At the Intersection of Health, Health Care and Policy Cite this article as: Mark A.

Hall The Three Types Of Reinsurance Created By Federal Health Reform Health Affairs, 29, no.6 (2010):1168-1172 doi: 10.1377/hlthaff.2010.0430

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By Mark A. Hall
10.1377/hlthaff.2010.0430 HEALTH AFFAIRS 29, NO. 6 (2010): 11681172 2010 Project HOPE The People-to-People Health Foundation, Inc.

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The Three Types Of Reinsurance Created By Federal Health Reform

Mark A. Hall (mhall@ wfubmc.edu) is the Fred D. and Elizabeth L. Turnage Professor of Law at Wake Forest University, in WinstonSalem, North Carolina.

The Patient Protection and Affordable Care Act contains three different forms of reinsurance, covering individual insurers, small-group insurers, and employers that insure early retirees. Each reinsurance program has a distinctive structure that serves a unique purpose. Each also has predecessors in various forms of public reinsurance implemented previously by state and federal governments. This article explains the structure of and purpose for each reinsurance provision and why it should no longer be needed once reinsurance helps launch health reform safely.
ABSTRACT

he Patient Protection and Affordable Care Act of 2010 was designed to be implemented gradually over the next half-decade. Among the provisions that take effect almost immediately is a provision for reinsurance for early retirees. For reasons that are not readily evident, the act allocates $5 billion through 2013 to reinsure high-cost claims submitted by employers for former employees ages 5564 who are covered by retiree health insurance. Then, beginning in 2014, the act provides for two other forms of reinsurance covering individual and smallgroup insurance (Exhibit 1). This essay explains the structures and purposes of these different reinsurance mechanisms.

Reinsurance Basics
I begin with a cursory overview of reinsurance drawn from several in-depth sources.16 Reinsurance, simply put, is insurance for insurers or for self-insured employers. Structured in various ways and sometimes called by other names, such as stop-loss coverage, private reinsurance is readily available in the market to help insurers or employers anticipate and shoulder the risk they assume in guaranteeing uncertain medical costs. 1168
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Costs can be uncertain both because various drivers of costs can intensify unexpectedly and because particular policyholder groups may have more than their expected average number of very large claims. Reinsurance helps guard against situations where historical trends or the law of large numbers do not pan out as actuaries predicted they would. Quite distinct from private reinsurance is the notion of using public funds or structures to provide government-sponsored reinsurance for health care. During the past fifteen years, various forms of public reinsurance have appeared in both state and federal health reform measures. Among states, industry-funded reinsurance pools were a key component of the small-group market reforms adopted in the mid-1990s.7 Also, in 2001, New York used reinsurance to subsidize insurance for low-income uninsured people.8,9 Texas recently emulated that program.10 At the federal level, Sen. John Kerry (D-MA), as a presidential candidate in 2004, brought public reinsurance to national prominence with his proposal for government to reimburse employers 75 percent of claims exceeding $30,000.11 Public reinsurance was also a littlenoticed feature of Medicares new Part D prescription drug benefit in 2006, and it was embraced by Republicans this year as part of their alternative approach to reform, titled the

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EXHIBIT 1

Attributes Of Reinsurance In The Patient Protection And Affordable Care Act Of 2010 Reinsurance program Early retirees (sec. 1102) Effective dates 201013 Market segment Former employees ages 5564 covered by employer plan Individual insurance Program structure Payment to employers, 80 percent of claims from $15,000 to $90,000 per person Scheduled payments to insurers based prospectively on subscribers with listed high-cost conditions Insurers with medical expense greater than 103 percent of expected are subsidized by those whose medical expense is less than 97 percent of expected Primary purpose Reduce premium costs Funding (total) $5 billion federal funds

High-risk conditions (sec. 1341)

201416

Counteract adverse selection

$25 billion assessments on insurers and third-party administrators Unspecified

Medical expense risk corridors (sec. 1342)

201416

Individual and smallgroup insurance

Reduce actuarial uncertainty

SOURCE Authors analysis.

Common Sense Health Care Reform and Affordability Act. Policy analysts have identified at least three discrete purposes served by these different forms of public reinsurance.16 Most straightforward is simply to subsidize health care costs in order to lower premiums, so that more people can afford health insurance. More sophisticated is using reinsurance to alter marketplace dynamics, by blunting the effects of adverse risk selection. Reinsurance does this by protecting insurers from losing as much on unhealthy patients, so they have less reason to avoid these patients. This might help insurers redirect their competitive energies to managing, rather than avoiding, the inevitable costs of care. Finally, government sometimes uses reinsurance to ease the market anxieties created by new government programs that alter basic market conditions in ways that might otherwise spook insurers. In this scenario, reinsurance typically is needed only until insurers have enough experience to adapt their business models and actuarial data to the new market conditions.

