Editor’s note: The topic of risk corridors will also be addressed in an upcoming Health Policy Brief. The briefs are produced by Health Affairs through a grant from the Robert Wood Johnson Foundation.

The Department of Health and Human Services (HHS) stated on March 11 in its Preamble to the Final Notice of Benefit and Payment Parameters for 2015 that it intends to implement the ACA’s risk corridor program “in a budget neutral manner.”  HHS had previously indicated in its March 2013 Notice, when insurers were making decisions about marketplace participation, plan design, and pricing, that budget neutrality during the program’s three-year life was not required by statute and that “payments will be made regardless of the balance between receipts and payments.”

Then, on April 11, HHS issued a FAQ explaining how it will achieve budget neutrality.  The upshot of the new policy is that health insurers can no longer be assured of receiving risk corridor payments as specified in the law.  This has produced considerable angst among insurers, especially those who could be financially challenged if their costs turn out to be higher than projected when they priced policies for 2014.

Addressing Uncertainty    

Given the scope of the ACA’s insurance market changes, it was understood that insurers would face enormous uncertainties when pricing plans, including the percentage of people who would enroll, their health status, their likely utilization of medical services, and competitors’ pricing.  Similar to an existing program for Medicare prescription drug coverage, the ACA’s risk corridor program was intended to partially shield insurers offering qualified individual coverage from unexpectedly high costs (after consideration of the law’s “risk adjustment” and “reinsurance” payments) in relation to premiums during 2014-2016, thus encouraging participation in the new markets at more affordable premiums.

The statute specifies that an insurer will be reimbursed (after submission of final data the following July) for 50 percent of “allowable” costs from 103 to 108 percent of “target” costs in relation to its premiums for the year, and 80 percent of any costs above 108 percent of the target.  If costs are lower than the target, an insurer will pay a fee equal to 50 percent of the shortfall within 92 to 97 percent of the target, and 80 percent of any shortfall below 92 percent.

The risk corridor program attracted little attention before the President’s decision last November that insurers could continue renewing health policies that failed to meet the ACA’s new coverage and rating rules until October 1, 2014 (later extended until October 2016).  That change increased the likelihood that risk corridor payments could exceed receipts if policyholders who extend coverage are, on average, healthier than new enrollees in the exchanges.  Given HHS statements that budget neutrality was not required, the change contributed to allegations by Senator Marco Rubio and others that risk corridor program could produce a substantial “bailout” of health insurers.

The Final Notice

The Final Notice allows for relatively greater risk corridor payments in states where more pre-ACA policies are extended.  But the adoption of the budget neutrality criterion represents an important change that has the potential to constrain risk corridor payments significantly. According to the details provided on April 11, if risk corridor receipts for 2014 are less than promised payments, payments will be proportionally reduced to equal receipts.

Any receipts for 2015 would then first be used to “payoff the payment reductions,” before funding promised payments for 2015.  Conversely, if receipts exceed payments for 2014, the excess will be used as needed to help fund promised payments for 2015.  A similar process will continue for 2016.  HHS “will establish in the future” how payments will be calculated if payments don’t match receipts in the final year.

As a result, if promised payments exceed receipts for 2014 , the year with the greatest pricing risk, insurers whose costs exceed the thresholds will receive after July 1, 2015, lower payments, perhaps much lower, than reasonably would have been anticipated given the statute and prior HHS statements.  They would likely be made whole a year later from receipts for 2015.

But, unless receipts for 2015 were large enough to cover the 2014 reductions and promised payments for 2015, payments would be reduced for insurers whose costs exceeded the targets in 2015.  Those insurers might be made whole from receipts based on 2016 , but those receipts might be insufficient to fund promised payments for 2016, with the ultimate resolution depending on HHS discretion.

HHS has expressed confidence that receipts will equal or exceed payments during the program’s life.  But it’s not at all clear why surpluses of receipts over promised payments, if any, for 2015 or 2016 would be expected to fully fund promised payments if payments are reduced for 2014 (or 2015).  This is especially true given a March 14 HHS proposal to reduce target costs in the risk corridor formula by several percentage points for 2015, thereby increasing potential payments and reducing potential receipts, and making it more likely that payment reductions would not be eliminated by 2017.

The Congressional Budget Office projected in May 2013 that the risk corridor program would be budget neutral.  In February this year, it then projected receipts of $16 billion and payments of $8 billion over the program’s life, based in part on historically favorable for the Medicare Part D risk corridor program.  But its update in April projected $9 billion of risk corridor receipts and $9 billion of payments, stating that the Administration has sufficient flexibility to ensure that “the program will have no net budgetary effect over the three years of its operations.”

Questions Remain

Regardless of HHS assurances and CBO projections, the potential magnitude of risk corridor receipts and payments and the effects on particular insurers and markets is highly uncertain.  The substantial uncertainty facing insurers participating in the exchanges in 2014 has only been partially resolved as they develop rates for 2015.  There remains a real possibility that promised risk corridor payments could significantly exceed receipts for 2014 or later.  If so, payment reductions could be problematic for some insurers, especially for smaller companies and/or new entrants.