The affordability and stability of premiums in the individual health insurance market figure prominently in the recent and ongoing debates over national health policy. Often overlooked in these debates is the role of risk adjustment and other risk-mitigation measures in promoting both objectives.

Risk adjustment is a vital tool in preventing community rating in the individual market from causing harmful risk selection against plans and insurers’ consequent risk avoidance. Effective risk adjustment lets insurers compete based on efficiency, networks, medical management, and consumer value, instead of by avoiding uncompensated risks. It also ensures that carriers can offer different levels of coverage, even though plans with the most comprehensive coverage are likely to disproportionately attract unhealthy members.

To better understand the role risk-mitigation tools play in promoting a more stable individual market under both current market rules and proposed rules recently under discussion in Congress and the Trump administration, the Urban Institute, and the American Action Forum convened a day-long, roundtable summit with experts from academia, industry, and the actuarial community. Here, we highlight some of the key themes that emerged during the summit. The full participant list and further findings are provided in an issue brief.

Risk Adjustment In The Current Individual Market Is Mostly Successful But Opportunities Exist For Improvement

In general, risk adjustment consists of payments to or from insurers that compensate for differences between the expected claims costs of an insurer’s members and its premium revenue. Under the Affordable Care Act (ACA), risk adjustment is “zero sum.” Dollars from insurers with low-risk members go to insurers with high-risk members, with no funds flowing into or out of the market overall. Alternatively, risk adjustment can be “guaranteed,” in which an insurer’s payments are not affected by the risk of the other insurers’ members. Guaranteed risk adjustment may require an external source of funding beyond premium payments.

The Center for Consumer Information and Insurance Oversight (CCIIO) is making changes to improve risk adjustment’s correlation with predictable costs and thus its ability to reduce incentives for carrier risk avoidance. For one, it plans to use claims data from the individual market to calibrate risk adjustment starting in 2019. Currently, the CCIIO does such calibration using commercially available data that primarily come from the large-group market. The contemplated shift has important advantages because the individual market differs from the large-group market, but the shift may lock in current market inefficiencies. If certain conditions are now undercompensated, the claims data used to calibrate risk adjustment will reflect insurer responses to that underpayment.

Another issue raised at the summit involved changing risk adjustment from zero sum to a guaranteed payment program. Currently, risk adjustment creates uncertainty and instability because plans may not be able to predict how risk adjustment will affect them. Whether a carrier is a net contributor or recipient of risk adjustment transfers depends on the characteristics of other carriers’ members, which can be difficult to forecast. If risk adjustment was guaranteed to each insurer based on the characteristics of that carrier’s members, plan liabilities and receipts would become less uncertain and more predictable. This would provide some market stabilization, although it would likely require funding external to individual market premiums. Because this step would likely lower premiums, the cost of external funding would be partially offset by savings on premium tax credits.

Different Rules For The Individual Market Could Require Different Risk-Mitigation Measures

Changes to the individual market may change the characteristics of participating consumers. At least temporarily, some form of safeguard could be offered to protect insurers against the risk of mispricing a very different individual market.

Some proposed policy changes, such those included in recent US House and US Senate legislation and in 1332 waiver applications filed by Iowa and other states, would increase state flexibility to define the rules governing the individual market. For example, states could narrow the range of required benefits, increase insurers’ ability to vary premiums based on individuals’ age and known health risks, broaden the spectrum of permitted actuarial variation or other parameters for out-of-pocket cost sharing, and so on. Each state’s configuration might require the recalibration of existing risk-adjustment measures and perhaps the establishment of other state-specific risk-mitigation measures.

But the details matter. States may find it difficult to develop sound models for risk adjustment or other risk-mitigation measures that fit the changed rules of a very different individual market. So far, every state has relied on the federal risk adjustment model instead of develop its own.

If Insurers Are Allowed To Offer Less Comprehensive Plans, Risk Adjustment Could Make Comprehensive Options Possible, But Only By Raising Premiums For Less Comprehensive Coverage

If future policy changes reduced the minimum requirements for coverage, plans’ benefit offerings might all closely reflect the new standard, with issuers concerned about risk selection against more comprehensive plan options. Risk adjustment could make it financially feasible for carriers to offer more generous coverage than the minimum required.

However, under risk adjustment, without substantial external funding, premiums charged for less generous coverage might have to rise well above the amounts otherwise needed to finance such coverage, given the favorable risk profile of likely enrollees. Those additional premium dollars would fund risk-adjustment transfers to insurers providing more generous coverage, which would disproportionately attract members with high expected health costs.

Without robust risk adjustment, more generous plans could cover the additional claims resulting from risk selection only by raising premiums substantially, potentially to unsustainable levels. Put simply, unless enrollees in less comprehensive plans paid increased premiums to defray the costs of enrollees in more comprehensive plans, the more generous plans might vanish.

Risk-Rating For Part Of The Individual Market Could Be Destabilizing

Some proposed legislation would let plans risk-rate premiums, but only for consumers who have experienced recent coverage lapses. Depending on its details, such an approach could encourage healthier consumers to drop coverage because that would qualify them for premiums lower than the community rate. The resulting market bifurcation—healthier consumers in risk-rated coverage and less healthy consumers in community-rated plans—could destabilize community-rated coverage. The latter coverage could become extremely costly or even unavailable. Risk adjustment and risk-mitigation measures might not be able to prevent such outcomes, unless policy makers forbid carriers from lowering risk-rated premiums below the community rate.

Under Almost Any Configuration Of The Individual Market, Policy Makers Face Tradeoffs Between Low Premiums And The Availability Of Comprehensive Options

Effective risk adjustment ensures that carriers can offer different levels of coverage, even though plans with the most comprehensive coverage are likely to disproportionately attract less healthy members. Through the choice of risk adjustment design, policy makers implement risk adjustment more or less intensively, for example, by varying the correspondence of risk adjustment to paid claims or the size of risk-transfer payments. In a zero-sum risk adjustment system, premiums for plans that attract comparatively healthy members must increase to finance risk adjustment for less healthy members.

Policy makers must therefore weigh the relative advantages of an individual market that: includes comprehensive coverage offerings for consumers with known health problems, while raising premiums charged by plans that serve younger and healthier consumers; or charges lower premiums because it mainly or only offers less comprehensive coverage attractive to younger and healthier consumers but does not include options that meet the needs of people with known health problems or makes those options available only at very high cost.

Looking Forward

Risk adjustment involves technical issues and policy tradeoffs that are rarely the subject of entertaining dinner-table conversation. Nevertheless, careful attention to those issues is crucial for the effective functioning of individual health insurance markets.

If risk adjustment amounts do not correlate well with the foreseeable costs of consumers who join the individual market, plans would have incentives to seek out members they predict to be profitable and avoid those they expect to cause losses. That could destabilize markets, yield needlessly high premiums, and prevent some consumers from being offered affordable coverage that meets their health care needs. If insurers are unable to forecast their overall cost exposure under a risk-adjustment regimen, they might limit their offerings, raise premiums to create a margin of financial protection, or avoid the market entirely.

Federal agencies have shown considerable ingenuity in fashioning and improving risk adjustment to meet the needs of carriers and customers alike. This work must continue, regardless of how the rules of the individual market change.

Authors’ Note

Support for this project was provided by Anthem Inc. and Eli Lilly and Company. For more information on the Urban Institute’s funding principles, click here.