Age-based “Rate Bands” for Health Insurance Premiums

There has been a lot of discussion lately about the premium rating restrictions in the ACA. I want to put some of this discussion in the context of the full set of regulations in the ACA because I feel that most of the discussion focuses on one particular rule and neglects to recognize that the rule interacts with other new policies in ways that could change the conclusions people are making about the potential effects of that policy. First, I’ll give some quick background for anyone who just wants to understand what the new laws about premium setting mean. Then, I’ll try to give a picture of how the rate setting policy interacts with other policies such as risk adjustment which will also go into effect around the country next January.

Background

Currently in most states insurers selling plans on the individual market (i.e. not employer-provided insurance) can charge different people different premiums for the same coverage. They vary these premiums based on expected cost. I’ll give two examples. First, let’s say there’s a pair of twin sisters, both age 35. One of the sisters has asthma, while the other is perfectly healthy. If both sisters attempt to purchase a plan from Blue Cross, Blue Cross is currently able to charge the sisters different premiums for the same plan, and they often do (sometimes they outright reject the sister with asthma). Second, let’s say there are two healthy brothers who were born 20 years apart. Tim is 35 and Tom is 55. Neither brother has any chronic conditions. Again, let’s say both brothers attempt to purchase the same plan from Blue Cross. Again, Blue Cross is able to (and does) charge different premiums for the two brothers based on the expected costs of a healthy 35 year old vs. the expected costs of a healthy 55 year old.

The ACA changes the rules regarding premium setting in the individual market. Charging different premiums based on health (example 1) will be prohibited starting next January. Insurers will also be prohibited from rejecting anyone who wants to purchase coverage. Therefore, our twin sisters will be charged the same premium for the same coverage. The premium paid by the sister with Asthma will likely go down and the premium paid by the healthy sister will likely go up. Charging premiums based on age, however, will still be allowed, though limited to a ratio of 3:1. This means that, as long as the ratio of Tom’s premium to Tim’s premium is less than 3:1, the insurer can continue to charge them the same premiums it was charging before.

Much of the discussion is about the new 3:1 age rate band. Insurers are warning that young people will experience “rate shock” when the law goes into effect because the insurers will have to raise their premiums on the young by a lot to comply with the 3:1 rate band. This is probably true. If we assume perfect competition, premiums are equal to average cost. According to calculations I’ve done using the Medical Expenditure Panel Survey (MEPS) the average health care costs for a 64 year old likely to be purchasing a policy on one of the new state health insurance exchanges are about 9 times the costs of a 21 year old. According to this metric, rate shock will be rather extreme for the young. Insurers argue that due to this rate band policy, the young will not purchase insurance and instead pay the penalty for being uninsured. This will induce adverse selection and cause major problems for the exchanges.

Policy Interactions

I don’t argue that this “rate shock” won’t occur. It probably will, though not to the extent the insurers claim it will because of several factors, mainly that the old and the young are likely to purchase different policies. The young will purchase bronze and silver plans and the old will purchase gold and platinum plans. If only healthy old people buy the lower coverage plans, the age rate bands are unlikely to bind, and the young will still pay similar premiums. However, if this age-based segmentation occurs, adverse selection into the comprehensive plans is likely to be extreme, causing large welfare losses.

This brings me to the real purpose of this post. There is another very important policy in the ACA that deals with this adverse selection problem: Risk adjustment. To give a simplified explanation, risk adjustment is a policy where an insurer sets its own premiums, but a regulator (the exchange) collects those premiums and pools all of the premiums for all of the plans in the exchange into one giant pot. The regulator then reallocates the premiums based on the premium the plan set and on the expected cost of individuals in the plan. The expected cost calculation is based on age, gender, and past health insurance claims. For example, it would predict that a 55 year old male with diabetes would cost much more than a 55 year old male without diabetes. It would also predict that a healthy 55 year old female would cost much more than a healthy 35 year old female. This policy attempts to remove the incentives for plans to select cheap enrollees. It makes all individuals equally attractive to plans (at least based on health status) so that the plans don’t attempt to induce selection using costly methods or by inefficiently rationing services that high-risk individuals demand, such as access to diabetes or mental health specialists (note that if it is efficient to ration access to diabetes specialists, then risk adjustment does not provide additional incentives for plans to inefficiently provide access; if implemented correctly, it just gets plans closer to the efficient allocation of services; see Frank, Glazer, and McGuire 2000, Glazer and McGuire 2000, and Glazer and McGuire 2002). It also causes risk pooling between plans to limit the effects of the age-based segmentation discussed above.

