In addition to creating health insurance Marketplaces (exchanges) and premium subsidies to make insurance more affordable, the Affordable Care Act (ACA) completely changed the way insurance is priced and sold in the individual market.
As of 2014, insurers (both those participating in the exchanges and those selling on the individual market outside the exchanges) face a number of new restrictions.
Insurers must accept every applicant, regardless of health status or preexisting condition(s), and cannot charge more for customers based on their medical history, a process known as medical underwriting. Insurers are limited in how much they can vary premiums based on age and tobacco use. Insurers cannot charge women more than men for a comparable policy and must spend at least 80 percent of premiums on medical claims, known as the minimum medical loss ratio requirement. (Age, sex, tobacco use, and previous medical claims are highly predictive of future medical expenses and were routinely used by insurers to set premiums or reject applicants.)
With the new restrictions on premium setting and the unpredictability of medical expenses from the newly insured, insurers faced a high level of uncertainty when setting their premiums. To buffer insurers from high losses in the initial years, keep premiums affordable, encourage insurers to participate in the exchanges, and minimize year-to-year premium fluctuations, the ACA authorized three premium stabilization programs: risk adjustment, reinsurance, and risk corridors.
Under risk corridors, the government reduces insurers’ risk by partially offsetting high losses and sharing in large profits. Risk corridors are based on how allowable costs compare with a target amount. Insurers whose ratio of allowable costs relative to the target amount is too high, meaning their premiums did not cover all their claims, will receive partial reimbursement for those losses. Insurers whose ratios are too low, meaning their premiums were much more than was needed to cover their expenses, will be charged an amount to partially offset their profits. By eliminating some of the pricing uncertainty associated with a new program and new population, risk corridors are intended to encourage insurers’ participation in the new market.