Cooperative health insurers (or co-ops) created under a federal grant and loan program in the Affordable Care Act seem to be falling like dominoes.
It started in February, when CoOportunity Health, which operated in Iowa and Nebraska, was ordered into liquidation. In July, Louisiana’s insurance department announced it was shuttering that state’s co-op. The following month brought news that Nevada’s co-op would also close. On September 25, New York ordered the shutdown of Health Republic Insurance of New York, which had the largest enrollment of all of the co-ops. Then, within the space of a week in mid-October, the number of failures doubled from four to eight, as state insurance regulators announced that they were closing the co-ops in Kentucky, Tennessee, Colorado and one of the two in Oregon. Last week came news that South Carolina’s co-op will be closed, followed this week by the announcement that Utah’s co-op is also being shut down.
In sum, of the 24 Obamacare co-ops funded with federal tax dollars, one (Vermont’s) never got approval to sell coverage, a second (CoOportunity) has already been wound down, and nine more will terminate at the end of this year.
So what is behind this, so far, 46% failure rate?
To start with, the program was a Congressional exercise in not merely reinventing the wheel, but doing a bad job of it.
Far from being a new idea, member-owned insurance companies—called “mutual” insurers—have a long history. For instance, life insurer Northwestern Mutual has been in business for over 150 years. Health insurers organized as mutual companies include, among others, Blue Cross plans in 10 states. Indeed, one of them, Florida Blue, converted into a policyholder-owned mutual company just last year. If having more health insurers owned by their policyholders was the goal, then there was no need for federal government action.
On the other hand, if the goal was to increase competition by stimulating the creation of new health insurers, then the ACA’s co-op program was, like other parts of the legislation, badly designed.
The daunting requirements of the ACA’s co-op program
The program offered federal loans and grants to startup insurers, but required that they be non-profits, not have anyone affiliated with an existing health insurer on their boards, and not spend any of their federal funding on marketing.
Co-ops are also subject to another provision of the ACA requiring all health insurers to pay out in claims at least 80% of premium revenues, or refund the difference to policyholders. By law, insurers can retain no more than 20%, out of which they must fund sales and administrative costs before booking any remainder as free cash. That significantly constrains a non-profit carrier’s ability to accumulate capital needed for growth, as it can’t raise funds through equity or debt offerings.
Imagine how a business school class would react to their professor assigning them the task of planning a start-up, but with the restrictions that: 1) experts at other companies in its industry were barred from serving on its board; 2) it would have virtually no access to capital other than government loans; 3) it couldn’t use those funds to market its products, and 4) if successful, it couldn’t retain more than nominal profits to fund future growth?
As if that wasn’t daunting enough, the law also required co-ops to focus “substantially all” of their activities on offering health insurance in the individual and small group markets—just as other provisions of Obamacare were thoroughly disrupting those markets by imposing new rules on insurers and complicated new payment arrangements for many of their customers.
Given all of the foregoing, 10 co-ops failing within two years is less surprising then the fact that 23 of them actually got to market in the first place.
Furthermore, the numerous changes imposed by Obamacare on the individual and small group health insurance markets scrambled the business plans of incumbent players as well. The performance over the last two years—of both new and existing insurance companies—largely reflects how their managements responded to those challenges.
More cautious insurers and co-ops fared better than their peers
The more cautious insurers generally fared better than their peers, and that was true for the co-ops as well. Companies that charged higher rates for Obamacare exchange coverage got fewer customers, but they also avoided incurring large losses. Conversely, those that set their rates lower got more customers, but many of those customers had claims that exceeded their premiums.
That difference is confirmed by the wide disparity in insurers rate increases for 2016—ranging from only a few percentage points for some to over 30% for others. As Warren Buffett said, “Only when the tide goes out do you discover who’s been swimming naked.” The carriers (both old and new) asking for big rate increases are the ones who failed to appreciate how risky Obamacare had made their markets.
For instance, PreferredOne in Minnesota got the biggest share of that state’s exchange enrollees in 2014, but suffered such large losses that it dropped out of the exchange in 2015. However, PreferredOne’s financial wound was not fatal, most likely because it is an established insurer (in business for almost 30 years). That was not case for another local carrier, WINhealth in Wyoming. In business for 20 years, and Wyoming’s fourth largest insurer, its losses from Obamacare exchange plans proved too much, and WINhealth is now closing as well.
Because the law constrains their access to capital, the co-ops were less able to recover from initial losses than either their established competitors or new entrants with traditional financing. It is worth noting that two other start-ups with conventional financing also entered the same market in 2014 and are still in business. One, Oscar Insurance Company, is backed by venture capital funding, and despite initial (and expected) losses, growing and expanding into more states this year. The other, North Shore-LIJ CareConnect in New York, is pursuing the well-worn path of a large, integrated (and deep-pocketed) provider health system creating a subsidiary to offer health insurance in its local market.
Obamacare has made health insurance costlier and the business of offering it riskier
Differences in management styles were also reflected in the differing assumptions that insurers made about the ACA’s “risk corridor” program. Under that program, insurers with higher than expected gains pay into a pool, with those funds then distributed to carriers with larger than expected losses. Several of the failed co-ops have publicly blamed the federal government for pushing them over the edge by not giving them sufficient risk corridor payments. In particular, they fault the Administration for misleading them about how much money would be available and Congress for insisting that the program operate on a budget neutral basis.
In truth, there was always a high probability of losses being bigger than gains in the risk corridor program. The companies that got burned—both new co-ops and incumbents like WINhealth—were the ones that banked on federal support payments to make their financial models work. The more prudent companies, including nearly all of the surviving co-ops, were the ones whose business plans didn’t depend on those uncertain revenues.
Finally, it also makes sense that state insurance regulators acted now to close down weak companies. Their job is to protect consumers, a big part of which involves ensuring that carriers can make good on their promises to pay claims. Acting now, when only a few months remain on existing policies and the next annual enrollment period is about to start, gives consumers an opportunity to pick a different plan for next year, minimizing any disruption from shutting down financially shaky insurers.
The bottom line: Obamacare has made health insurance costlier and the business of offering it riskier. To survive in that new world, health insurers need to be cautious, or even pessimistic, and hope that their customers can continue to pay escalating premiums. It’s not a pretty picture.
First appeared on Forbes.