Reinsurance For Early Retirees

With this background in mind, we explore the new health reform laws three forms of reinsurance (Exhibit 1), beginning with reinsurance for early retirees. This program is a fairly straightforward example of public reinsurance that reduces insurance costs. Employers are encouraged to continue offering health benefits to early retirees for the first three years under the legislation. The law promises that if employers document annual claims for a person amounting to anywhere from $15,000 to $90,000, the federal government will reimburse 80 percent of

the costs. Reinsurance Emerges This program first surfaced in the House of Representatives health reform legislation, backed by an appropriation of $10 billion, but the bill signed into law in March 2010 caps the appropriation at $5 billion. Critics charged that Democrats included early retiree insurance as a payback to labor unions for their political support, but the assertion is based on speculation.12 The largest employers are the most likely to offer retiree health benefits, and although some are unionized, many are not. Moreover, state and local government employers are equally likely to benefit, since the law also applies to them, and they usually provide retiree health benefits. Help For Employers In any event, the stated purpose is to encourage private and government employers to maintain retiree health benefits, at least until new affordability and access rules take effect in 2014. Over the past two decades, employers have dropped or scaled back retiree health benefits.13 This puts a particular burden on early retirees, who are too young to qualify for Medicare but old enough to either have health conditions precluding individual coverage or face premiums that are too expensive.14 In 2006, 15 percent of adults ages 5564 were uninsured, and 16 percent were covered by retiree insurance.15 For these reasons, the Senate considered allowing people ages 5564 to buy into Medicare, but Sen. Joseph Liebermans (I-CT) opposition to even this limited public option eliminated that idea. Reinsuring private coverage is a partial fallback for early retirees until new market rules take hold in 2014. Reduced Claims Costs Estimates of the reduction in claims cost through reinsurance are not
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readily available, but they might be gauged from two rough benchmarks. New Yorks reinsurance program for low-income uninsured individuals and small employers reduced premiums five years ago by roughly 20 percent. That program reimbursed 90 percent of claims between $5,000 and $100,000.2,5 Senator Kerrys 2004 proposal to reinsure all employers for 75 percent of claims greater than $30,000 was estimated to reduce total costs by about 10 percent.2 These estimates suggest that reinsuring 80 percent of claims between $15,000 and $90,000 now, for an older age group, would reduce total costs considerably less than 20 percent. Reinsurance Versus Direct Subsidies Acknowledging the desire to support private coverage of the near-elderly, why should this support take the form of reinsurance for employers, rather than direct premium subsidies to retirees themselves? There are several possible answers. First, the bill requires that employers use reinsurance payments to reduce insurance costs, either for the employer or the retiree. Even if employers capture all of the benefit, these reduced costs should help them maintain coverage or avoid reducing benefits, either of which helps retirees. Second, distributing subsidies directly to all early retirees would cost much more. The only way to reduce that cost would be to target subsidies to some but not all deserving subscribers, but those lines would be politically difficult to draw. Therefore, it is expedient to allocate the subsidies more indirectly to employers. Similarly, for employers, there may be other more targeted methods to provide relief from the costs of insuring early retirees. But those methods would also be more complex. Reinsurance might instead be paid to insurers, but it would be difficult to ensure that they passed the savings on to subscribers. Simply reimbursing a large portion of employers high-cost claims is thus a convenient way to distribute a moderate-size subsidy that encourages retention of insurance for a population that otherwise would be difficult and expensive to cover. Prospects For Success It is hard to predict how well this mechanism will work. A different subsidy to employers that provide drug benefits to retirees covered by Medicare has been credited with helping stem employers reduction of that coverage. However, employers cost for drug coverage is much less than that for full health insurance for retirees, and so a proportionate subsidy of 28 percentthe amount for drug benefitswould leave employers bearing much higher net costs. Moreover, the reinsurance subsidy for early retirees is capped at $5 billion, which probably

Distributing subsidies directly to all early retirees would cost much more.

