually be preferable.  That remains to be seen. And of course the political case against market-oriented Medicare reform has been made with great vigor in this election cycle. Regardless, I think we’ve made at least some progress. 

This leaves the extremely vexing question of what to do about high-cost nongroup health insurance. This issue is particularly salient as the share of non-elderly Americans covered by employer-sponsored health insurance (ESI) erodes for a variety of reasons, among them the growing number of part-time workers, changing family structure, the proliferation of smaller firms, and, perhaps most importantly, the rising cost of health benefits relative to productivity gains.

The Affordable Care Act essentially creates a second Medicaid program to address this problem. Recall the following from Ramesh Ponnuru’s latest column:

Supporters of the legislation wanted to encourage states to set up the exchanges. So they offered the states a deal: If they did so, they would get to write their own rules, and their citizens would be able to get the tax credit.

That is, the states would set the rules and the federal government would foot the bill. Under ACA, households are meant to pay no more than 10 percent of their income for health insurance. Federal tax credits are designed to make up the difference between 10 percent of household income and the cost of providing insurance. If state governments write rules that raise the cost of private insurance considerably, to please various local medical providers and other constituencies, etc., it is the federal government that will be obligated to bear the fiscal consequences. 

One alternative to the ACA approach, as we’ve recently discussed, is to create well-designed, better-funded high-risk pools (HRPs) to meet the needs of the relatively small high-risk population.

As Katherine Swartz, author of Reinsuring Health, has argued, however, even a well-designed high-risk pool has downsides. In Swartz’s view, the central problem with HRPs is that they might actually increase the incentive to use selection mechanisms. She instead proposes greater use of public reinsurance programs, i.e., systems through which state governments or the federal government offer insurance against high costs:

Insurer concerns over adverse selection and the risk of covering people with extremely high medical costs must be reduced. Unless this happens, insurers will not significantly cut their use of selection mechanisms or substantially reduce premiums. The most efficient way to reduce insurers’ risk of covering people with very high costs is to have a government-sponsored reinsurance program. All of us would help pay for the costs of the few people who, by random bad luck, were extremely sick in a particular year. 

A number of states, including New York, Arizona, Connecticut, and Idaho, have experimented with limited reinsurance programs that have embraced a variety of different approaches (e.g., some essentially force all insurers to share in the cost of covering the highest-cost beneficiaries while others use general revenues to reduce premiums and increase coverage). Families USA, a left-leaning group that advocates coverage expansion, profiled a number of state programs back in 2008. The Robert Wood Johnson Foundation and Academy Health did the same that same year.

So what might a federal reinsurance program designed to reduce premiums in the nongroup health insurance market cost? In Reinsuring Health, published in 2006, Swartz estimated that it would cost as much as $20 billion, a number that would have to be adjusted sharply upwards to account for the rising cost of health insurance and the growing number of uninsured individuals, etc., in the years since:

My own rough estimate is that a government-sponsored reinsurance program restricted to the small-group and individual insurance markets could cost $18.5 billion to $19.5 billion per year (in 2005 dollars). This calculation is based on estimates of the number of people with small-group coverage and the number with individual coverage, a threshold level that defines the top 1 percent of the population ($50,000 in 2005), and government cost-sharing of 85 to 90 percent of costs above the threshold. This estimate does not account for the expected growth in the number of people who would find it easier and cheaper to obtain coverage in these markets. …

As these cost estimates illustrate, if the reinsurance program is available to insurers of large employers as well as in the small-group and individual insurance markets, the costs will be substantially higher. Since our interest is primarily in making small-group and individual insurance coverage more widely available, the estimates of $5 billion to $20 billion per year for reinsuring these markets are plausible starting points. 

Swartz posits that government-sponsored reinsurance program would lower premiums, give the government leverage to restrain unnecessary medical expenses (an aspect of the proposal many conservatives will presumably dislike), and encourage insurers to reduce the use of risk selection.

Intriguingly, Swartz compares the cost of her proposed reinsurance program with the cost of the tax exclusion for employer-sponsored health insurance:

The tax code treatment of employer-sponsored health insurance and the self-employed’s purchase of coverage were recently estimated to cost the U.S. Treasury about $140 billion. Since approximately 165 million to 170 million people under the age of 65 have either employer-sponsored coverage or are self-employed and purchase their own coverage, this tax subsidy equals $825 to $850 per person covered, If 15 to 20 million uninsured people can be covered by insurance because of a reinsurance program that costs $15 to $20 billion, the subsidy per person amounts to about $1,000. The cost of the reinsurance program would be of the same order of magnitude as the current subsidization of employer-group coverage and the self-employed’s purchase of individual coverage. 

