Hypothetical Mean

Commentary from an Actuarial and Economic Perspective

Archive for October 2009

Playing “What If” with the CBO numbers

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What if the CBO was more than $90 billion off its cost estimate for HR3962 (blog entry here)?  I think it may be, and it is easy to explain why.

Yesterday, I pointed out that the projected non-group enrollments outside of the Exchange were highly implausible.  Specifically, since individual new-sales outside of the Exchange would be made illegal, it seems illogical to project a static or increasing population of individual policy holders outside of the Exchange.

In today’s marketplace, people tend to cycle through individual coverage; as many as 35%-40% of policies terminate before they reach their first anniversary.  We could take all of the CBO assumptions, but simply assume that only 25% of individual policies lapse annually.  The result would be more than $90b in additional costs between 2015-2019, as illustrated in the table below.

The first three lines in the following table are straight from the various CBO reports.  The fourth line simply assumes that 25% of the policies that existed in 2015 lapse in 2016, and so forth through 2019.  I then assumed that those who lapse join the exchange at an average cost equivalent to those already on the Exchange.  The result is a whopping $91 billion difference.

This illustrates two things.  First, we have very little idea what is really going on inside the CBO models, and results this bizarre suggest that more peer review is warranted.  Second, even if the initial CBO model is perfectly fine, tiny tweaks in assumptions can result in massive swings in cost for this sort of program.  I would argue that this program design is inherently risky; the only way to keep the costs even remotely under control is to build a series of firewalls between employer-based coverage and individual coverage (less than 20% of people are even eligible for the Exchanges let alone the subsidies).  If any of these firewalls leak or if any of these assumptions are slightly wrong, we could be in serious fiscal difficulty.

2015 2016 2017 2018 2019 TOTAL
Cost of Subsidy ($b) 82 96 103 111 120 512
Baseline Non-Group Enrollment (m) 14 14 14 14 15 71
CBO Non-Group/Other Enrollment (m) 8 8 8 8 9 41
Reform Mkt w/ 75% Retention (m) 8 6 5 3 3 24
Add’t’l Subsidy Cost ($b) $0 $10 $18 $26 $38 $91
Avg. Subsidy/Subsidized Enrollee 5500 5800 6100 6500 6800

Written by Victor

October 31, 2009 at 2:35 am

CBO weirdness with HR3962

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Compare and contrast Table 2 from the CBO analysis of HR3962, the new House healthcare bill.  Specifically note that non-group /other net enrollment increases from 24 million to 30 million between 2015 and 2019.  Now compare this to the bill itself, Title II, Section 202, Page 94:

Individual health insurance coverage that is not grandfathered health insurance coverage under subsection (a) may only be offered on or after the first day of Y1 as an Exchange-participating health benefits plan.

How can enrollment go up if new enrollment is disallowed outside the Exchange?

The problem is further exacerbated when you realize the new dependents born after “Y1” (A-1-B, page 91) are not allowed onto their parents’ plans and that individual business generally has a 30-40% lapse rate annually.  Granted, people may not be willing to part with the relatively cheaper grandfathered plans, so the lapse rate is likely to fall.  But it can’t go negative.

Perhaps the circle is squared by the ephemeral “other” category in the analysis.  But I doubt it.  Compare the HR3962 score with the Baucus bill score, which separated “other” from “non-group”.  In that score, those two categories moved in tandem under “current” law, and it seems reasonable to presume that the “other” category is mostly unaffected by reform (I presume it is Medicare disability, etc.).

There are many such examples like this, where you just want to shake the CBO and ask “What are you smoking?  And … Can I have some of that?”  I think I’ll need it.

Written by Victor

October 30, 2009 at 1:50 am

Once Covered, Always Covered

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Tom Maguire at “JustOneMinute” came up with that catchy phrase — Once Covered, Always Covered — to discuss the main component of my desired healthcare reform approach that I began to outline last year. With a catchy phrase in hand and with no hope of having any impact on the current healthcare deform bills being discussed today, here’s a talking-point listing of some of the components of my reform ideas.


Portability of one’s insurance is the most easily addressed component of reform.  That’s where the Once Covered, Always Covered approach kicks in.  By law, everyone who is currently covered could switch coverage if they move, if they leave their job, or whatever.

All plans would be assigned an “actuarial value” and you could seamlessly turn in a group coverage plan for an individual-market plan as long as the newer plan was at the same actuarial value or lower.  Currently, the transition from group coverage to individual coverage is non-standard across states.  The transition to group coverage is covered by HIPAA, but has some holes.  Lastly, a Once Covered, Always Covered approach would eliminate administratively costly COBRA provisions.

All reform proposals carry with them tradeoffs; any pretention otherwise is dishonest.  The downside of this approach is higher “new business” individual rates.  State insurance departments would have to be vigilant to prevent carriers from capriciously entering a market, buying business, exiting the market, and then raising rates rapidly.  I have solutions in mind to minimize these problems, but they would get technical and wouldn’t entirely solve the problem.  But this is a tradeoff that I think many would willingly make.


If people are denied coverage today, they have guaranteed-access to state-run high risk pool insurance.  I would build on this in one of two ways.  First, we could federally subsidize the pools and streamline access.  Alternatively, we could work through the private insurance system entirely and have the federal government reinsure/subsidize high risk individuals.  Expected costs for initially sick individuals lower over time just as expected costs for initially healthy individuals rise over time.  I would taper the subsidies to mirror this reverse “underwriting curve”.  In either case, the federal subsidy should not fully pay for the increased cost of these individuals; there has to be some penalty for remaining outside the system until you become sick.  The penalty in today’s world is the administrative hassle to get into a high risk pool as well as the relatively high premiums in them.


