Adverse selection on the HIEs is real, and accelerating; why this makes drug price reform unlikely in the early days of the next administration

Richard
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Richard Evans / Scott Hinds / Ryan Baum / Hardy Evans

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September 7, 2016

Adverse selection on the HIEs is real, and accelerating; why this makes drug price reform unlikely in the early days of the next administration

  • Persons buying health coverage on the Affordable Care Act’s health insurance exchanges (HIEs) are heavy users of health services, so much so that in many markets and for many underwriters claims paid have exceeded premiums collected
  • Using data on household expenditures, we put numbers to the obvious: households whose likely costs of medical care exceed their net costs of buying HIE coverage are 1.5x to 2x as likely to enroll as households where anticipated medical care costs are less than the net costs of coverage
  • Such an imbalance typically leads to a scenario in which premiums inflate to cover claims, and fewer (and on average sicker) people enroll in subsequent periods. Yet despite this imbalance, enrollment on the HIEs has grown, because: 1) enrollment barriers have fallen (remember the IT hurdles in the first 2 enrollment periods); 2) general awareness of the HIEs, subsidies, and penalties has grown; and 3) penalties (which lower net enrollment costs by lowering any savings achieved by not enrolling) have grown. These enrollment drivers have either expired or reached their maximum effects; as such adverse selection pressures are now likely to take over, with smaller and sicker enrollee pools from 2018 forward
  • Making the HIEs work (i.e. collecting more in premiums than is paid out in claims) obviously means enrolling more households whose premiums exceed their health spending. This can be done by lowering their net premium costs (raising subsidies, lowering penalties, and/or allowing the young to buy at even lower prices relative to the old), by modifying the insurance product to something more people are likely to buy (e.g. narrowing the scope of mandatory services, and/or allowing higher out-of-pocket maximums), and/or by merging the lower quality HIE risk pool with other higher quality risk pools. No single step is likely to be adequate, implying that any effective policy response to adverse selection pressures on the HIEs will be a technically complex, and politically difficult, heavy lift
  • We believe the Clinton camp is aware that HIE adverse selection pressures likely would force healthcare reforms onto that administration’s agenda late in a first term. Because of this, we doubt a Clinton administration would freely choose to spend political capital on any type of health reform – drug price reforms included – early in a first term. In contrast the Trump campaign’s approach to health policy is a black box – so we have no reasonable means of handicapping how and when a Trump administration might address health policy generally, much less HIE adverse selection pressures or drug pricing specifically

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. AMGN, BAYER, BMY, GILD, ROCHE, SHPG, SNY, VRTX); Biopharma companies with pending major product approvals (e.g. ACAD, ADMA, ALIOF, BIIB, CHMA, CLVS, CPRX, CTIC, GILD, ICPT, JAZZ, LLY, LPCN, MRK, NVO, OCUL, PTCT, SRPT, TEVA, ZSPH); SNY on sales potential for Praluent (alirocumab); CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WBA, CVS); ABBV on Humira US pricing risks; ENDP on risks to branded Rx price premia; Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, ICLR); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE)

Politics v. practicalities – insurers’ retreat from the HIEs

Larger health insurers recently have announced a fairly widespread retreat from the Affordable Care Act’s (ACA’s) health insurance exchanges (HIEs), citing underwriting losses. Many of these announcements follow decisions by the Justice Department and multiple state attorneys general to block mergers involving larger insurers, raising the question of whether the underwriters’ exits from the HIEs are more politically than practically motivated. The latest data characterizing HIE beneficiaries make a strong case that adverse selection pressures are present, and growing; thus insurers have compelling practical reasons to exit the HIEs

Using MEPS[1] data, we compared the characteristics of 2014 HIE enrollees who had private insurance in 4Q13 (the last quarter prior to operation of the HIEs), to all persons with private insurance in 4Q13. We found that among those with private insurance in 4Q13, those who enrolled in the HIEs were older, used more services, and filled more prescriptions (Exhibit 1), among other differences. We also compared 2014 HIE enrollees who were uninsured in 4Q13 with all persons who were uninsured in 4Q13, and found that these HIE enrollees also were (much) older, used more services, and filled more prescriptions (Exhibit 2), among other differences. Both comparisons make clear that the HIEs (at least in 2014) enrolled persons with substantially higher claims costs than the privately insured and uninsured general populations

Health coverage on the HIEs is mis-priced, leading to adverse selection

Elsewhere[2] we’ve argued that potential enrollees can be organized into three groups according to relative likelihood of enrollment: those for whom coverage is free, those for whom net coverage costs are lower than anticipated medical costs; and, those for whom net coverage costs are higher than anticipated medical costs. For simplicity’s sake, here we lump the first two groups together, and look only at persons for whom 2014 coverage costs[3] were either less than or greater than anticipated 2014 medical costs[4]. For persons uninsured in 4Q13, the odds of enrolling if the net costs of Silver level coverage were lower than anticipated medical costs were 8.8%, as compared to 5.9% for persons whose net costs of Silver coverage exceeded anticipated 2014 costs – a ratio of 1.5:1. For persons privately insured in 4Q13, the odds were 2.4% for persons whose net costs of Silver coverage were less than anticipated 2014 medical costs, and 1.2% for persons whose net costs of Silver coverage were greater than anticipated 2014 medical costs – a ratio of 2:1 (Exhibit 3).[5] This is simple consumer price behavior – ignoring risks for a moment, if it’s cheaper to buy insurance than to pay for medical costs out of pocket, you buy insurance, and vice versa. To bring risk back into the picture, the only reason to pay more for insurance than you would otherwise expect to spend for medical care is to avoid the risk that your estimate of medical care costs is too low. We know that younger (and healthier) persons assign much lower values to risk transference than older (and less healthy) persons – 18-24-year-olds are nearly 4 times as likely as people ≥65 to say that they do not need health insurance, and are nearly 2 times as likely to describe themselves as risk-takers (Exhibit 4). So to the extent that consumers are choosing insurance to mitigate risks, this dynamic is likely contributing to adverse selection

