Six years after passage of the Affordable Care Act (ACA), the individual and small-group insurance markets—the markets that the ACA remade—are still having growing pains. Health insurers have endured large losses and a number of ACA-created co-ops and other small insurers have failed. Consolidation among providers and insurers is an increasing and concerning trend. And many insurers are poised to raise premiums substantially for 2017, further stoking frustration with the insurance industry.

Even as the press vilifies insurers, however, the ACA’s supporters can’t afford to be indifferent to their struggles. Private insurers sell the managed care plans that are the central vehicle for expanding access to middle- and lower-income Americans. One day, those plans may cover many of the 11 percent of Americans who remain uninsured.

Part of insurers’ difficulty is that the risk pool in the individual and small-group markets, particularly on the exchanges, is sicker and smaller than originally projected. But the three programs—reinsurance, risk corridors, and risk adjustment—that the ACA’s drafters hoped would help stabilize premiums in the revamped markets have also not performed as expected. Dashed expectations have led to market instability and to a flurry of lawsuits around the “3Rs.” What does this unpredictable and difficult situation mean for 2017 and for the ACA more generally?

The 3Rs and the Individual and Small-Group Markets

Each of the 3Rs has generated unique operational challenges and political controversies.

Reinsurance is a three-year program that makes payments to insurers for their particularly costly members. Per the ACA, reinsurance payments to insurers are supposed to decline each year. At the same time, some of the funds collected each year are supposed to be returned to the U.S. Treasury. Because collections were lower than expected, however, the Department of Health and Human Services (HHS) opted to prioritize payments to insurers without directing funds to the Treasury.

HHS recently announced that it would pay insurers 55 percent of what they claimed based on their 2015 experience. Had HHS not prioritized payments to insurers, reinsurance payments would be lower. Nonetheless, the move was controversial: Congressional Republicans are now holding hearings into whether HHS’ effort to prioritize insurers contravened the ACA.

The risk corridor program is also a temporary, three-year program. Insurers that sustain heavy losses are supposed to receive federal support; by the same token, highly profitable insurers are required to return some of their gains to the federal government.

Recent budget legislation effectively required risk corridor payments to be budget neutral, which blocked HHS from finding additional funds to make risk corridor payments. Partly as a result, HHS could only pay out 12.6 cents on the dollar for insurers’ 2014 losses. Similar shortfalls appear likely for the 2015 year, which will be paid this fall. Prominent GOP leaders, including Senator Marco Rubio, have derided the ACA risk corridors as a “slush fund” for insurers. Given the political climate, it appears unlikely that the budget neutrality requirement will be lifted.

Risk adjustment is the only permanent premium stabilization program. In principle, it’s supposed to eliminate insurers’ financial incentive to “cherry pick” healthy enrollees or “lemon drop” sick members. To that end, each insurer must submit demographic data and clinical codes to document the risk profile of its membership. The federal government then totals the risk adjustment score of each insurer in a given state and redistributes money within the state in a zero-sum fashion. Insurers with the highest risk scores are compensated with funds from insurers with lower risk scores.

But the devil is in the details. While the average payout is about 10 percent, risk-adjustment distributions have topped 20 percent of premiums for several smaller insurers, leading to charges that risk adjustment doesn’t accurately measure members’ actual risk, but instead rewards those insurers who most aggressively “code capture.” Such insurers may, for example, pay vendors to sift through claims data and push physicians to assign all applicable diagnosis codes to members.

The Litigation

The unexpected difficulties surrounding the 3Rs have damaged the ACA-reformed insurance markets. Several insurers, including United and Humana, have lost hundreds of millions of dollars that they expected to have repaid. Partly as a result, they have chosen to leave the ACA markets in several states in 2017. Other insurers, including a few of the Blues, the backbone of the exchanges, are narrowing their plan offerings.

While insurers and regulators are still negotiating 2017 rates, it appears likely that rate increases will be higher next year than any other year since the ACA was implemented. Meanwhile, insurers with small capital reserves—most visibly the co-ops, but others too—are going out of business. Two thirds of the co-ops have failed, and more will likely fail by January 1, 2017.

Predictably, insurers that were promised relief in the event of large losses are now suing the federal government.

Risk corridor litigation

Insurers have so far filed at least six lawsuits in the Court of Federal Claims to recover money due under the risk corridor program. Although Congress has not fully funded the program, the insurers argue that the federal government has promised to make those payments. The insurers believe that, under the Tucker Act, they can recover the promised funds in court.

