First, second and WTF policy making styles

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.

11 replies
  1. 1
    daveNYC says:

    I disagree, I think both groups of economists apply a supply-demand framework to the question, but the second group uses that as a useful framework to build on, while the first group considers it to be the finished product.

  2. 2
    MomSense says:

    The Republicans are not interested in governance and I don’t think they actually care about economic theories. They will use anything to justify their actions on behalf of their benefactors.

  3. 3
    JPL says:

    Risk insurance that will promote health care for all is not the American way. The protection of banks selling derivatives is of utmost importance.

    Richard, Josh at TPM has a negative view on whether or not ACA will survive after the Supremes are done with it.

  4. 4
    Tommy says:

    @JPL: I have no idea what the SCOTU will do, but I fear Josh is correct. With that said, I don’t mention this much here, but I have a number of clients that sell a health care related product. Telehealth/telemedicine. I am basically the default web development guy for anybody that wants to resell the product. I’ve worked with dozens and dozens of firms, most of which also put together benefits plans for both small and large organizations.

    Long story short, not many of them are remotely liberal. Often far right. As the ACA was rolling out you can’t believe the hate I heard from my clients. Funny thing, they don’t bitch about it anymore, because well it seems to have worked out well for their clients. They are making more money, selling more policies.

    So it seems to me that if the Court guts the plan, well the American public might push back some, I know I will.

  5. 5
    Villago Delenda Est says:

    Markets have imperfections because markets are a social construct of humans.

    Who are imperfect.

    Even James T. Kirk.


  6. 6
    mainmati says:

    Good post and as always thr GOP is steadily chopping away at law in true sociopathic fashion. BTW, it is avant garde.

  7. 7
    RaflW says:

    “WTF avant garde experimentalism”

    Clever. But as it applies to the GOP, there is one problem. They reject science, so it’s not really experimentalism. It’s just avant garde nihilism, particularly if they succeed in gutting affordable care for most Americans.

    It still sort of amazes me how much cruelty is just baked into the cake of Republicans these days. But then, Ebenezer Scrooge was dreamed into being in 1843, so I guess I am the one who is ahistorical. Shitheel conservatives who proffer suffering as the lot in life for most, well that has been around a long time.

  8. 8
    Villago Delenda Est says:

    @RaflW: “Who is that, then?”
    “I don’t know, he must be a king”
    “He hasn’t got shit all over him.”

  9. 9
    big blue says:

    The author is incorrect about the intent of risk corridors, like everyone else he is confusing “risk adjustment” with risk corridors. Risk corridors were put in place because nobody knew what the OVERALL risk of these new pools would be. If only the high risk pool people and those denied coverage in the past do to pre-ex rules showed up in the exchanges and none of the lower risk uninsured people, insurers basic pricing assumptions could have been way off and the corridors were in place to protect against this. On the other hand if they over estimated the risk of the population showing up then they would give back money as to not make a windfall and have less people covered because prices were too high, encouraging insurers to feel comfortable to risk under pricing as opposed to over pricing and thus setting prices lower and therefore more people could be covered. After a year or so the insurers would know what the risk profile looked like and could then price appropriately and that is why the corridors phase out. Risk adjustment is in place forever and that helps to normalize risk among insurers in the pool and is a zero sum game, insurers with above average risk get paid from insurers with below average risk, determined by how many people they have with a set list of high cost diseases, generally chronic diseases, this stabilizes the market and pricing. The key concept is that risk corridors should NOT be used to pay back insurers who priced aggressively to gain market share and I believe that is what the republicans see as the risk pool that developed was close to projections..

  10. 10
    mclaren says:

    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.

    More lies from Richard Mayhew.

    The point of risk corridors is to maintain corrupt greed-crazed wildly excessive profits in an insane health care system that’s collapsing and disintegrating from its out-of-control greed and rampant corruption.

    Tell the truth, Mayhew. Just stop lying for once, will you?

  11. 11
    Monopolydog says:

    Employer offered coverage or group insurance has always dealt with risk while providing almost 100% of the patient protections in the PPACA. Yes, very expensive. The elephant that neither party has the balls to address is the fictional cost system which prices healthcare in our country. If you think the real estate meltdown was a mess, wait a couple more years when regardless of size of tax credit, no one will be able to afford health insurance with sensible benefits.

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