No one has a good idea how to rein in cost in the current system.  Therefore, the only way we can be certain to lower costs is to reduce what is covered.  I would divide claims into four categories.  1) Claims that would be continued to be paid under private insurance, 2) claims that are not socializable and therefore will not be allowed to be paid under private insurance, 3) claims that fulfill a well-defined public objective, 4) non-essential medical services.  Examples of the latter two cases are as follows.  Examples of “non-socializable” claims are those that aren’t clinically more effective than cheaper and available alternatives, drugs advertised direct to consumer, claims that carry a disproportionate personal benefit and therefore don’t need to be socialized, like Chantix for smokers (Chantix is cheaper than cigarettes).  Examples of claims that fulfill a public objective include vaccinations, preventive health measures, etc.  I would also argue that maternity claims (which aren’t “insurable”) should fit into the category, including the extremely high cost and ethically electric issues of premature baby costs.  Tax revenue would have to raised to pay for this last category of benefits.  Non-essential medical services would include chiropractic services, mental health benefits, etc.  These services could be included in healthcare plans, but plans without these services must be sold to make sure coverage for essential services is affordable.

By focusing private insurance on just those sorts of claims that are medically necessary and that can be insured and socialized across individuals, we can significantly reduce the cost of coverage.  We need to begin a wave of “reverse insurance mandates” because we need to make truly necessary care affordable.  And if you want to tack federal subsidies onto these leaner.

I could go on, but what are the odds that anyone is actually reading this, let alone someone who could make this healthcare deform movement make some sense?

Written by Victor

October 26, 2009 at 11:45 pm

Adverse Selection is Not the Problem

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I hate to say it, but I think the excellent bloggers/economists Andrew Samwick and Donald Marron are entirely wrong when they say that “The problems of adverse selection and moral hazard in insurance markets are well known — they are what stands in the way of extending the benefits of competition to health care.  Addressing them should be the central features of the reform, with a risk-adjustment mechanism to address the former and high-deductible plans to address the latter.”

Adverse selection does not exist when the insurance company knows more about your expected costs than you do.  Here’s a quick question to illustrate:

You’ve had a simple fracture in the past three years.  What is your additional expected healthcare cost next year?  Do you know?  I do.  Change the question to a “wait-and-see” diagnosis for a pre-cancerous lesion and I’d still say I know more about that expected cost than you do.  We’ll rate for that expected cost, load for profit, and sign the contract.  Cool?

Insurance companies can issue surcharges for significant extra risk.  Profits don’t come from only insuring the healthy.  Insurance companies actually earn more profit insuring the <i>identifiably</i> sick <i>who also choose to be covered</i>.  Those contracts have more risk and more associated profit, almost always (if nothing else, profits are generally priced as a percent of premium, and the sick will be charged more premium because insurance companies are able to identify them with reasonable accuracy).

The problem is that there comes a cost level where the expected cost plus needed risk charges will exceed the person’s willingness / ability to pay.  And/or the needed price will be so high that it will make a demure health insurance company blush, making them worry about PR.  And rates are also frequently capped by regulatory limits on surcharges (I’m not arguing against those regs, I am simply pointing out that their existence leads people to be denied coverage).

This leads naturally into a second error I believe that Andrew and Donald are making when they trumpet potentially imperfect and administratively costly risk-adjustment mechanisms (actuaries are a top 3 profession and someone has to pay us for something).  Risk adjusters aren’t really a solution for adverse selection; risk-adjusters are really a way to transfer resources between individuals.  Again, an illustration:

A 20 year old male with a risk-score of 0.5 walks into a bar that sells insurance (yeah, yeah).  The bartender says “what’ll you have?”  The male says a $1,000 deductible plan.  The bartender says that he used to be able to sell that for $100 … but now he has to compensate for the 20-year old’s low risk score, so that he has to charge $300.

A 55 year old woman walks into that same bar.  She has a risk score of 1.5 because she had a zit on her nose when she was a teenager.  Yadda, yadda, yadda, and instead of being charged $600, the bartender can sell a policy to her for $400.  The bartender can (has to) do that because he has $200 shifted from the 20-year old.

Has any adverse selection problem been solved here?  Nope.  Either could have gotten the service for the initial price (and notice that the initial prices are independent of the quantity of competitors since they are simply a function of their true cost, which insurance companies can guess at better than you).  The difference is that after risk-adjustment, the healthier pay more and the sick pay less.

In fact, risk-adjustment may <i>cause</i> adverse selection, because, suddenly, the bartender can’t charge the 20-year old the low rate his health deserves.  The 20-year may just tell him to kiss off.  In which case everyone except the actuary will lose since you’ll have to pay the actuarial salaries to offer the exact same contract to the 55 year old that you would have without risk-adjustment.  Because even risk-adjusted markets can cause adverse selection, actuaries are (misguidedly) demanding that an insurance coverage mandate accompany this push to deform healthcare.

One of the fundamental questions of healthcare reform is “Who has the right to benefit from or pay for your health?”  If you answer that you do, then you don’t support risk-adjusters.  That has very little, if anything, to do with adverse selection.  Conversely, if you answer that no single person should benefit from or pay for their health, then by all means, risk-adjust away. They are great make-work for actuaries with tons of cool intellectual problems I’d like to try to be clever and solve.  And if that isn’t enough of a reason to support them, they can also be very successful at redistributing the financial gains and losses that would otherwise be caused by your health.

Just don’t pretend that you did it to solve a perceived adverse selection problem.  You did it to solve a perceived maldistribution of resources.

Written by Victor

October 8, 2009 at 3:33 am