# Hypothetical Mean

Commentary from an Actuarial and Economic Perspective

## The \$20,000 Annual Cap on Medical Costs: Healthcare Reform and You, Part II

Part II: The Math of Individual Coverage

The benefit plan defined in the House healthcare reform bill is designed to limit a family of four’s annual healthcare expenditures to under \$20,000 in 2013, assuming they are at 400% of Federal Povery Level (FPL) or lower.  Here’s how they do it.

First, the direct premium subsidies in the bill will limit the premium paid by a family of four to just over \$800 per month, or \$9,680 per year (see Section 243; assuming 400% of FPL and no increase in salaries between today and 2013).

The plan that can be purchased for that price, or lower, is the “basic plan” that will be designed to cover 70% of your allowable medical costs.  For a typical plan that might have \$10,000 in expected allowed costs, this means that the family of four will expect to have \$3,000 in additional copayments and coinsurance amounts.  The total expected outlay would therefore be less than \$12,680 in after-tax dollars.  Impressed yet?  If not, there’s more.

This plan separately caps the household’s potential out of pocket cost.  For that same family in 2013, the House bill promises that you will not owe more than \$10,000 per year.  The total annual out of pocket outlay would therefore be capped at \$19,680 for that family.  This out of pocket maximum is much higher than the expected outlay in 2013.  In later years, the expected outlay will increase faster than the out of pocket maximum, pushing those values closer together.  I’m not sure why they chose to do that.

This maximum \$19,680 will have to come from after-tax income.  Most families at 400% of FPL are in a 15% tax bracket and perhaps a 5% state bracket.  That means that \$24,825 in pre-tax earnings will cover the maximum outlay designed by the basic plan in the House.

For the same family of four earning 200% of poverty, things look much better.  Their maximum premium is \$2,200, with (potentially) the same out of pocket maximum.  Their total maximum out of pocket cost would then be \$12,200.  On average, they would expect to pay “only” \$3,700 in cost in after-tax dollars, however, because they will enjoy another feature of the bill: lower copayments for poorer families.  This after-tax difference of about \$9,000 represents a sizeable implicit penalty that this plan will levy against those who get wage increases, take on second jobs, etc.  When making forecasts, the CBO assumes that this implicit penalty does not signficantly affect the labor market.

For those earning more than 400% of FPL, there is no cap on premiums, but the \$10,000 cap on out of pocket medical expenses remains in the base plan.

Expect the Senate Finance Committee to be much stingier with subsidies, thereby raising these annual cost levels.  Also expect the Blue Dogs to fight to reduce these subsidies, also increasing these annual costs.  Lastly, this bill is planned to increase the size of all deficits in 2013 and beyond.  This increased budget pressure in the second half of this decade will force budget cuts, also decreasing these subsidies.

Therefore, I suspect that the \$20,000 annual cap on costs is a best-case scenario.  We do need healthcare reform.  I’m concerned that the focus on federal deficits and budgets has obscured the fact that this bill does little to solve the average family’s problems.  If anything, it could make it worse.  Sad.

The first part of this series was posted here.

Written by Victor

July 30, 2009 at 3:47 am

## What Healthcare Reform Means for You

Part I: Individual Coverage Purchased after 2013

The House healthcare reform bill will significantly change the way you buy individual coverage.  Here’s a summary of the more striking provisions, and possible ramifications:

