Obamacare's Nonprofit Insurers Are Failing, Predictably

From Megan McArdle. Excerpt:

"Remember health care co-ops? No, of course you don’t, because unlike some people I could name, you did not spend most of 2009 and 2010 reading white papers, scouring newspapers and attending panels to keep up with the exciting minute-to-minute details of Obamacare’s evolution.

So, health care co-cops. The idea was that the administration would provide the seed capital for nonprofit insurers that would provide an alternative to traditional insurers on the exchange.  A sort of “non-public option,” if you will. This August, Robert Pear of the New York Times reported that “most of the insurance co-ops enrolled fewer people than they had predicted, and that 22 of the 23 co-ops lost money last year.” Three have already announced that they were going out of business, and recently they were joined by Health Republic of New York State, which covers more than 200,000 people through its individual and small group policies.

I’ve been expecting something like this for a while, and not because I’m psychic. I kept reading articles about how well they were doing. Now, I know that sounds ridiculous, but bear with me. How does a brand new insurer that no one has ever heard of manage to make inroads against established behemoths with brand recognition? By offering a better product than the incumbents, obviously. But when you’re buying on the exchanges, “better” largely means “cheaper.”

Now, if incumbents are enjoying enormous margins, then an upstart can come into the market, underprice them a bit, and potentially make a killing. (At least, unless the incumbents decide to crush said upstart with a price war the upstart doesn’t have the reserves to ride out.) But health insurance margins aren’t particularly spectacular. Though consumers hate hearing this, the price of your health insurance is tightly tied to the amount that insurers expect to pay out in benefits -- if not for your care, then for some other, sicker person in the pool. And new rules under Obamacare make that tie even more binding than it used to be. So unless the co-ops had found some fantastic way to save money on paper clips and toner cartridges, I suspected that they were underpricing the product -- a conclusion that seems to be borne out by Pear’s article.

Now, it could actually make sense to underprice your product at the beginning. Insurance is basically an exploitation of the law of large numbers: gather enough people together in a group, and individual differences smooth out into a nice, neat curve that tells you how much you can expect to pay out. The larger your pool, the smoother the curve. So co-ops may have intentionally underpriced to try to get an actuarially sound pool. Or they may simply have lacked the actuarial expertise of the incumbents. Or both. It hardly matters.

The co-ops do not have the kind of massive capital reserves that incumbents can use to survive a few years of mispricing. The temporary programs the law contains to help smooth out these issues turned out to be less generous than expected after Republicans insisted they be made revenue-neutral, and at any rate, they were set to expire. So it’s not exactly an enormous surprise to see the co-ops starting to drop out."