Risk corridors

What Is Risk Corridors?

Risk corridors are a mechanism in healthcare market regulation designed to limit the financial exposure of insurance companies to unexpected gains or losses. Falling under the broader financial category of risk management, these programs create a shared risk environment between insurers and a governing body, typically the government. The primary aim of risk corridors is to stabilize premiums and encourage insurer participation, particularly in new or uncertain markets where pricing accuracy for medical claims is challenging to determine upfront. By buffering against significant deviations from projected costs, risk corridors help maintain market stability and discourage practices like adverse selection, where insurers might try to avoid sicker enrollees.

History and Origin

The concept of risk corridors is not new to the U.S. healthcare landscape. A similar program was first implemented in 2006 with the introduction of the Medicare Part D prescription drug benefit, designed to help stabilize costs for newly participating plans. This precedent aimed to encourage private insurers to offer plans by mitigating the financial uncertainty associated with prescription drug pricing.¹¹

Risk corridors gained significant public attention with their inclusion in the Affordable Care Act (ACA), enacted in 2010. The ACA established a temporary risk corridor program for health insurance plans offered on the new health insurance marketplaces for the plan years 2014 to 2016.¹⁰ The intent was to protect insurers from large financial losses or excessive profitability during the initial years of the marketplaces, where insurers faced significant uncertainty in setting premiums for a newly insured population, including those with pre-existing conditions.⁸, ⁹

However, the ACA's risk corridor program became a point of significant political contention. In December 2014, Congress passed the Consolidated Appropriations Act, 2014, which included a provision that explicitly restricted the use of funds for risk corridor payments, effectively making the program budget-neutral by limiting payouts to only what was collected from profitable plans.⁷ This legislative action led to a substantial shortfall in payments owed to insurers, prompting numerous lawsuits against the federal government.⁶ Ultimately, in April 2020, the U.S. Supreme Court ruled in Maine Community Health Options v. United States that the government was obligated to make the full risk corridor payments to insurers, asserting that the appropriations riders did not nullify the original statutory commitment.⁵

Key Takeaways

• Risk corridors are a mechanism to share financial risk between insurers and a government entity, stabilizing new or volatile insurance markets.
• They typically involve a target amount for an insurer's costs, with the government paying insurers for losses above a certain threshold and insurers paying the government for gains above another.
• The ACA's risk corridor program (2014-2016) aimed to encourage insurer participation and stabilize premiums in the newly established health insurance marketplaces.
• Controversy over the ACA's risk corridors, including legislative restrictions on funding, led to significant lawsuits and a Supreme Court ruling affirming the government's payment obligation.
• These programs are distinct from other premium stabilization mechanisms like risk adjustment and reinsurance, though they work in conjunction.

Formula and Calculation

The calculation for risk corridor payments or charges under the ACA program was based on a comparison of an insurer's "allowable costs" to a "target amount" (typically a portion of the premium revenue after administrative costs). The program operated with specific percentage bands around the target amount:

• No Payment/Charge Zone: If an insurer's actual allowable costs were within 3% (either above or below) of the target amount, neither the insurer nor the government made a payment. This represented the band where insurers retained full risk and reward.
• Shared Loss Zone (for insurers):
  • If allowable costs exceeded the target amount by more than 3% but not more than 8%, the government was intended to pay 50% of the difference between the 3% and 8% thresholds.
  • If allowable costs exceeded the target amount by more than 8%, the government was intended to pay 80% of the amount above 8%, in addition to 50% of the 3-8% band.
• Shared Gain Zone (for government):
  • If allowable costs were less than the target amount by more than 3% but not more than 8%, the insurer was required to pay 50% of the difference between the 3% and 8% thresholds to the government.
  • If allowable costs were less than the target amount by more than 8%, the insurer was required to pay 80% of the amount below 8%, in addition to 50% of the 3-8% band.

This tiered structure aimed to limit extreme gains and losses for insurers, thus encouraging broader participation in the market.

Interpreting the Risk Corridors

Interpreting risk corridors involves understanding their role as a temporary safeguard rather than a permanent market fixture. They are typically implemented when actuarial science and underwriting practices face high levels of uncertainty, such as in the launch of a new insurance market or significant regulatory changes. The bands defined within a risk corridor program indicate the degree of shared risk. A narrower corridor implies greater government intervention and risk sharing, while a wider corridor places more risk on the insurer. The objective is to foster a stable environment that allows insurers to gain experience with new populations and adapt their pricing strategies over time, eventually transitioning to a market where such mechanisms are no longer needed. They are a tool for mitigating the "unknown unknowns" of a nascent market.

Hypothetical Example

Consider "HealthGuard Co.," an insurer operating in a new health insurance marketplace. For the year, HealthGuard Co.'s target allowable costs are $100 million.

