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Health Policy Brief: Medicaid Premium Assistance

June 7th, 2013

A new Health Policy Brief from Health Affairs and the Robert Wood Johnson Foundation examines a range of policy issues surrounding the concept of Medicaid premium assistance. States that decide not to expand Medicaid under the Affordable Care Act (to date, 19 states fall in that category) could create large coverage gaps for many of its low-income residents. One potential solution to this problem would be to use federal Medicaid expansion funds as “premium assistance,” enabling eligible Medicaid beneficiaries to purchase insurance through its newly minted exchange.

As some states explore this option, proponents hope the program will allow states to enroll more people, improve beneficiaries’ care, and reduce churning between Medicaid and the exchange. However, skeptics believe the program’s cost-efficiency is yet to be proven.

Topics covered in this brief include:

  • How did the idea evolve? In June 2012 the US Supreme Court struck down the mandatory expansion of Medicaid coverage, a key part of the Affordable Care Act’s means to extend health coverage to many poorer Americans. As states consider whether or not to expand their Medicaid coverage, Arkansas has been working out a new arrangement with the Department of Health and Human Services (HHS), using its federal Medicaid funds to assist residents earning just over $15,000 annually to purchase private coverage from that state’s health insurance exchange. Several other states are also exploring the possibility.
  • How can a state receive approval from HHS? For a state to provide premium assistance using Medicaid expansion funds, it must show that the approach is cost-effective compared to enrolling the same people in its Medicaid program. Also, it needs to ensure that the coverage from the exchange meets federal Medicaid requirements. These caveats, plus the challenge of getting any proposal through a state’s legislature, make it a challenging option for states to enact.
  • What’s next? Although the option appeals greatly to conservative leaders looking to reduce the role of government in health care, many details have yet to be determined. States will have to negotiate program changes individually with HHS. If Arkansas can figure out how to make premium assistance work, other states, such as Florida, Texas, Tennessee, and Pennsylvania, may attempt similar program modifications and follow suit.

About Health Policy Briefs. Health Policy Briefs are aimed at policy makers, congressional staffers, and others who need short, jargon-free explanations of health policy basics. The briefs, which are reviewed by experts in the field, include competing arguments on policy proposals and the relevant research supporting each perspective.

Sign up for an e-mail alert about upcoming briefs. The briefs are also available from the RWJF’s Web site.

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2 Responses to “Health Policy Brief: Medicaid Premium Assistance”

  1. whitney59279 Says:

    HMS is hosting a webinar on this very topic Thursday June 13, 2013 at 2pm EST. Please join us in the discussion! Register here:

  2. Thomas Cox Says:

    Apparently insurance is a lot more difficult to understand than one might think. So, some review of Insurance 101.

    An insurance premium can be broken down into four components:

    1. The average cost of claims generated from the policy. In an efficient health care (finance) system with well defined benefits, this is the same for all insurers selecting policyholders at random from the population for which the premium is calculated. This tends to be about 65-85% of insurance premiums for many lines of business.

    2. The average cost of non-claim related costs: Sales commissions, rent, utilities, staff salaries, benefits, taxes, license and fees and court fees, legal consultation etc. This tends to be about 15% of insurance premiums for many lines of business.

    3. The profit margin sought by the insurer.goal

    4. The risk premium the insurer charges to protect its profit margin from the vicissitudes of the insurance business.

    Since the average claim cost is the bulk of the premium and relatively little variation exists in expense ratios from insurer to insurer, I will focus attention on it.

    The key to insurance is that nobody knows, when policies are issued, what the average claim cost will be. The policy issuance costs are very stable, so they do not account for the uncertainty (risk of poor results) insurance is designed to manage.

    The profit margin is a goal, and it is often relatively low, perhaps 5% of the premium.

    The other uncertainty is the correct amount of the risk premium. Here too, nobody actually knows what it should be, because nobody knows what the average claim cost for the insurer’s policyholders will be.

    So, what can we say about the average claim cost and the risk premium. Quite a lot actually.

    Insurance is viable because when an insurer issues hundreds of thousands, even millions or tens of millions of policies, the central limit tells us that there will be very little variation, from the expected amount, for the aggregate loss ratio of all the insurer’s policyholders.

    Absent this remarkable feature, insurers would have no benefit over individual policyholders and insurance itself would be impossible.

    Second, when an insurer issues this many policies the risk premium it needs to be very confident of earning its profit margin is very low.