is insufficient to cover the entire period until 2014.12 The White House projected that reinsurance would average $1,200 per covered worker. 16 If so, $5 billion would not extend beyond a year, based on a 2006 estimate of five million retirees ages 5564 covered by employer-related insurance15 and assuming that all eligible employers participated. Congressional Action Some have speculated that Congress will increase the reinsurance funds if they begin to run dry before 2014, just as it did recently for the more popular parts of stimulus funding. But what happens in 2014, when new insurance rules are implemented? The unsubsidized market will then become much more accommodating to the near-elderly. Not only will preexisting conditions be covered without extra cost, but rates for the oldest subscribers will be capped at three times the rates for the youngest adults, which is considerably less than the current five-to-sixfold range justified by actuarial costs. The resulting premium reductions for the near-elderly will make it easier for employers to justify dropping retiree coverage in favor of coverage available through insurance exchanges. Adding those higher-cost subscribers to the community-rated exchange pools would push rates up for others, however, so Congress may find itself hard-pressed to let the reinsurance subsidy expire as planned in 2014.

Reinsurance And Risk Corridors

The bill provides for two additional reinsurance mechanisms, starting in 2014 and lasting for three years (Exhibit 1). High-Risk Conditions For individual insurance, states will establish a prospective reinsurance program. This federally prescribed program will identify high-risk subscribers based on a list of 50100 expensive conditions and pay scheduled amounts to insurers to offset their expected costs, regardless of how much their actual costs might be. These costs will be borne by assessments on all

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Once most people enter the reformed market, the prospect of adverse selection will diminish.

insurers of up to $25 billion over three years. Insurers will be assessed in proportion to their total market shares for all commercial health coverage, including claims administration for self-insured employers, and not just for individual insurance. Thus, insurers that cover large groups will help subsidize reinsurance for high-cost individual subscribers, for these initial three years. Risk Corridors For small-group and individual insurance, the new health reform law subsidizes insurers whose medical costs are 3 percent more than expected. It does so by assessing insurers whose costs are 3 percent less than expected. The subsidy and the assessment are each half the amounts between 3 percent and 8 percent of each insurers expected cost corridor, and 80 percent of the amounts beyond 8 percent. The health reform law seems to assume that assessments on low-cost insurers will naturally equal subsidies to those with higher costs, but mathematically that is not at all likely to be the case, and the law fails to address how the reinsurance subsidy will be funded in such an event. Prospective Risk Assessment These reinsurance mechanisms are distinct from, and in addition to, another of the laws risk-adjustment mechanisms. This mechanism will measure the actuarial risk of each insurers individual and small-group populations and will assess insurers below the states average and subsidize insurers above the states average. This prospective risk assessment extends indefinitely and is likely to be based substantially on demographics in addition to medical conditions. Therefore, it serves different purposes and is not regarded here as a form of reinsurance. Risk Adjustment In Medicare Part D This unique blend of risk-spreading mechanisms is

based on a similar configuration under the Medicare Prescription Drug, Improvement, and Modernization Act (MMA) of 2003.17 MMA also provided for both retrospective and prospective reinsurance, for a limited time, to cover private insurers that participated in either the new Part D prescription drug benefit or the expanded Part C Medicare Advantage program. The stated purpose under the new health reform law, as well as the Medicare Modernization Act, is to help stabilize premiumsduring the first three yearswhen the risk of adverse selection related to new rating rules and market changes is greatest.18 Without these government guarantees, the threat of adverse selection either might cause insurers to set initial rates too high, in overly conservative anticipation, or might deter them from entering the new market environment altogether when exchanges are first implemented. The merits of using reinsurance for this purpose are confirmed by the insurance industrys broad participation in Medicare Part D. Importantly, however, this need is temporary. Once most people enter the new or reformed market, the prospect of adverse selection will diminish, and actuarial data will exist to manage its impact more credibly.19 This likelihood is supported by research in small-group markets reporting that within a few years after enactment of state laws that barred insurers from turning down any small employers, reinsurance pools for unhealthy subscribers were no longer needed to protect against adverse selection.2,7

Making Sense Of It All

When Medicare was first enacted, lawmakers feared that hospitals would boycott. Likewise, the Patient Protection and Affordable Care Acts success will be muted if insurers stay away from the new exchanges and if employers take this opportunity to drop coverage. To address these concerns, the new health reform law makes deft but limited use of reinsurance in several forms, drawing from experience in the states and with the Medicare Modernization Act. Each mechanism targets one of the three distinct purposes for reinsurance: subsidizing costs, countering adverse selection, and increasing actuarial certainty. But, unlike most of the bill, these features, like booster rockets, have a limited life. Once they propel the launch of the reform law, we expect them to fall safely away.

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The Blue Cross and Blue Shield Association supported some of the authors earlier research on public reinsurance, but this article is entirely his own and does not necessarily represent the associations views.

