The purpose of reinsurance in the ACA

Reinsurance has several flavors and purposes in the ACA individual marketplace.  The first flavor is traditional commercial reinsurance.  Here an insurer buys protection from large claims from another, bigger reinsurer.  The reinsurance contracts can either be fairly general such as the reinsurer will pay 20% of the claims between $500,000 and $1,000,000 and 35% of the claims above $1,000,000 (these numbers will vary greatly) or more specific where the previous terms apply to anyone except for Bob, Mary and Joe.  These reinsurance contracts limit downside risk to the insurer for a fairly small(ish) population by spreading the rare risk of a massive claim across hundreds of millions of lives.  Another flavor of reinsurance is known as “quota” reinsurance where an insurer will have a contract where the insurer gives the reinsurer a percentage of premium to cover a percentage of claims.  This effectively rents capital and offloads risk from the insurer’s books.

Federal ACA reinsurance is a super-high cost claim coverage.  Each insurer pays into a federal pool $0.25 per member per month.  That money is then used to pay a fraction of the claims that are over a million dollars.  This eats up some of the extreme tail risk for insurers.

Both traditional private and federal reinsurance use premium revenues from a large pool to cover idiosyncratic high cost events.  They smooth any one insurers’ claims experience by spreading good luck and bad luck nationally and internationally.

State waiver/1332 reinsurance programs are different.  They look superficially similar to the other reinsurance programs in that a pool of money is used to pay for some proportion of a pre-defined set of high cost claims or claims of individuals whose diagnoses set makes them likely to have high claims.  The big differences between state reinsurance waivers and other types of reinsurance is intent and therefore where the money for that pool comes from.  The intent of state based waivers are mostly to lower gross premiums.  Gross premiums are relevant to non-subsidized buyers who are price level sensitive and price-spread insensitive.  Non-subsidized buyers (mostly over 400% FPL) pay the full gross premium.  They are also one of the few groups in America who pay transparent high premiums without direct or even indirect subsidy.  It is painful.

As a class, this is a group that can organize, scream in pain and get heard.  State reinsurance waivers have been a means of assistance in response to their real pain.   States apply for these waivers partially to smooth claims experience across insurers but primarily to lower gross premiums and reduce pain for non-subsidized buyers.  These programs work by the state injecting some source of non-premium funds into the pool of funds that are used to pay claims.  Premiums no longer are required to be sufficiently high to pay for all of the claims and overhead.  Since claims are mostly independent of the source of funding to pay them, premiums go down.  This then creates an incremental wedge of federal funds that would have been spent on subsidies to be used to also lower premiums.  The end result of a state reinsurance program is to lower gross premiums by slightly increasing net subsidized premiums and adding state based funds.

This is our reality as it is today.

It is not the reality as it will be by this time next week.

Federal reinsurance and private reinsurance arrangements will still have risk spreading and smoothing functions.  Incentives, structures and outcomes won’t change under the ARP.  Risk spreading and smoothing is quite valuable.

However, state reinsurance programs will be intellectually and programmatically contradictory.    These programs are mostly justified on the basis of reducing premiums for a fairly large class of people who are premium level sensitive.  The ARP will dramatically shrink (but not eliminate) the pool of people who are premium level sensitive to either older families with incomes five, six, seven or eight times federal poverty level or more where the benchmark plan is less than 8.5% of income or very young people earning over 300% FPL in very competitive markets.  But most people who currently benefit from 1332 reinsurance programs will no longer benefit from the program.  They will be transformed into price-spread sensitive buyers who are mostly if not completely indifferent to the premium level due to the expansion of subsidy eligibility to anyone who pays more than 8.5% of income for the benchmark silver plan.

At this point, most of a state’s 1332 reinsurance waiver is acting as a transfer back to the federal treasury as the blending of state revenues to the claims paying pool of funds merely lowers premiums and lowers federal subsidy spending.  And if there is value in a state 1332 program in eating some types of risk and more importantly, smoothing risk in order to make a state market more attractive to new entries for more competitive and more price-converged markets, most of those benefits accrue again to the federal treasury as spreads get compressed and benchmark premiums decline.

In the universe as it will be next week, state reinsurance waivers in 2022 don’t make a ton of sense.