Herein lies the issue with the insurers’ complaints about the age-based rate band policy. My point is a technical one, but an important one. Rate shock is a big worry, but not because of the age-based premium rating restrictions; rather, rate shock is a worry because of risk adjustment. The risk adjustment models that will be used by HHS to predict cost include age as a predictor of cost. Therefore, the risk adjusting of premiums described above will make a 35 year old and a 55 year old look pretty similar in terms of cost. In a competitive environment, this would mean that a plan would charge them the same premium. In simulations using MEPS data and the CMS-HCC risk adjustment model, McGuire et al. (2012) show that assuming perfect competition, after implementing even partial risk adjustment, the 3:1 rate band is not binding. In other words, plans would charge a 55 year old and a 25 year old premiums that vary by less than 3:1. In simulations I’ve done for another project, if premiums are fully risk adjusted, the premiums plans charge are virtually identical. This means that the premiums charged to the young will spike, but not because of the rate bands. Rather, they’ll spike because of risk adjustment.

All of the policy discussion going on is about the effects of the rate bands and how they will cause extreme adverse selection on the exchanges. Unfortunately, nobody is discussing the real driver of this rate shock and selection: risk adjustment. This is probably because the purpose of risk adjustment is to limit selection, not to expand it. Unfortunately, that only works if mandates work. Since the ACA’s mandate may not be large enough to get the young to buy insurance, it could instead cause more selection due to premium compression. There is a fix to this, though a complex one: Take into account the tradeoff between the gains from risk adjustment (due to improved selection incentives to health plans) and the losses from the premium compression it causes (due to the young dropping out and driving up the costs for those remaining in the exchange; i.e. adverse selection) and use partial risk adjustment instead of full. The optimal amount of risk adjustment that should be used will depend on the demand curves of the young, and it is likely to be far less than 100%. Again, unfortunately nobody is talking about this. Instead, the focus is on rate bands that are unlikely to bind after risk adjustment.

All of this has assumed perfect competition between health plans. In my next post, I’ll talk about what happens when we introduce imperfect competition (which is probably more realistic) and provide an argument for why the insurers may really be arguing for the elimination of the rate bands. Hint: it’s not because of rate shock on the young.

References

McGuire, Thomas et al. 2012. Integrating Risk Adjustment and Enrollee Premiums in Health Plan Payment

Glazer, Jacob and Thomas McGuire. 2000. Optimal Risk Adjustment. American Economic Review

Frank, Richard, Jacob Glazer, and Thomas McGuire. 2000. Measuring Adverse Selection in Managed Care. Journal of Health Economics

Glazer, Jacob and Thomas McGuire. 2002. Setting Plan Premiums to Ensure Efficient Quality in Health Care: Minimum Variance Optimal Risk Adjustment. Journal of Public Economics

Service-level Selection in Health Insurance Markets

I came across this NY Times article this morning about Chiropractors and Acupuncturists lobbying to be part of the Essential Benefits Package in various states across the country. Being part of this package means that in order to meet the minimum credible coverage requirements in a state, a plan must cover these services. I found it a little odd that these two groups in particular are aggressively lobbying to be covered. You may say, “Of course these groups would want to be covered. They’re often not covered, and of course they would want to use crony capitalism to boost their business.” However, this situation is slightly more complicated.

The essential health benefits requirement is mostly for the individual and small business markets (both of which will move to the new state exchanges in 2014). The purpose is to make sure that healthy people and sick people pool their risks. If people were able to buy policies that were essentially the same as being uninsured, many healthy people would flock to those policies, leaving the sick in the more comprehensive policies, driving up prices, and making the comprehensive insurance less “insurance” against the costs of getting sick per se and more membership fee equal to the average cost of being sick, the classic adverse selection problem. I leave alone whether that argument is a good enough one to justify the essential health benefits provision, which is clearly open to corruption, for now and focus on a different aspect of this situation.

