Wednesday, October 16, 2013

What is the Reinsurance Tax in ACA and What Does it Have to do with Nonprofits?

As federal budget negotiations have repeatedly stalled and restarted, one obscure component of the ACA ("Obamacare") has proven to be a sticking point – the transitional reinsurance fee.  If you're like me, you may be curious about what this fee entails and what its purpose is; unfortunately, most discussion of it is too partisan to see its basic premise.  Below is my attempt at explaining it.

First, let's discuss what reinsurance is.  The point behind insurance is to pool together many risks to make them more predictable.  The chance that any one person will need a knee replacement is small, but in that unlikely event they will not be able to afford it out-of-pocket; but, the aggregate number of knee replacements needed among a pool of 1 million individuals is very predictable and the average cost is quite small.  By pooling together enough risks, insurance permits individuals to take something that is risky to them and make its cost predictable and manageable.  Reinsurance offers this same benefit to insurance companies.  After all, insurance companies may not have a sufficiently large pool to eliminate uncertainty, so a portion of that uncertainty can be pooled together with others via reinsurance.  It is a way to guarantee the largest pool of risks is brought together.  Individuals sign up for insurance with an insurance company.  The insurance company, in turn, signs up for insurance with a reinsurance company.  The reinsurance typically takes the form of reimbursing the insurance company a percentage of its losses (the "co-insurance rate") that exceed some threshold (the "attachment point"); the insurance company, in turn, pays a fee (the "reinsurance premium") for this protection against losses.  By having access to reinsurance to reduce risks, insurers are able to charge lower premiums to individual insurance buyers.
Traditional Reinsurance Market

Reinsurance Provision of ACA
Under ACA, traditional commercial reinsurance continues, but it is complemented by a transitional reinsurance provision that offers additional reinsurance for insurers participating in the individual exchanges.  It is transitional in that the provisions only last for three years.  Each state makes use of a nonprofit reinsurer to provide the reinsurance coverage for insurance provided on the exchanges.  The reasoning behind the provision is that it is believed that (at least initially) individuals covered under the exchanges will be, on average, higher risk (e.g., more pre-existing conditions) than those covered under employer plans.  This high-risk pool can lead to adverse selection problems – since they are viewed as higher risk, individuals under the exchange are charged higher prices, which may then turn the lower-risk among them away from the exchange, leading to a downward spiral.  To keep premiums low enough to keep participation rates up, then, this "free" reinsurance is offered to policies provided under the exchanges.  The reinsurance is paid for by an additional fee/tax paid by traditional insurance plans (approx. $60 per covered individual).  In other words, the reinsurance provision is best viewed as a combination of a reinsurance plan for exchange policies and a subsidy provided to exchange insurance providers given by non-exchange insurance providers.

ACA Reinsurance Market

How does this Affect Nonprofits?
The reinsurance provisions of ACA may be particularly pertinent to nonprofits, because the tax is levied on each individual covered under group plans, including self-insurance and multi-employer plans.  Many nonprofits participate in multi-employer plans where employers themselves provide the insurance.  Even though the insurance is not provided by a for-profit insurance company, these plans are nonetheless subject to the tax.  Though some efforts have been made to exempt nonprofits, they have thus far been unsuccessful.

Ok, that is the premise of the reinsurance provision of ACA as best as I understand it.  Clarifications or corrections? Please share them.

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