Dani Rodrick in 2007 had a fascinating post on the different groups of economists when looking at policy problems. He divided them into two basic mindsets:
You can tell what kind of an economist someone is by the nature of the response s/he offers when confronted with a policy issue. The gut instinct of the members of the first group is to apply a simple supply-demand framework to the question at hand. … No matter how technical, complex, and full of surprises these economists’ own research might be, their take on the issues of the day are driven by a straightforward, almost knee-jerk logic….
the second group are inclined to see all kinds of complications, which make the textbook answers inappropriate. In their world, the economy is full of market imperfections ….
Policy making has the same type of division. There are those who advocate for the most efficient and effective policies as first best solutions, and there are those who acknowledge the possibility of first best solutions but are also aware of other strong constraints so sub-optimal improvements to policy can be implemented. Finally there is a school of policy making which can only be described as WTF avant garde experimentalism.
Risk corridors in PPACA are a good example of these three schools of thought. The point of risk corridors to is to minimize the cost to an insurer of it getting stuck with an especially sick pool of people it has to cover.
The NBER recently published a working paper on what the authors argue is a first best solution to risk corridors.
Fundamentally, reinsurance and risk corridors act as insurance for insurers as they aim to protect insurers from the potential losses that could occur if they enroll an unexpectedly unhealthy group of enrollees….
risk is reduced most efficiently by eliminating the tails of the distribution, risk corridors are likely to reduce insurer risk more efficiently than reinsurance….
both reinsurance and one-sided risk corridors with power equal to 0.8 generate a cost distribution with a standard deviation of about $90. On the other hand, two-sided risk corridors with power equal to 0.8 generate a cost distribution with a standard deviation around $120. This implies that reinsurance and one-sided risk corridors out-perform two-sided risk corridors according to this measure of insurer risk: they both achieve larger reductions in insurer risk for any given level of power.
A one sided risk corridor program just sends money to companies that have large losses. In the PPACA setting the money flow would be from the US Treasury to health insurers with very sick populations. This would be the most efficient and effective program to keep insurers in the Exchanges for the first three years. After that, the risk corridor program disappears per the law. The downside to this is a two fold political downside. First, it would be exclusively net expenditure. The writing of PPACA was significantly constrained by conservative and centrist Demcorats being extraordinarily concerned about the CBO score. This model would make the CBO score worse. Secondly, it looks like a bailout in a thirty second ad.
The actual policy implemented in PPACA is a clear example of second best policy making. PPACA adapted what is known as two sided risk corridors. In this scheme, health plans with very healthy and profitable risk pools sends money to the US Treasury/Centers for Medicare and Medicaid Services (CMS). CMS then sends big checks to insurers who got stuck with very sick and costly risk pools. The downside is that this type of scheme is less efficient. The upside is that depending on whether or not the program was revenue neutral in design, it was either a net zero to the CBO score or added to the deficit reduction score. Since mid-2014, the program has been designed to be roughly revenue neutral. There is one further problem with the program. The money was authorized to be spent but there was not a specific appropriation for the money to go out the door.
And this is where we enter advant garde WTF policy experimentation. The Crominbus does not appropriate money to be sent out the door for this program. It still will be collecting payments from very healthy risk pools but that money will go to the general fund and not health insurers. So a policy that was supposed to minimize risk to insurers of getting stuck with very sick populations takes away that minimization function while still taxing very healthy risk pools.
I don’t think this is a fatal blow; instead it is a papercut squirted with lemon juice on PPACA as it may prompt companies that would have left the Exchanges in 2017 to leave in 2016, but it perverts incentives.