How to Increase Competition Under the Affordable Care Act

Competition is diminishing under the Affordable Care Act. More than 650 counties are on pace to have just one insurer on their state exchanges by 2017, according to recent analysis by the Kaiser Family Foundation. This is mostly a result of exits by large insurers such as Aetna, United Healthcare and Humana.

As a consequence, prices are rising, with average premiums predicted to increase more than 20 percent next year on the exchanges. Even Blue Cross Blue Shield plans, which are the backbone of the exchanges, are struggling in many states. In fact, the only large insurers growing their exchange footprints are the Medicaid HMOs like Molina Healthcare and Centene Corporation. But their presence in the exchanges is still too small to offset the plans already exiting these markets.

These problems stem from a combination of factors that have made it hard for health plans to turn a profit in the exchanges, but all too easy for them to lose money. That’s left existing insurance carriers weary of either entering the exchanges or expanding their presence. Among the challenges are rules that create costly adverse selection and lackluster adjustments for risk. But equally key are regulations that make it difficult for brand new health carriers to even get started.

When Medicare’s Part D drug benefit and its Medicare Advantage program first launched, hundreds of new carriers were started to offer products in these markets. Many were backed by venture capital. When it comes to the ACA, though, no new net health carriers have started since 2008. In other words, for the small number of new carriers that got started (mostly “co-ops” and provider-sponsored plans) there were an equal number of exits.

That means most of the “new” insurance plans on the exchanges are just different iterations of health plans already offered by legacy insurance carriers. The ACA has been devoid of the kind of brisk new health plan company formation seen with the launch of Medicare’s Part D drug benefit and its Medicare Advantage program. The question is, why?

One of the big culprits is the cap that the ACA places on the operating margins of insurance carriers. Under new provisions, insurers can only spend 20 percent of their premiums on running a health plan if they offer policies directly to consumers or to small employers. The spending cap is 15 percent for insurance policies sold to large employers.

The Obama administration included these provisions as a way to manage insurance industry profits and, more notably, to make sure the bulk of premium revenue was funneled back to patients in the form of medical care. But the provisions have had an unfortunate consequence —constraining the ability of new insurance carriers to get started.

Health plans often lose more money when they first launch. This is, in part, a result of high start-up costs associated with a new insurance plan. So new carriers need to channel a higher proportion of premium revenue into overhead to pay for start-up costs.

For these reasons, the medical loss ratios (MLRs) are typically lower on new plans. More revenue gets spent on the high start-up costs of the new plan. The MLRs erode over time as more of the premium revenue is consumed by medical costs and less is spent on overhead.

Caps on operating margins make it hard for new insurers to get started. These rules have the effect of favoring existing insurance carriers without high start-up costs. The rules also favor large, national insurers able to spread their fixed administrative costs over a bigger number of health plans and beneficiaries across many different markets.

The ACA included some provisions to exempt smaller plans (with low enrollment) from these caps. Under the rules, insurers with a small number of enrollees (less than 1,000 life years) are called “non-credible” and are therefore presumed to be in compliance with ACA’s MLR requirements, regardless of whether their MLR meets the 20 percent threshold.

Insurers with slightly higher, but still low overall enrollment (between 1,000 to 75,000 life years) are called “partially credible” under the ACA rules. These insurers receive an adjustment that increases their MLR (by adding 1.2 to 8.3 points to the reported MLR). But these “credibility adjustments” are so narrow that few plausible startup health plans qualify.

Moreover, new plans that have successful launches will quickly outgrow the exemptions, even though their high startup costs would persist for many years. So the “credibility” exemptions don’t offer much of a reprieve to brand new, start-up health plans.

If policy makers want to instigate more competition under the ACA, they can start by broadening these “credibility adjustments” to make it easier for new plans to get started. The exemptions should cover all new carriers that enter the exchanges. They should be deeper and apply for an extended period over which a new carrier faces high start-up costs.

This reprieve would make it easier for new health plans to attract capital to enter these markets. It’s one step toward enabling more choice and competition on the exchanges.