Reducing the Cost of Health Insurance: Reinsurance, the One Thing the ACA Got Right

Introduction

Outliers in health insurance cost us all.  Should a hemophiliac present with complications the treatments could cost in excess of a million dollars per year.  If that patient also presents with non-behavior based chronic conditions like Type 1 diabetes, arthritis, Alzheimer’s, cancer or epilepsy, their care could be orders of magnitude more costly than the average, mean or calculated risk for their insurance.  This could, with just a few people, bankrupt the insurance company, denying coverage to all their patients.

The Problem

Insurance works by spreading the risk among a population.  The earliest known instance of this risk spreading was found in King Hammurabi’s Code, literally carved in stone, in about 1750 BC.  A ship’s cargo could be pledged in exchange for a loan. If the ship and its cargo never returned, the loan was forgiven.  This functioned as a rudimentary form of insurance by mitigating the risk for a part of the cargo.  In 1654, Blaise Pascal invented a calculator to assess the risks of a cargo voyage from Europe to the new world.  The risks were spread among many investors or underwriters, spreading the risk of a loss by having several underwriters for a voyage and underwriters paying for several voyages at a time.

In the present day these risk calculations are amazingly complex and undertaken by smart people called actuaries.  Actuaries in health insurance calculate risk according to demographics like age, gender and behaviors, like smoking.  The total cost of the risk is then divided by the size of the population and everyone pays his or her fair share.  This pool of resources covers the healthcare of the entire population.  Some use more, some use less, but every one is covered.  We have been over the failings of health insurance companies at least a dozen times in these articles, so we will abstain from that here.  There is a huge problem though. Sometimes an outlier, like patients suffering from hemophilia, Type 1 diabetes, arthritis, Alzheimer’s, cancer or epilepsy can consume enough resources to bankrupt the entire system. These are not behavior based chronic conditions but they are expensive.

Sentia believes in rewarding people for good behavior.  With good behavior we won’t have to worry as much about the other problems on the list of worst chronic diseases, like Type 2 Diabetes, heart disease and stroke, obesity and tooth decay.  Since we reward good behavior with discounts, the incidence of these diseases will either decrease or the patients engaging with the risky behaviors that cause them will pay for the higher incurred risk and keep all our costs lower.  That is not what we are talking about, however, we are discussing outcomes that do not involve behavior.  There is nothing the patient could have done to prevent the diseases on the first list.  How, then, do we keep these increased costs from affecting everyone?

The Solution

Reinsurance

Reinsurance is the art of spreading risk amongst insurance companies.  The insurer, or payer, transfers some of its risk to a reinsurance company for a fee.  This insulates them from disasters and from the patients who require more money to cover their care.  This risk is absorbed over many insurance companies all using a reinsurer.

From the National Institutes of Health article titled “RISK CORRIDORS AND REINSURANCE IN HEALTH INSURANCE MARKETPLACES”

“It is well known that health insurance markets are subject to a variety of distortions and market failures that threaten efficiency. The most commonly cited problems are adverse selection and moral hazard. However, an additional factor, the level of risk borne by insurers (i.e., the probability of randomly getting a high-cost draw of enrollees) can also limit efficiency. Under high levels of uncertainty, risk-averse insurers will charge higher premiums, potentially exacerbating inefficiencies from adverse selection (Einav and Finkelstein 2011). Risk-averse insurers may also be less likely to enter high-risk markets, worsening inefficiencies from imperfect competition. It may, therefore, be socially beneficial to limit insurer risk by implementing reinsurance and risk corridors.”

More on Risk Corridors in a moment. 

From the National Institutes of Health in an article titled “Effects of state reinsurance programs on health insurance exchange premiums and insurer participation”

“Reinsurance programs were associated with a decline in premiums in the first year of implementation by 10%–13%, 5%–19%, and 11%–17% for bronze, silver, and gold plans (p < 0.05). There is a trend of sustained declines especially for states that implemented their programs in 2019 and 2020. The SCM analyses suggest some effect heterogeneity across states but also premium declines across most states. There is no evidence that reinsurance programs affected insurer participation.”