• Beginning in 2013, all individual insurance must be purchased through the government’s Exchange.  No more ehealthinsurance.com, although I wouldn’t be surprised if they aren’t a bidder for the government contracts to build the Exchange.
• Premiums on young men must be at least 50% of the premiums charged men age 64; the impact of this will differ around the country.  In states like New York where full community rating is already in place, this may lower premiums for young men; in most of the country, this will significantly increase premiums for young men.
• Premiums cannot reflect the cost differences between men and women; since women utilize care more intensely than men, at least through most of the age spectrum, this means that women will enjoy better value from plans offered after 2013.
• You will have up to 4 possible plans to choose from, three of which will basically be the same but with slimmer copays, with the fourth potentially adding dental and vision benefits.  These plans will focus on the use of copayments, avoiding coinsurance whenever possible.  Plan design will be governed at the national level through the Benefits Advisory Committee.
• Member copayments will increase faster than medical cost inflation which in turn will almost certainly continue to increase faster than the Consumer Price Index; the reason for the rapid rise in copayments is technical, and I’ll reserve for another post.  This is also little different than what is going on in the market today; the important distinction is that the Exchange plans will be tightly constrained by this law in how they deal with this mathematical problem whereas in today’s market, consumers decide how they want to spread this cost around.
• Over time, the basic plan will converge into something that will look like a \$5000 deductible, 100% coinsurance major medical plan; the other plans will likely follow suit unless Congress intervenes.
• For members with incomes less than 400% of the Federal Poverty Limit, payments will be made by the Commissioner to the offering healthplans to help offset lowered copayments.  Healthplans, in turn, are to require lowered copayments, consistent with subsidized actuarial values.  How this consistency is determined is quite complex theoretically, and the proposed law is silent on measurement and enforcement, other than that the Commissioner’s actuarial models are to be used to establish the size of the payments from the Commissioner to the healthplans.
• For healthy members, the basic plan will almost certainly be the best value.
• For poor members, the basic plan will almost certainly be the best value, since the plan will be enhanced, for free, through government subsidies.
• You will need to annually file evidence of coverage.  Healthplans will send you information on what months you had qualifying coverage.  You will owe 2.5% of gross income in taxes if you did not have qualifying coverage for yourself or your dependents.  This is prorated if you let coverage lapse for any portion of the year.
• You will need to notify the commissioner when your income or family status changes.  This way your subsidies and plan design can be reconfigured by the Benefits Advisory Committee.  Failure to do so may result in penalties, especially if your benefits or subsidies should have been reduced because of an increase in income.
• If you don’t like the commissioner’s reconfiguration (i.e., change in copayments), you will be allowed to change plans during your annual election period.

Some other items (either more obvious or related to features that exist today):

• The policies won’t have pre-ex periods or exclusion riders.
• The first few years are likely to see volatile premiums; after that, however, rate increases should be more stable than what you see in the individual market today.  That’s because rate increases due to aging will be limited (you will pay a much, much higher premium when young, but the flip side of that is that your premiums won’t increase as much as you age), rate increases due to “duration wear-off” won’t exist because initial underwriting won’t exist; and you will be part of a larger risk pool.
• The larger risk pool likely means you will be included in a higher average cost risk pool, but administrative expenses may be somewhat lower because of reduced underwriting costs.  This improvement in administration costs may be offset by behind-the-scenes reporting requirements for risk-adjusters, monthly copayment recalculations, plan coordination, and increased bureaucratic oversight.  The CBO has net yet modeled these administrative costs.

For CNN’s perspective on what healthcare reform means to you, see this piece by Sahadi.  Obviously, I think CNN’s discussion focuses more on the talking points than the likely result of the specifics of the legislation.  Lastly, these plans are in flux and so any of the aforementioned opinions or predictions may be obsolete at the time of this writing.  I also wrote these while reading the legalese of the House bill while playing with my oldest son.  Caveat emptor.  But I feel confident that these predictions are reasonable enough that they should be contravened carefully before being dismissed.  The devil is truly in the details.

Part II of this series details the House’s \$20,000 annual household cap on medical costs.

Written by Victor

July 25, 2009 at 3:18 pm

## Adventures of an Actuarial Therapist

It was a dark and stormy night.  I was closing up my office, and this scraggly old man in a red, white and blue top hat came scrambling in.  He called himself Sam.

Sam: Hey doc, you gotta see me.  My fiscal situation is a “ticking time bomb”.  We’re racing toward financial ruin, and I need to talk.

Me: Take a seat on my couch.  Tell me more.

Sam: Let’s talk Medicare.  In the near-term, the aging of the population is estimated to explode its costs beyond our means.  In the longer-term, medical innovation and utilization patterns threaten to bankrupt the country.

Me: Sounds rough.  Any ideas on how to fix the problem?

Sam:  I thought I’d start by offering somewhere between a \$1 trillion and \$2 trillion entitlement to help working age people get insurance.

Me: I think I missed something.

Sam: No, you didn’t.  I think that if we can wring a trillion dollars of revenue and cost savings out of the American public and Medicare, then we can give that extra entitlement and not speed up our impending fiscal disaster.  If we are lucky, we can put private insurance companies into the same situation I am.

Me: You mean fiscally insolvent?

Sam: Don’t worry.  We’ll set up a public option that will always be there if private insurance can’t survive under our new mandates.

Me:  I’m still stuck on how you are going to help Medicare or your fiscal situation.

