Moving to state based exchanges and catastrophic reinsurance

Pennsylvania is in the process of moving their individual market from being hosted and run by Healthcare.gov to a state based exchange. This is a step that several other states are taking. However, Pennsylvania is being really creative in why they want to do this. First let’s get the details from WESA:

House Bill 3 would have Pennsylvania operate the online health insurance exchange that has been run by the federal government since 2014 through the Affordable Care Act.

The bill is being co-sponsored by Lancaster County Republican state Rep. Bryan Cutler and Allegheny County Democratic state Rep. Frank Dermody. Both are their respective parties’ floor leaders….

Pennsylvania pays the federal government about $94 million a year to run the marketplace, Cutler said. With the proposal, Pennsylvania would use technology other states have already shown to be effective to run the marketplace at a much lower cost, which he estimated to be about $35 million annually…

the measure would also take advantage of a federal Section 1332 “reinsurance” waiver that can help to lower costs and tailor the program for Pennsyvlanians.

That last sentence is the most interesting and unique part of the Pennsylvania plan.

Pennsylvania wants to take the difference between what they pay to Healthcare.gov and what they think they can run their own exchange for and apply that increment to a Section 1332 reinsurance waiver. This is nifty. 1332 waivers are fairly common for reinsurance purposes in red, blue and purple states. Waivers are required to be federal budget neutral against a “no change” baseline. Reinsurance waivers bring in a non-premium infusion of funds that creates a wedge between claims and premiums. That wedge reduces federal subsidies and those lower federal subsidies are then fed back into the reinsurance program. The end result is that non-subsidized premiums are lower and the relative spreads of subsidized premiums are compressed. This leads to higher non-subsidized enrollment and slightly lower subsidized enrollment.

Usually, the state reinsurance waivers have the non-premium cash infusion come from some state tax revenue. Pennsylvania is not doing that. Instead, they are betting that they can run the exchange cheaper and while charging insurers the same amount of money, there will be a wedge that can be diverted to paying off some catastrophic claims. This is different.

I am not sure how much rate relief reinsurance provides when the reinsurance is funded by premiums. It is not a new wedge of non-premium related cash. It does two things. First it slightly increases the amount of premiums paying claims so total premiums can go down. It is also a pool of money that might be worth one or two percent of state wide premium that can eat some catastrophic claims. This is valuable. It reduces extreme tail risk for any one insurer. Less variance means marginally lower rates as well.

More importantly from the goal of reducing non-subsidized gross premiums, removing some catastrophic claim risk marginally increases the incentives for current insurers to expand their footprint and minimize the number of monopoly counties. Iowa’s insurance markets had an extreme example of a hyper expensive individual with recurring million dollar claim months.

In a competitive market where the subsidies are tied to the second least expensive Silver and there is one super-outlier who can not be re-insured against, every carrier lives in fear of being chosen by the one outlier. If they set their rates low enough to be attractive to healthy people, they lose money on the catastrophic expected claims. If they set the rates high enough to cover a $12,000,000 claim, no one buys their product.

No one wants to catch a spinning, falling knife.

Reinsurance funded by a fixed surcharge on premiums among all individual market insurers in the state smooths the pool and dramatically reduces risk.

If the Pennsylvania proposal goes through and the waiver gets approved, this is an interesting experiment to increase competition.