New Rules Could Make a ‘Risky Business’ Riskier

Federal bureaucrats haven’t yet figured out a way to repeal the law of gravity, but Florida’s lawmakers are paying attention as the feds implementing the Patient Protection and Affordable Care Act (PPACA) busily chip away at another long-established principle: that when it comes to insurance, an evaluation of risk ought be considered when it’s time to set rates.

That principle explains why motorists whose driving record includes a series of at-fault crashes, speeding tickets, and convictions for driving drunk don’t expect the GEICO gecko or Progressive’s “Flo” to show up at their door offering a big discount on their car insurance.

Indeed, when it comes to setting a price for a particular motorist’s car insurance coverage, past performance – a form of “pre-existing condition,” after all — is an important determining factor, along with a consideration of relevant predictive factors such as demographics (gender, age), location (Miami? Two Egg?), and the vehicle – i.e. whether it’s a brand-new Rolls or an aging Chevy.

Yet when it comes to health insurance as operated under the PPACA, the rules will now be different.  Indeed, there is a growing concern over some of the new price regulations being imposed on insurance companies because of the PPACA.

Consider: As a result of those regulations, insurers won’t be able base their prices on assessments of risk to the same extent they did prior to the PPACA’s implementation. The result is a huge shift in costs. Lower risk policy holders such as healthy young people will see an increase in their health insurance premiums, even as higher risk policy holders see a decrease.

Here’s why: Age is one of several factors that insurance companies have used to set prices for their coverage. This is known as “absolute risk,” a concept the Mayo Clinic illustrated in relation to cancer by saying it “refers to the actual numeric chance or probability of developing cancer during a specified time period.” For example, what are the odds of someone between the ages of 20 and 40 developing cancer? How about between 40 and 60? Or between 60 and 80?

Insurers make these kinds of statistical calculations and projections in order to make sure they can cover the future costs of all the necessary treatments and procedures when policy holders do develop cancer or some other medical condition that requires extended (and costly) care.

Assessing risk has had some limitations, even prior to the implementation of the PPACA. Up until now, for instance, the range in risk-adjusted prices generally reflected a seven-to-one “compression ratio.”

That is, if the cheapest price of a particular policy was, say, $100 per month, then hypothetically the highest price for the same coverage would be $700 per month. Under this scenario, a policy holder in his 60s might pay seven times the amount paid by a healthy 20-year-old.

Now that’s going to change. The new compression ratio will be 3 to 1. As a result, if the cheapest price of a particular policy was, say, $100 per month, then the highest price for the same coverage would be $300.

For insurers, however, there’s an inherent problem with this change. The math does not compute. Under the 3-to-1 ratio, an insurer would be making significantly less money if it kept its rates the same for the healthy young policy holders at $100 a month while also lowering the rate for the higher risk policy holders to $300 per month.

Therefore, an insurer trying to comply with the new 3-1 ratio while also protecting its reserves and making a reasonable profit would need to raise the price for its low-risk policy holders – generally the young — to, say, $200 a month to offset lowering the price for the high-risk folks, in this case to $600 from the previous $700.

This bit of legerdemain thus amounts to a massive generation-to-generation cost shift. That’s ironic because the PPACA was touted as a solution for cost shifting – or at least the kind that occurs when the patients who pay are charged more for their care in order to offset the costs incurred providing “uncompensated care” to those who don’t pay – typically uninsured folks who use the nearest emergency room for their care.

Last week, during the Florida Senate’s Select Committee on the PPACA, Chairman Joe Negron, R-Stuart, took note of this, observing that “There is going to be a cost shift from older to younger consumers.”

Proponents of the new restrictions governing “compression ratios” claim it was unfair to charge such widely varying rates for the same policy coverage. They successfully fought to spread the costs among all policy holders. Their idea seems to be that everyone should be able to afford health insurance, so it can’t be left up to the insurance companies gauge their risks and set prices.

There are two unintentional but yet foreseeable consequences that may emerge from these stricter price controls. As RAND economist Susan Marquis has pointed out, under this new scenario, “…high risks are not charged premiums that fully reflect their higher risk.”

Moreover, because of the tighter 3-1 compression ratios, most people, not just the young, might well see an increase in premiums in order to pay for any underestimations of the costs of insuring higher risk policy holders at the relative discount mandated by the new ratio.

There may also be other unintended consequences. As Michael Cannon, Director of Health Policy Studies at Cato, explained, “Congress cannot police the thousands of subtle ways that insurers would respond to price controls by courting the healthy and avoiding the sick.”

It’s a reminder that a basic principle underlying all kinds of insurance involves spreading individual risks among a much larger group, with the price of participation in a given “risk pool” ideally reflecting the best available predictors of cost, whether it be driving records for car insurance or actuarial charts and family histories for life insurance.

When, in the name of “fairness,” government imposes unreasonable rules that bar health insurers from using the risk-related principles that underlie insurance, the unintended consequence may well be a disaster that leaves the whole system of private health insurance in intensive care.