Written by Victor

July 18, 2009 at 2:08 pm

## The House’s Benefit Advisory Committee

Democrats like to complain about insurers denying claims to boost profits.  I debunked that linkage in my immediately prior post.  But what I have found truly amazing is that neither the House nor Senate HELP bills propose a mechanism for changing insurer claim denial practices.  What’s worse, people think that they have.  Here’s ABC News:

The House bill includes a proposal for a so-called health benefit advisory committee, which would include 25 people appointed by the president and the surgeon general to determine benefit eligibility.

“The decisions, right now, are being made by insurance companies. And I think a whole lot of people out there are having bad experiences because they know that recommendations are coming from people who have a profit motive,” the president said in an interview with ABC News’ Dr. Tim Johnson Wednesday. “If I’ve got a panel of doctors and experts whose only motivation is making sure that we get the most bang for the buck in our health care, I think that’s a situation that most Americans would feel pretty good about.”

Notice that this committee, described in Section 123 of the House draft says nothing about approval of specific claims.  Instead, what it does is work on benefit design.  For the uninitiated, what that means is that the Benefit Advisory Committee will determine whether chiropractic therapy has to be included as part of the basic benefit or whether that is an ancillary coverage insurance companies could voluntarily provide.  They will also determine maximum allowable copayments and coinsurance provisions, weighing the impact on “public health” and the ability to reduce “health disparities”, whatever the heck that that means.

What Obama’s channeling about public dissatisfaction has nothing to do with benefit design, however.  There will always be those grey areas, however, where a particular person is asking for an advanced treatment or an experimental approach, or a desperate hail-mary treatment.  The House bill is silent on those issues, yet those issues proved electric in the recently concluded campaign.

Currently, profit-driven insurers sell what people will pay money for.  If they want their lifestyle drugs covered, they will get them.  If you don’t like one insurer’s attempt to steer you to generics, you can pick a different copay structure or dump that insurer.  To date, state legislatures have borne the burden of requiring coverages when they saw the need.  The House’s Benefits Advisory Committee will be the federal voice for mandated benefits.  With very big teeth.

I think what we will find is that this committee will become politicized and will do a very poor job of mandating truly public health services, especially relative to the status quo where most of this is already covered somewhere.  Instead, I predict that this Committee will become a lobbying target of choice for various practices and require significant attention from insurance carriers, distracting them from the preferred goal of designing benefits that people will value highly as evidenced by voluntary purchase.

The bottom line: there is something called benefit design and there’s something called claims approval.  Those are two different functions and the House and Obama seem focused on the first, while the latter is what, I believe, has soured people’s perceptions of insurers.

(for this post I chose to ignore a potential alternative interpretation of Obama’s quote, which is that he believes that people are currently dissatisfied with their insurance because it covers too many things and therefore doesn’t provide sufficient bang for the buck; in this interpretation, they would trust the government to trim their benefits but not private insurers.  Possible, but I just don’t see it.)

Update:  Section 132 of HR3200 does provide for an additional layer of claim denial review.  It’s just three paragraphs long, and I’m not clear at all what it will accomplish that the current insurance department / judicial review process does not.  Therefore, I stand by my assertions above, but I thought I’d mention this section, in case people want to dig that out.

Written by Victor

July 17, 2009 at 3:41 am

## Healthcare Benefit Determinations and the Profit Motive

with one comment

The public and journalism seems to be very confused on the linkage between claim denials and insurer profits. They also seem to ignore the role of the actuary as the middle-man in that linkage.

There is the common misperception that if a company denies a transplant, say, then the reduced claim costs flows to the company’s bottom line as profit. This linkage is tenuous, at best.

1) Many people aren’t actually insured by insurance companies; they are instead insured by their employer and a reinsurer. The “insurance” company in such situations has been hired to perform claims administration and to make their medical staff available as an arbiter for benefit disputes. This is the situation Cigna was in back in 2007 in the now infamous Sarkisyan transplant denial, made famous by John Edwards (recently resurfacing in this CNN article).

2) To price fully insured groups, large insurers develop “manual” rates, calibrated to the company’s claims experience.  As such, the actuaries involved either implicitly or explicitly consider the company’s past business practices, as dictated in Actuarial Standard of Practice #5 (Section 3.2).  What this means is that companies that are stingy with benefit determinations tend to have lower claims experience and therefore have lower manual claims and lower premium rates. This means that the “benefit” of the denied claims flows not to the insurer’s bottom line, but to the subsequently insured members.