• Scenario A: Within Corridor

  • HealthGuard Co.'s actual allowable costs are $102 million (2% above target).
  • Since the deviation (2%) is within the 3% corridor, no risk corridor payment is made or received. HealthGuard Co. absorbs the $2 million difference.

• Scenario B: Moderate Loss

  • HealthGuard Co.'s actual allowable costs are $106 million (6% above target).
  • This falls into the 3-8% loss band. The deviation beyond 3% is 3% (6% - 3% = 3%).
  • The risk corridor program would pay 50% of this additional 3% deviation (50% of $3 million = $1.5 million). HealthGuard Co. receives $1.5 million from the program.

• Scenario C: Significant Loss

  • HealthGuard Co.'s actual allowable costs are $110 million (10% above target).
  • This loss exceeds the 8% threshold.
  • The program would cover 50% of the amount between 3% and 8% (50% of 5% = $2.5 million for this band, since 8%-3% is 5%).
  • Additionally, the program would cover 80% of the amount above 8% (10% - 8% = 2%). So, 80% of $2 million = $1.6 million.
  • Total payment to HealthGuard Co. = $2.5 million + $1.6 million = $4.1 million.

This example illustrates how risk corridors are designed to cushion insurers against severe unexpected expenditures.

Practical Applications

Risk corridors are primarily a tool for government subsidies and regulation in specific markets, particularly those undergoing significant structural changes or facing high uncertainty. Beyond the ACA and Medicare Part D, similar risk-sharing mechanisms can be found in other sectors where public-private partnerships aim to expand access to services, such as certain housing finance programs or agricultural insurance. Their application is typically finite, intended to provide a bridge during periods of market formation or transition. They help to ensure the long-term solvency of providers by preventing catastrophic underwriting losses that might drive them out of the market. For instance, in the initial years of the ACA marketplaces, risk corridors, alongside risk adjustment and reinsurance programs, were designed to promote insurer competition and market stability.⁴

Limitations and Criticisms

Despite their intended benefits, risk corridors have faced significant limitations and criticisms, particularly concerning their funding and perceived fairness. A major point of contention for the ACA's risk corridor program was the argument that it constituted a "bailout" for health insurers at taxpayer expense, especially when payments to unprofitable plans exceeded collections from profitable ones.³ The Consolidated Appropriations Act, 2014, specifically prohibited the use of general government revenues for these payments, leading to a substantial shortfall and sparking legal challenges. Critics argued that insurers should bear the full risk of their pricing decisions and that government intervention distorted market incentives. The ensuing legal battle, which culminated in the Supreme Court's ruling, highlighted the complexities and political sensitivities surrounding such risk-sharing arrangements.² The failure of the government to make full payments as originally intended also led to some health insurance cooperatives, established under the ACA, going out of business due to their inability to recover owed funds.¹

Risk Corridors vs. Reinsurance

While both risk corridors and reinsurance are mechanisms designed to stabilize insurance markets and manage insurer risk, they operate differently.

Risk Corridors are typically a government-backed program that shares the gains and losses of individual insurance plans with the government based on a predetermined formula related to actual costs versus target costs. They address overall plan profitability within defined percentage bands, effectively limiting both the upside and downside for insurers during periods of high uncertainty. The program often involves transfers between profitable and unprofitable plans, with the government making up any shortfall or retaining any surplus.

Reinsurance, on the other hand, is a practice where insurance companies transfer a portion of their risk to another insurer (the reinsurer) in exchange for a premium. This protects the primary insurer from large claims by limiting their potential losses on individual high-cost enrollees or specific catastrophic events. While the ACA also included a temporary reinsurance program, its focus was on mitigating the costs associated with very expensive individual claims, rather than a plan's overall financial performance within a broader cost range. Reinsurance is a standard commercial practice, whereas risk corridors are typically a policy-driven governmental initiative.

FAQs

Q1: Are risk corridors a permanent feature of the U.S. healthcare system?

A1: No, risk corridors are typically temporary programs implemented during periods of market uncertainty or significant reform, such as the initial years of the Affordable Care Act's health insurance marketplaces. Their aim is to provide stability until the market matures and insurers gain sufficient claims experience.

Q2: Who benefits from risk corridors?

A2: Both insurers and consumers can benefit. Insurers benefit from reduced financial uncertainty, which encourages them to offer plans and competitive premiums in new markets. Consumers benefit from a more stable and competitive market with a wider variety of plans and potentially more affordable health insurance options.

Q3: How do risk corridors differ from risk adjustment?

A3: Risk corridors protect insurers from overall plan-level losses or gains that deviate significantly from expectations. Risk adjustment, by contrast, is a permanent program under the ACA designed to mitigate the effects of adverse selection by transferring funds from plans that enroll healthier, lower-cost individuals to plans that enroll sicker, higher-cost individuals. It aims to ensure that insurers compete on quality and efficiency, not by trying to avoid sicker enrollees.