A large subsidy program that has helped insurers offering Affordable Care Act (ACA) compliant coverage in the individual market expires this year. In 2017, for the first time, insurance premiums alone must cover expenses in the individual market. A new working paper released today by the Mercatus Center at George Mason University measures the importance of this subsidy program, sheds new light on insurers’ generally poor results in 2014, and discusses what likely lies ahead for the law.

The study, authored by myself, Doug Badger of the Galen Institute and Ed Haislmaier of the Heritage Foundation contains two key findings. First, insurers incurred substantial losses overall despite receiving much larger back-end subsidies per enrollee through the ACA’s reinsurance program than they expected when they set their premiums for 2014. Second, we estimate that in the absence of the reinsurance program insurers would have had to set premiums 26% higher, on average, in order to avoid losses—assuming implausibly that the overall health of the risk pool would not have worsened as a result of the higher premiums. Our findings raise serious questions about the ACA’s future, particularly when the reinsurance program ends and premium revenue must be sufficient to cover expenses.

Big Losses Despite Larger Than Expected Subsidies

The ACA established the reinsurance program to assist insurers offering ACA-compliant plans so insurers could charge lower premiums and attract more enrollees as the law’s changes took effect. These payments are an explicit subsidy benefitting individual market ACA-compliant plans financed by fees on nearly everyone with private insurance.

Prior to insurers setting their 2014 premiums, the Department of Health and Human Services (HHS) announced that it would pay insurers 80% of the cost of claims incurred by enrollees between $60,000 and $250,000. As an example, an insurer could expect to receive a payment of $112,000 for an enrollee with $200,000 in claims ($200,000 − $60,000 = $140,000 x 0.8 = $112,000). The Congressional Budget Office estimates that insurers were able to reduce premiums by 10% in 2014 because of expected reinsurance payments.

Largely as a result of fewer enrollees than expected in 2014, HHS made the program more generous to insurers by agreeing to pay 100% of the cost of claims incurred by enrollees between $45,000 and $250,000. In the previous example, this formula change increased the payment received by the insurer for the high expense individual to $155,000. In 2014, net reinsurance payments received by individual market Qualified Health Plans (QHPs)—plans satisfying the ACA requirements and certified to be sold on exchanges—totaled $6.7 billion, nearly 20% of premium revenue. This amounted to an $833 subsidy for insurers per QHP enrollee.

In addition to the back-end subsidy through the reinsurance program, insurers also received front-end subsidies designed to make coverage more affordable for people, as well as an individual mandate penalizing people who failed to purchase their product. Despite these advantages, insurers made large losses in 2014 as the overall risk pool was much older and less healthy than they expected.

Premiums Going Much Higher

In the study, we calculated that insurers would have had to raise premiums by 26%, on average, in order to cover expenses—medical claims and administrative costs—in 2014 without the reinsurance program and assuming the same population enrolled and received the same services. If average premiums had been 26% higher, however, relatively healthy people as well as higher income enrollees, who qualify for little or no subsidies that make the insurance more attractive, would have been deterred to a greater degree than people who expected to use more health care services. This is the adverse selection spiral—higher premiums lead to a worse risk pool, which leads to higher premiums, which leads to an even worse risk pool, and so on.

Since 2016 is the last year of the reinsurance program, insurers can no longer count on these large back-end subsidies. Since reinsurance payments accounted for such a large share of premium revenue in 2014 and insurer performance offering QHPs does not seem to have improved yet, average premiums will likely go up considerably next year while insurers also shrink the number of doctors within QHP networks and attempt to more aggressively manage medical utilization of their enrollees.

Performance Varied Across Insurers

Nearly 60% of the 8 million individual market QHP enrollees in 2014 were in a plan affiliated with Blue Cross Blue Shield. The performance of Blue carriers varied widely. QHPs offered by Anthem and Blue Shield of California, which tended to have narrow provider networks, fared relatively well. However, other Blue carriers, particularly the five plans that comprise Health Care Service Corporation (HCSC) and Blue Cross Blue Shield of North Carolina, incurred huge losses.

Kaiser was the insurer with a sizeable market share that performed the best in 2014. QHPs offered by carriers whose principal pre-ACA business in the state was Medicaid managed care also performed relatively well in 2014.

The worst performing insurers were the health care cooperatives, started with funding authorized by the ACA. The co-ops’ average per-enrollee medical claims were much higher than for other insurers. Despite receiving net reinsurance payments of more than $1,100 per enrollee, co-op losses were staggering and likely exceeded $1,500 per enrollee.

If the ACA’s risk adjustment program was functioning as intended so that plans with healthier enrollees transferred money to plans with less healthy enrollees, our findings suggest that people with more expensive conditions were more attracted to plans that ended up losing money. We also found that the substantial variance across insurer performance was mostly driven by large differences in average medical claims across insurers and not differences in premium revenue.

ACA in Trouble

The ACA’s first year did not go well. The problems with HealthCare.gov epitomized government failure on a shocking scale, but the first year’s problems were much broader. Insurers suffered large losses despite the reinsurance program paying out much more on a per enrollee basis than insurers expected.

In retrospect, we know that many insurers significantly underpriced premiums in 2014. These lower premiums might have been expected to attract more young and healthy people to purchase coverage. Insurers need young and healthy people to enroll since the ACA’s general effect was to make selling insurance to older and less healthy people a losing proposition for them.

The ACA’s main failure thus far is that QHPs are not attractive to relatively young and healthy people who earn too much to receive subsidies large enough to substantially reduce premiums and deductibles. This failure is compounded by reports that people have learned how to the game the ACA by purchasing insurance only when they need medical care and dropping it soon after.

The reinsurance and risk corridor programs expire at the end of this year, which means that in 2017, for the first time, premiums must cover expenses. In order to reverse their losses, insurers will undoubtedly have to raise premiums and redesign plans to make them less generous. Of course, these changes, particularly the premium increases, will make the coverage look less attractive for those who insurers most need to sign up.