In an exchange, insurers will be required to charge everyone essentially the same premium, whether they’re sick or healthy (there is some latitude for premium variations based on age and smoking status, but they’re restricted). Because of this, sick people will be seen as potential losses to the insurers and healthy people will be seen as potential profits. Naturally, insurers will want to do anything they can to get the healthy folks. There are several ways to do this: Cream-skimming, dumping, or service-level selection. The last of these, service-level selection, is the one I think is most interesting in this situation.

Service-level selection is practiced by managed care organizations (MCOs) when individuals are choosing plans in a market where there are many plans competing for their business. It occurs when the MCOs ration care demanded by high cost individuals, things like diabetes specialists or flagship hospitals. They can do this by increasing cost-sharing for these services or by removing these types of providers from their networks. When a diabetes patient goes to an exchange to purchase coverage, they’re not likely to pick a plan that doesn’t have their (or any good) diabetes specialists. This sends the sick patients to more comprehensive plans for their coverage, driving up prices in those plans, where only the sick go. This is the same classic adverse selection problem (see Frank, Glazer, and McGuire 2000 and Ellis and McGuire 2007).

There are two sides to service-level selection. A plan can restrict access to services demanded by high-cost patients, as described above, or it can loosen access to services demanded by low-cost patients to cause this selection problem. This is where the Times article comes in. It turns out that Chiropractic and Acupuncture services are at the top of the list for services demanded by low-cost patients. Ellis and McGuire (2007) have shown that these are the most attractive services for MCOs in a free market to offer, and Ellis, Jiang, and Kuo (2012) have shown that these services are offered more often by MCOs than non-managed plans. So, it is likely that the free choice available through the exchanges will lead to these services being offered by the MCOs even without a mandate from the state, unless, of course, the risk adjustment schemes in the exchanges (a topic for another post) are good enough that the sick and the healthy are equally attractive to the plans.

So, my point here is that the lobbying of these groups may not be necessary. The groups that should be lobbying for mandated coverage are those that are demanded by the sick, high-cost patients: Diabetes care providers, hospice care, etc. My guess is that the acupuncturists and chiropractors don’t realize this and that they want mandated coverage because they know that individual’s are more price sensitive when it comes to their services than other medical services. I guess we’ll see what happens in the states where acupuncture isn’t mandated compared to the ones where it is. I doubt there will be much difference.

Baselines

We all know that in the debt limit agreement, there was a provision calling for the creation of a “supercommittee” that must come up with something like $1.2 trillion in cuts by Thanksgiving to present to congress for an up or down vote. One thing we don’t all know, but that I was made aware of through a recent podcast from the Brookings Institution, is that the agreement leaves the issue of what baseline to use completely up to the committee. By baseline, I mean the original, pre-cut amount of spending to which the committee will compare the new, post-cut amount of spending to determine how much was “cut.” While this may seem to not be a very big deal, it’s important to note that there are a wide variety of “baselines” out there. Some include the extension of the Bush tax cuts, some include the elimination of Iraq war spending, some include all kinds of crazy stuff. it just depends what kind of assumptions you want to make about what politicians will do over the next 10 years.

The important question is how much these baselines vary. The answer to this question is somewhere around $4.5 trillion dollars. So, if the committee is supposed to cut $1.2 trillion, and going from one baseline to another can save $4.5 trillion, it sounds to me like the committee’s job is already done.

And, yes, this first post in months does mean that I’m back to blogging…hopefully.

The $23 Million Book

I thought this was pretty funny. Enjoy.

The Possibilian

This is a great story in the New Yorker about a Neuroscientist who studies our perception of time. Enjoy.

http://www.newyorker.com/reporting/2011/04/25/110425fa_fact_bilger?currentPage=1

East of Eden

East of Eden by John Steinbeck

My rating: 5 of 5 stars

Best book I’ve ever read. Seriously. I wish it went on forever.

View all my reviews

Angles

 

I’ve loved The Strokes since they, along with the other “The” bands (White Stripes, Vines, Hives, etc.), made music enjoyable to listen to again in the early 2000′s. After lots of side projects (Albert Hammond Jr.’s “Como Te Llama?”, Little Joy’s self titled album, Julian Casablancas’ “Phrazes for the Young”) and way too much time off, they released their newest album today: Angles.

Listen to it here.