    A very large insurer, such as a state medicaid program will have a very modest variation in its average claim cost from year to year and can adequately meet its operating goals with a very modest risk premium factored into its premiums (A state budget, funded perhaps with large numbers of federal dollars).

    In short, the Medicaid program, insuring all the Medicaid eligible citizens will have very predictable costs and will not need a high risk premium. There is another advantage of course, because the Medicaid doesn’t seek to earn a profit. So the amount of money needed to fund a Medicaid program is the average claim cost plus the expenses of the Medicaid program and we can actually eliminate the profit margin and risk premium.

    Now, let’s consider what happens when the Medicaid eligible beneficiaries are given vouchers or otherwise transferred to the private insurance sector.

    In an efficient health care finance system the average expected claim cost doesn’t change at all because the eligibility for benefits do not change. The largest chunk of the cost of Medicaid remains the same in an efficient health care finance system whether the insurer is the state exchange/Medicaid program or a private insurer..

    Policy issuance costs will actually rise because the determination of who will get Medicaid funded premium support is to be done by the state AND the insurer will still have policy issuance costs..If a voucher/premium support program is used the costs to establish eligibility for vouchers/premium support is the same process needed to issue a Medicaid card PLUS the policy issuance costs of the private sector insurer.

    But the big problem, and why vouchers/premium support for Medicaid and Medicare can NEVER, NEVER, NEVER work is that the year to year variation in these smaller insurers’ average claim costs may be ten times the variation in average claim costs for the Medicaid program. For example, suppose we encourage competition among many (100) insurers, each of whom accepts 1% of the eligible Medicaid beneficiaries…

    If the variation around expected losses was such that over many years the actual Medicaid losses ran between 70%-80% of premiums, the average losses for one of the small insurers would be 10 times as large. The small insurers would have average losses that varied between 25-125% of premiums. Understanding the portfolio size dependence of the variation in the average loss ratio is the KEY to insurance.

    How much should these small insurers get to accept their much higher risks of adverse financial outcomes?

    If an insurer wants to be very sure that it is going to earn profits, it should be asking for enough money to cover all its losses in a reasonably bad year, plus its routine expenses and an amount equal to its profit margin.

    To accomplish such a goal its risk premium should be quite high, enough to cover a loss ratio of 125% of its premiums plus its policy issuance costs and its profit margin.

    Once you start focusing on the realities of insurance, and the impact of portfolio size, you quickly conclude that no private sector insurer can possible offer identical benefits at a lower cost than the larger, more efficient Medicaid program.

    True, about half of the insurers will have actual claim costs that are lower than expected. They will make excessive and inefficient profits. So, as a system, transferring Medicaid beneficiaries to these companies will have cost more than their care would have cost. This is certainly not good.

    Half the insurers will have average costs that are higher than expected. Some of these will still earn their profit goals if the risk premium they received covers the discrepancy between the expected claims cost and their actual claims cost.

    But about 35-40% of these insurers will have average claims costs that exceed the combination of the average cost provision, the profit margin and the risk premium in the payment passed to them to take on the Medicaid beneficiaries.

    These 35-40% of insurers will lose money. Some will shut their doors without covering all the costs of their beneficiaries. Since they will be bankrupt Medicaid cannot get their payments back and their beneficiaries will still have to be treated. Who do you suppose is going to pay for their treatment if their private insurer becomes insolvent.

    Want a good business plan? Open up 10-20 private insurer all of which contract to take on Medicaid beneficiaries.

    About half of them will have much higher than expected profits because their Medicaid beneficiaries are healthier than expected. Those profits can be converted to executive bonuses or stockholder dividends. These profits will be in excess of 10% per insurer.

    About 10-15% of your insurers will not experience losses. So their profits can also be privatized but here the average profit margin is about 5%. Still, not so bad.

    That leaves the 35-40% that will incur losses, leaving beneficiaries’ illnesses and injuries to be socialized to taxpayers when these insurers are shut down. You shut down those insurers, foist the losses on to the taxpayer and walk away with virtually guaranteed profits from what was supposed to be a risk enterprise.

    If it walks like a duck, quacks like a duck and smells like a duck it is probably a duck.

    The most efficient way to insure the entire Country’s Medicaid eligible population would be through a single Federal Medicaid program. Anyone who tells you that small insurers can do this at the state level, at a cost lower than Medicaid does already is either innumerate or a liar.

    As one might realize, this is also the reason that Rep Ryan’s Medicare voucher program can NEVER, NEVER, NEVER work.

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