Risk Adjustment and Co-Op Financial Status

Staff portrait of Kathy Hempstead

Katherine Hempstead, PhD, MA, director and senior program officer, leads RWJF's work on health insurance coverage.

The recently released 2015 Risk Adjustment and Reinsurance payments came as fairly unmitigated bad news for the Affordable Care Act (ACA) co-ops. Only three of the 10 remaining co-ops were net beneficiaries of risk adjustment, and for most of the seven that must pay, the amount is not insignificant. While carriers are able to calculate reinsurance payments straightforward throughout the year, they are less able to anticipate how they might fare with respect to risk adjustment. For at least some co-ops, the recent Centers for Medicaid & Medicare Services (CMS) release came as an unpleasant surprise.

There have already been several reactions. In Illinois, the insurance department is attempting to prohibit their co-op, Land of Lincoln, from paying their risk adjustment obligations, arguing that this would place them into insolvency. In Connecticut, the insurance department has announced the wind down of Healthy Connecticut, which will withdraw from the marketplace in 2017. More developments along these lines would not be surprising.

In thinking about the impact of Risk Adjustment payments on co-op financial status, one relevant factor is the extent to which these recently announced payments differ from co-ops’ expectations. The annual financial statements for 2015, which were filed in March 2016, are one place where these expectations are made explicit. There are limitations to this approach, since it doesn’t incorporate any information about 2016 financial performance or other ways in which co-ops’ expectations about risk adjustment payments may have changed since the filing of the financial statement. Yet since expectations about risk adjustment informed the portrayal of financial health reported in the statement, this comparison seems like a reasonable way to get some perspective on how the recent news may have affected co-ops’ financial well-being. While the estimated reinsurance payments listed in the annual statement generally do not match those recently released by CMS, they were left unadjusted in this comparison, under the assumption that carriers should at all times have a fairly accurate estimate of their gains from reinsurance, since they are straightforwardly calculated based on claims.

The difference between expected and actual risk adjustment payments are shown in Table 1. For four of the co-ops—HRI of New Jersey, Evergreen, Land of Lincoln and New Mexico Health Connection, the gap exceeded $10 million. For these four, the gap between anticipated and actual risk adjustment payment exceeds 10 percent of revenues.

To the extent to which these recently announced risk adjustment figures are experienced as an unexpected shortfall by the co-ops, one important question is how they affect financial solvency. Insurance carriers are required to maintain a certain amount of risk-based capital. Usually this is described as a ratio of capital to an authorized control level. Both the available capital and the authorized control level are listed in the financial statement. In general, a risk based capital ratio greater than 4:1 is desired as an indicator of solvency. A ratio under two is viewed with great concern. While all of the co-ops reported net income losses in 2015, by issuing surplus notes, they were able to increase their capital to the point where their risk-based capital was at least 3:1.

As seen in Table 2, the newly announced risk adjustment payment created significant changes for a number of co-ops, particularly HRI of New Jersey, Evergreen, and Land of Lincoln, whose risk based capital ratios fell below two. For four of the co-ops, Common Ground (WI), Maine Community Health Options, Oregon’s Health Cooperative and Montana Health Cooperative, the risk based capital ratio changed very little. Interestingly, Healthy Connecticut does not appear from this analysis to be close to insolvency, since their risk-based capital ratio only declined from 6.3 to 5.5. The fact they have chosen to wind down suggests that available information about 2016 financial performance has dampened their financial outlook even further.

As seen in Table 3, the risk adjustment payments add to an already grim financial picture. All of the co-ops lost money in 2015, even those who were not required to pay into risk adjustments. Some of the figures are quite large. Land of Lincoln, for example, reported an unadjusted net income loss of $96 million on 147 million in premiums. Maine Community Health Options, long considered one of the successful co-ops, lost over $75 million in 2015. Some co-ops have sought greater diversification into the small group market as a way to offset risk in the individual market, but the risk adjustment payments suggests that has not been without its challenges. Most notably, Evergreen must pay over $20 million into risk adjustment for their small group business, which consisted of approximately 10,000 members in 2015.

While many carriers have lost money in the ACA marketplace, most are able to draw from profitable lines of business to cover losses. The co-ops lack such options, and primarily respond by resorting to federal credit in the form of surplus notes. Yet, the supply of this credit is rapidly dwindling, and co-ops face many limitations in their ability to raise additional capital. There is no sustainable path forward that does not involve profitability, and for many, this seems far from being achieved. Planned revisions to risk adjustment calculations may prove more favorable, but it's not clear whether this will be sufficient for all. For most co-ops, these recently announced risk adjustment payments have made a bad situation worse, and for a subset, they may prove to be the proverbial last straw.