Risk Corridors

A Risk Corridor is a way to transfer money between insured groups.  We will discuss two kinds of risk corridors, but since they are a part of the Affordable Care Act (ACA) , and they are less effective than reinsurance, we won’t go into detail.  

Two-Sided Risk Corridors

Plans that enroll an unexpectedly high-cost group get positive transfers and plans that enroll an unexpectedly low-cost group are assessed penalties.  Basically, this is transferring money from a low-cost group to a high-cost group.  

One-Sided Risk Corridors

This is the same as a two-sided transfer but without the penalties.

Risk Corridor Conclusions

The result that reinsurance does as well as risk corridors at reducing insurer risk may seem at odds with economic theory: risk corridors eliminate the tails of the insurer’s cost distribution and, as Arrow (1963) pointed out, an insurance policy that achieves the greatest risk reduction for a given actuarial value would do just that. Reinsurance, on the other hand, results in payments transferred to insurers in all parts of the cost distribution: whether the insurer incurs devastating losses or makes extraordinary profits, if its enrollment base includes at least one high-cost individual it will receive a payment. It seems odd, then, that an insurance policy that pays out when the insurer makes profits (reinsurance) could match (and sometimes surpass) the performance of a policy that only pays out when the insurer incurs large losses (risk corridors). The intuition behind this result is similar to the intuition set out by Zeckhauser (1970): efficiency depends not only on risk protection but also on any behavioral response of the insured, that is, moral hazard. A significant portion of insurer nonsystematic risk is driven by a few extraordinarily high-cost individuals. Because reinsurance focuses on these high-cost individuals, it generates dramatic reductions in insurer risk while only affecting insurer incentives for an extremely small part of its enrollment base. This allows reinsurance to achieve significant risk reduction with only small effects on power. Comparing reinsurance and risk corridors for a given level of power shows that, despite the ability of risk corridors to precisely target the parts of the insurer’s cost distribution that are most influential on insurer risk, reinsurance can perform just as effectively because of its more limited impact on power.

Conclusions

We have demonstrated two ways to lower the cost of health insurance by double digit percentage points: Reinsurance and Risk Corridors.  We didn’t go into detail on Risk corridors due to the fact that reinsurance works just as well, and doesn’t increase costs for healthy, younger people to insure older less healthy people.  We are doing four things differently:

1. Your old, legacy insurance company only returns 53% of your premium as benefits.  With Sentia’s new system that uses its own electronic medical records system (EMR) to detect and pay for procedures we can give the patient back that 47% in lieu of a $10 per month health insurance subscription on our platform.
2. With this EMR comes the elimination of medical coding, compliance reporting through automation and insurance adjudication, cutting the financial burden on the practitioner by over $70,000 per year per practitioner.
3. By providing built in, science based patient education with incentives to live a healthier lifestyle in the form of discounts for demonstrated healthy behavior through bloodwork, we have further reduced the cost of health insurance through increased population health and reduced payments for chronic disease.
4. By mitigating the risk of extremely high-cost care individuals through reinsurance we have further reduced costs by an average of 12.5%

With these four things we will have reduced the cost of health insurance by far more than half.  Then, we will be not only the cheapest medicine in the world, but also the best.  We already have the best doctors and the best equipment; we just need to implement the above detailed framework to give them all the tools necessary for success.

We have this system in prototype now, fully functioning.  

Contact us here or on our site and we will be happy to provide a demonstration of the fully functional prototype.

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We have built a comprehensive health information system to keep the patient healthy and on the right track with the ability to incentivize healthy living.  Implementing this system should be fairly simple and will completely revolutionize the way healthcare is paid for, saving countless lives.  We have shown a way to use this system to make the best healthcare system in the world also the most efficacious and the most affordable, and a way to move toward value-based care.