The insurers are likely to prevail in these lawsuits — eventually. HHS acknowledges that the insurers are entitled to the promised money under the ACA. And, as the Government Accountability Office’s bible of appropriations law explains, “[a] failure to appropriate [money for a program] will prevent administrative agencies from making payment, but … is unlikely to prevent recovery by way of a lawsuit.”

For now, however, the federal government has moved to dismiss the cases, arguing that they have been brought too soon. In the government’s view, insurers will only know what they’re owed under the three-year program once it has run its course. If that’s right—and insurers cannot know precisely what they’re owed until the end of the three-year program—the eventual date of recovery will be delayed to fall 2017, when HHS will likely make its final risk corridor calculations. Thinly capitalized insurers and co-ops may have a difficult time weathering the delay.

Risk adjustment lawsuit

A struggling co-op, Evergreen of Maryland, recently filed suit to challenge HHS’ implementation of the risk adjustment program. In Evergreen’s view, the administration has arbitrarily designed the program to prevent insurers from taking full account of the health status of their members. Evergreen also believes that HHS improperly ousted states of the responsibility to administer the program and that, in any event, the risk adjustment program should have been amended when it became clear that Congress would not fully fund the risk corridor program.

On the merits, Evergreen’s lawsuit appears weak. Under the law, HHS is afforded wide discretion to administer the risk adjustment program. Even though risk adjustment has contributed to the instability of certain small insurers and could be improved—and HHS is in fact working to improve it—it doesn’t follow that HHS acted unlawfully in structuring the program in the first place. Even though the case appears weak, however, other insurers are expected to follow in Evergreen’s footsteps.

In the meantime, other risk adjustment fights are brewing. Earlier this month, the Illinois insurance commissioner attempted to block a co-op, Land of Lincoln, from paying into the risk adjustment program until HHS pays what is owed on risk corridors. When the federal government rejected the insurance commissioner’s gambit, Land of Lincoln went into liquidation. This early tussle between state and federal officials could presage additional lawsuits and federalism contests.

‘Selective netting’ case

The Iowa Insurance Commissioner, in its role as receiver for the estate of a failed co-op, has sued HHS in an Iowa federal court to block it from recovering on its loans to the co-op before other creditors are paid back. Among other things, the commissioner maintains that HHS owes the co-op’s estate money under the risk adjustment, reinsurance, and risk corridor programs.

In his view, governing regulations require that 3R money should be “netted” with the amount that the estate owes to the federal government on its defaulted loans. For its part, HHS believes that the Iowa court lacks jurisdiction and denies engaging in any “selective netting.” The court has yet to act on the case.

What Do These Challenges Mean For the Future Of ACA-Reformed Markets?

Unanticipated difficulties with the 3Rs have put HHS in a tough spot. On risk corridors, Congress has tied the agency’s hands and spurred a half-dozen massive lawsuits in the Court of Federal Claims. On risk adjustment, small insurers facing unexpected liabilities have taken their concerns to both Congress and the courts. And on reinsurance, the agency’s decision to prioritize payments to insurers over Treasury has sparked legislative outrage and congressional subpoenas of HHS officials.

Although HHS cannot avoid this quagmire altogether, it is taking concrete steps to ease the situation. It has proposed changes to the risk adjustment program, for example, though it remains suspicious of simplistic “circuit breaker” solutions that set limits on the amount any one insurer can owe. The agency is also providing risk-adjustment webinars for insurers that submit risk adjustment data to CMS.

But the risk adjustment program does not add money to unprofitable markets; it only moves it around. More ambitiously, HHS has announced a string of initiatives designed to convince more of the so-called “young invincibles” to purchase insurance this fall. Ultimately, growing and improving the individual and small-group markets’ risk pools is the most effective way to help insurers.

But make no mistake about it: trouble with the 3Rs has spooked insurers and raised questions about the viability of the ACA-reformed markets. Based on preliminary analyses, the 2017 exchanges will have fewer options, larger premium increases, and less generous benefits than any year since the ACA marketplaces came on line in 2014. Congressional intervention has damaged the ACA markets — hurting both insurers that sell health plans and the consumers who purchase them. Perhaps the exchanges will find their footing again, but the difficulties with the 3Rs serve as a stark reminder that ACA implementation remains much harder than supporters anticipated.