NOTES
1 Swartz K (Harvard School of Public Health, Boston, MA). Reinsuring health: the dilemma of the uninsured middle class. New York (NY): Russell Sage Foundation; 2006. 2 Hall MA. Government sponsored reinsurance. Ann Health Law. Forthcoming. 3 American Academy of Actuaries. Medical reinsurance: considerations for designing a government-sponsored program [Internet]. Washington (DC): AAA; 2005 Jan [cited 2010 May 6]. Available from: http://www. actuary.org/pdf/health/ reinsurance_jan05.pdf 4 Bovbjerg RR. Reform of financing for health coverage: what can reinsurance accomplish? Inquiry. 1992;29(2):15875. 5 Bovbjerg RR, Garrett AB, ClemansCope L, Masi P. Reinsurance in state health reform [Internet]. Washington (DC): AcademyHealth; 2008 May [cited 2010 May 6]. Available from: http://www.academyhealth .org/files/publications/SCI_ Reinsurance08.pdf 6 Families USA. Reinsurance: a primer [Internet]. Issue Brief. Washington (DC): Families USA; 2008 Apr [cited 2010 May 6]. Available from: http://www.familiesusa.org/ assets/pdfs/reinsurance-aprimer.pdf 7 Hall MA, Lawlor JS. Reinsurance pools for small-group health insurance. J Ins Reg. 2001;19(4):63855. 8 Swartz K (Harvard School of Public Health, Boston, MA). Healthy New York: making insurance more affordable for low-income workers [Internet]. New York (NY): Commonwealth Fund; 2001 Nov [cited 2010 May 6]. Available from: http://www.cmwf.org/usr_doc/ swartz_healthyny_484.pdf State Coverage Initiatives. Profiles in coverage: healthy New York [Internet]. Washington (DC): State Coverage Initiatives; 2005 Jul [cited 2010 May 6]. Available from: http://www.statecoverage.org/ node/482 Texas Department of Insurance. Healthy Texas: a private/public health insurance product [Internet]. Austin (TX): Department of Insurance; 2009 [cited 2010 May 6]. Available from: http://www.tdi .state.tx.us/health/documents/ lhhealthytx1.pdf Collins SR, Davis K, Lambrew JM. Health care reform returns to the national agenda: the 2004 presidential candidates proposals [Internet]. New York (NY): Commonwealth Fund; 2003 Sep; updated 2004 Oct [cited 2010 May 6]. Available from: http://www. cmwf.org/usr_doc/671_ Collins_candidates_update_ Oct2004.pdf Greenhouse S. Bristling at health plan to cover early retirees. New York Times. 2009 Sep 9. Fronstin P. Implications of health reform for retiree health benefits [Internet]. Issue Brief no. 338. Washington (DC): Employee Benefit Research Institute; 2010 Jan [cited 2010 May 6]. Available from: http:// www.ebri.org/pdf/briefspdf/ EBRI_IB_01-2010_No338_ RetHlth1.pdf Holahan J. Health insurance coverage of the near elderly (Urban Institute, Washington, DC). Washington (DC): Kaiser Family Foundation; 2004 Jul [cited 2010 May 6]. Available from: http://www. kff.org/uninsured/upload/HealthInsurance-Coverage-of-the-Near-Elderly-Report.pdf Vistnes J, Cooper P, Bernard D, Banthin J. Near-elderly adults ages 5564: health insurance coverage, cost, and access [Internet]. Rockville (MD): Agency for Healthcare Research and Quality; 2009 May [cited 2010 May 6]. Available from: http://www.ahrq.gov/data/meps/ mepsneareld/nearelderly.pdf White House. Health reform for early retirees: the Affordable Care Act gives early retirees greater control over their own health care [Internet]. Washington (DC): White House; [cited 2010 May 6]. Available from: http://www.whitehouse.gov/ files/documents/health_reform_ for_early_retirees.pdf Congressional Budget Office. A detailed description of CBOs cost estimate for the Medicare prescription drug benefit: the drug benefits risk corridor system [Internet]. Washington (DC): CBO; 2004 Jul [cited 2010 May 6]. Available from: http://www.cbo.gov/ ftpdocs/56xx/doc5668/07-21Medicare.pdf Patient Protection and Affordable Care Act, sec. 1341(c). Chaikind HR, Morgan PC. Medicare advantage payments [Internet]. Washington (DC): Congressional Research Service; 2004 Sep 29 [cited 2010 May 6]. Available from: http:// www.law.umaryland.edu/marshall/ crsreports/crsdocuments/ RL32618.pdf

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