3) More directly, denied claims don’t fall to the employer’s renewal in those situations where there is an experience rating.  This means that the future premiums for the employer are lower because of the denial.  This stream of lower future premiums may help retain the group business and therefore be a profitable venture for the insurer.  However, it is predicated upon the group’s continued satisfaction with the benefit plan itself and is not the direct linkage frequently suggested.

Now, it is true that actuaries can be tricked.  Companies can also change their business practices suddenly, resulting in a one-time windfall.  More often, however, healthcare works the opposite way, with new procedures and processes being put into place all the time, resulting in higher future claim costs and higher future premiums.  Actuaries account for this in an opposite way of claims denials: by “trending” their observations of the past.

I am fully aware of the fact that the bullet points mentioned above are generalities and there are exceptions.  I also am aware that I am greatly simplifying the work of actuaries.  However, I believe that the general truth is as stated: claim denials tend to be reflected in premium levels more than profit levels.

Policy Implication

This has an important policy implication that I personally like.  Specifically, people who eschew heroic medicine can tend to find insurers that don’t allow heroic medicine.  People who want heroic medicine, in contrast, can commit a priori to plans that approve heroic medicine.

The reality of today’s marketplace is that legal liability and the involvement of employer choice in the insurance decision water down the ability of people to select in the type of claims approval regimes that they would ideally prefer.  But as we consider reform options, I think it is important to evaluate whether the reforms will push us closer to allowing voluntary selection into relatively generous plans or not.

Written by Victor

July 17, 2009 at 3:18 am

## Fiscal Irresponsibility

The CBO preliminarily estimates the cost impact of the House healthcare bill to be \$1,042,000,000,000 over a 10 year period.

The Joint Committee on Taxation estimates that the proposed income tax surcharge and other revenue raising items will raise \$583,000,000,000. Superficially, you would think that the House has “paid for” roughly 56% of the cost of the healthcare insurance provisions in this bill. That’s what House Democrats want you to think. But you would be very wrong.

The taxation would begin in 2011. The spending would begin a phase-in in 2013. By the time the spending is fully phased in, the annual tax revenues would pay for less than 45% of the spending provisions. By 2019, there’s a \$115,000,000,000 per year hole blown into the federal budget, prior to the anticipated but still unscored Medicare spending reductions. The longer you extend the horizon, the less of this program they have actually paid for.

This is represented graphically below. The next time someone says that these bills will be “paid for”, remember that you can play funny games with the 10-year scoring window. Frontloading revenues and backloading spending is just one of those games. We didn’t hire these people to plays games with us, however. We hired them to govern us like adults. Time they started acting like them.

(note: it is possible that the Medicare cuts they come up with will exponentially grow in size; I am skeptical, however. Congress doesn’t have a good history with long-term and effective cuts in Medicare, nor are the truly serious delivery system reforms on the table any longer, as best as I can see. I also don’t believe that magic prevention improvements will ever end up giving us long-term cost savings, let alone exponentially increasing cost savings as required to pay for this sort of program.)

(BTW, this is a bipartisan maturity problem; the Republicans rammed through an entirely unfunded Medicare Part D program using similar budget gimmicks)

Written by Victor

July 16, 2009 at 3:46 am

## Taxation Delusion

Schumer offered some very strange logic on the latest tax plan offered by Senate Democrats:

He said there is “broad support” among Democrats on the finance panel to include new fees on insurance premiums, and “some of the Republicans” have said they will consider it. While he declined to discuss how the plan might be structured, he said lawmakers want to find a way to prevent insurers from simply passing the fees on to their consumers.

“If there’s real competition, there’s less likelihood and ability to pass it through” to consumers, Schumer said.

If Schumer’s right that real competition is sufficient to prevent passing taxes through to consumers, then why isn’t the “competition creation” in his proposals sufficient? Either the public plan and Exchange ideas aren’t going to provide real competition, or he’s blowing smoke about competition protecting the consumer from a tax pass through. Unfortunately, I think both may be true.

And since when does a competitive market place make it harder to pass along a tax hike? Higher taxes would normally reduce the quantity supplied and/or raise the price. However, if you legislate that the quantity supplied can’t decrease — like in this same proposal to pass individual mandates for health insurance — the tax incidence will almost surely be squarely on the consumer.

Therefore, what Schumer is really saying is that he’s going to raise the cost of insurance in order to pay for insurance.

And if that makes sense to you, you’ve been reading too many healthcare reform proposals.

Written by Victor

July 16, 2009 at 12:31 am