It should go without saying that these numbers have changed, e.g., the tax exclusion was worth $260 million in 2010. Yet I can’t help but think that there is something to Swartz’s proposal, even now.

There are a a number of intriguing aspects to adding a public reinsurance concept into the mix:

(1) Per Eugene Steuerle’s trenchant critique of ACA, we would still have a four-tranche system — Medicare, Medicaid, ESI, and a revamped small-group and individual insurance market (SGI) that is reinsured by the federal government. Yet the gap in subsidies between ESI and SGI would be much smaller than the gap between ESI and the ACA exchanges.

(2) The cost of financing the new SGI reinsurance program could be met, at least in part, by capping the tax exclusion for high-earners.

(3) Swartz’s proposal does not involve an individual mandate. This will, of course, limit the amount of coverage expansion, but it will address one of the chief political objections to the ACA. Coverage will expand not because people will be required to purchase insurance, bur rather because purchasing insurance has become more attractive — and because the incentives to engage in risk selection will have been weakened. 

(4) So what is the biggest objection? My guess is that critics will focus on the fact that the federal government will have taken on tremendous risk. Do we have any reason to believe that the federal government will be particularly well-equipped to contain costs above the attachment point, i.e., the level at which reinsurance kicks in?

This is an extremely good question. The most thoughtful and detailed discussion I’ve seen of these issues is Harold Luft’s call for a “universal coverage pool,” a version of which he floated during the ACA debate as a “major risk pool.” I should stress that Luft’s idea is quite different from Swartz’s, though my sense is that they are broadly compatible. Basically, Luft sees a quasi-public reinsurance program as a vehicle for driving the transformation of the health system — an ambitious idea that many will find discomfiting:

The rationale for the MRP is twofold. (1) By pooling risk for the most expensive and financially threatening components of health care, it spreads risk broadly. Allowing health plans to buy coverage at demographically determined rates, it eliminates significant administrative and marketing expenses. (2) By paying in new ways for what covers, it will transform the delivery system.

Hospitalization and chronic illness costs account for more than 60% of all medical costs. Some hospitalizations are totally unpredictable, but most are related to chronic illnesses. People with chronic illnesses have above-average costs; plans incur substantial underwriting, marketing, and administrative costs attempting to avoid such people. Addressing plans’ legitimate concerns about adverse selection eliminates such costs that add nothing to health care delivery.

Other proposals for reinsurance pools have surfaced over the years; in 2004 Sen. John Kerry (D-MA) proposed a reinsurance plan. The MRP, however, differs markedly from reinsurance that simply reimburses insurers after they have incurred unusually high costs. Classic reinsurance generates no incentives for more efficient behavior by providers and blunts incentives for insurers to manage high-cost cases. The primary purpose of the MRP is to change payment incentives for providers; it can best do so by attracting the high-cost cases. Unlike conventional insurers, the MRP seeks risk.

By not providing insurance directly to consumers, the MRP sidesteps the need to define a basic benefit package — many states have already done that. The MRP will rarely make decisions about paying for specific items and services, an area in which Medicare is often caught in the crossfire. Both issues are highly political, with lobbying by providers and manufacturers of specific products.

The MRP simply provides funds for certain broad types of illnesses: (1) major acute and interventional care requiring a facility, and (2) care for chronic illnesses. The clinicians involved and the health plans providing the wraparound coverage decide what services and products efficiently achieve the best outcomes. As discussed below, the MRP will make available the underlying data needed by independent analysts to inform providers’ and patients’ choices. [Emphasis added]

Luft envisions an MRP that will leverage its scale and its resulting pricing power to encourage providers to form care delivery teams (CDTs) and to provide detailed data on cost-effectiveness and performance, which it will make available to insurers.

Katherine Swartz supports the Affordable Care Act, and I imagine Luft does as well. But if its flaws grow more pressing, as I and many others assume will happen, we might need to cobble together a workable solution sooner rather than later, and reinsurance for the small-group and individual insurance markets might be a part of it.


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