Cherry picking and the department of the obvious

NBER released an interesting paper this week (#22382 )

a long theoretical literature describes how contract design can also be used to screen consumers by profitability. In this paper, we study this type of screening in the ACA Health Insurance Exchanges. We first show that despite large regulatory transfers that neutralize selection incentives for most consumer types, some consumers are unprofitable in a way that is predictable by their prescription drug demand. Then, using a difference-in-differences strategy that compares Exchange formularies where these selection incentives exist to employer plan formularies where they do not, we show that Exchange insurers design formularies as screening devices that are differentially unattractive to unprofitable consumer types. This results in inefficiently low levels of coverage for the corresponding drugs in equilibrium. Although this type of contract distortion has been highlighted in the prior theoretical literature, until now empirical evidence has been rare.

Or what was written here in July 2014:

Insurance comnpanies still want to tilt their risk pools to be as healthy as possible while letting their competitors eat the costs of covering the known sick. This is despite some back-end risk adjustment mechanisms that are supposed to transfer money from health plans that are composed of overwhelmingly healthier than average members to health plans that are composed of sicker than typical members. Plans want to be as attractive as possible to healthy people and as unattractive to known sick people. This incentive structure creates an adverse selection mechanism collective action problem. We are seeing this problem emerge with AIDS/HIV drugs in Florida.

What do I mean by an adverse selection collective action problem?

Let’s assume that any given insurance company wants to minimize their HIV treatment costs and that they are also required to cover any HIV patient who signs up with them. The goal then for the insurance company is to make themselves as unattractive as legally possible to HIV patients. Futzing around with networks is possible, but since most HIV treating docs and facilities are common providers for lots of much healthier members, this will not be too effective. Additionally plans are required to contract with Ryan White AIDS clinics. The simplest legal way to target unattractiveness to HIV patients is to make the drugs as expensive as possible….

Even relatively inexpensive AIDS mediciation for the first insurance company with this idea would get put on the most expensive formulary where pre-authorizations, high co-insurance and high co-pays apply until the member reaches the out of pocket maximum. This anti-social but rationally based business model should make the plan very unnattractive to individuals with HIV. They will logically look at the market and look for a plan that does not completely fuck them over.

The same logic applies to diabetics, cancer survivors, transplant recipients and other high cost individuals.

And here is where problems emerge. Once one plan in a market decides to make themselves as unattractive as possible, every other plan has to either follow suit in making themselves unattractive or be willing to take on massive health costs as they become the preferred plan for HIV positive individuals. At that point, there is a local death spiral as the attractive plan has to raise premiums to cover costs which drives them away from the Second Silver subsidy determination point, which then drives away cost sensitive but fairly healthy individuals from the plan. So a region will see either the “nice” plan become a “nasty” plan as a self-defense measure or that “nice” plan will leave the market so the new baseline is “nasty”. It is Gresham’s law for health insurance.

The NBER paper provides a static analysis while somehow this foul mouth blog provided a dynamic analysis two years ahead of time.