The demonstrated fact that HIE enrollees are older and sicker than the general population, and the apparent fact that claims costs in many cases exceed premiums, both indicate that HIE-based insurance offerings are mispriced, and by extension that the HIEs are unstable. From the perspective of many potential enrollees, net prices are too high – unless they’re older and/or less healthy. From the perspective of underwriters, net prices are too low, since claims costs in many cases exceed premiums collected. As insurers increase premiums to cover claims, the number of persons who see higher premiums as worthwhile shrinks to an ever smaller, older, and sicker population – in other words, adverse selection

Adverse selection has been masked by start-up phase enrollment gains; these offsets have played out, making adverse selection far more apparent in and beyond 2018

Insured populations experiencing adverse selection tend to shrink, but HIE enrollment has grown, and it bears examining why. We find 3 main reasons, each of which have more or less fully played out. First, well-publicized IT problems with HIE enrollment interfaces almost certainly reduced enrollment numbers, especially early on. Second, general awareness of coverage availability, subsidy availability, and exposure to tax penalties began from a very low level and grew slowly. Third, penalties have grown from (practically) zero to now much more significant values[6]

We calculate net costs of coverage as premiums, minus subsidies, minus applicable penalties. Since penalties have the effect of lowering any savings that might be realized by choosing not to pay premiums, raising penalties reduces the net cost of buying insurance. Since the HIEs began operating in 2014 applicable penalties have grown substantially, and reached their maximum inflation-adjusted levels[7] for the 2016 benefit year

Starting with the estimated 5.0M persons who enrolled in the HIEs in 2014, and who were either privately insured or uninsured in 4Q13, we calculated how 2014-2017 penalty growth would be expected to impact enrollment. Assuming 2017 premiums are 25% higher than 2016 premiums, relative odds of enrolling by 4Q13 insurance status and relative cost of premiums and medical care remain exactly as shown in Exhibit 3, and no other changes (i.e. no ease-of-enrollment or awareness effects) we would expect 2014-2017 enrollment growth of 6.7% (Exhibit 5). Changing the 2016-2017 premium inflation assumption to 10% and keeping all other assumptions constant, we would expect 2014-2017 enrollment growth of 7.3% (Exhibit 5, again). These predicted enrollment gains occur simply because penalties lower potential beneficiaries’ net premium costs (despite rapid premium inflation), moving more people out of the leftmost column in Exhibit 3 (net premium costs exceed anticipated health costs) and into the middle column (net premium costs are less than anticipated health costs). Notably, if we assume that there was no change in penalties between 2014 and 2017, then estimated enrollment would have fallen slightly (by 20bps at 10% assumed premium inflation, Exhibit 5, again)

Adverse selection pressures on the HIEs have been masked by enrollment gains, but the drivers of these enrollment gains have reached their peak effects. Enrollment barriers are unlikely to fall further, awareness is unlikely to grow further, and penalties are at their (inflation-adjusted) maximum value. Since none of these masking effects can be expected to have any appreciable impact on adverse selection pressures going forward, enrollment is likely to shrink toward an older, sicker population beginning with the 2018 benefit year

The next administration almost certainly cannot sidestep the issue of adverse selection on the HIEs … and this has relevance for whether and when other health policy issues (e.g. drug pricing) are handled

Left unchecked, adverse selection pressures tend to grow at an exponential rate, collapsing insurance markets. As such, we believe the next administration will be forced to deal with adverse selection on the HIEs, in all likelihood during the 2017-2020 term. Policy options include higher subsidies, higher penalties, narrowing the scope of required benefits, allowing greater premium differences according to age, allowing higher out-of-pocket maximums, and/or merging the lower quality HIE risk pool with other higher quality (e.g. Medicaid, employer sponsored) risk pools. No single option is likely to be adequate, thus the policy changes required to save the HIEs are likely to be complex, and will require a heavy political lift

Because adverse selection almost certainly forces healthcare onto the next administration’s agenda, and because considerable effort will be required to pass requisite reforms, we seriously doubt that a newly elected administration would choose to proactively seek any major healthcare reforms – including in particular drug pricing reforms – early in its tenure

 

  1. Medical Expenditure Panel Survey; we take advantage of the fact that MEPS is structured with overlapping panels of survey respondents who are each followed for two calendar years. Specifically, for our purposes, Panel 18 was enrolled in both 2013 and 2014, allowing us to observe the longitudinal consumption and enrollment decisions of families before and after the launch of the exchanges in 2014
  2. See, most recently, “Why Adverse Selection Pressures Are Building Rapidly on the HIEs,” December 7, 2015, SSR Health, LLC
  3. Net costs of coverage = premiums + out-of-pocket costs (up to the deductible) – subsidies (both premium and cost-sharing reductions) – penalties
  4. We defined 2014 anticipated medical costs as 2013 actual costs x 1.049
  5. Presumably, privately insured in 4Q13 are significantly more likely to have another source of coverage in 2014 – whether ESI, or non-exchange non-group coverage – hence the +/- 5 fold difference in enrollment rates between the two groups, regardless of potential cost savings
  6. The max of $95/adult and $47.50/child (capped at $285) or 1% of household income in 2014; the max of $695/adult and $347.50/child (capped at $2,085) or 2.5% of household income in 2016.
  7. Penalties inflate at CPI after 2016

 

©2016, SSR, LLC, 225 High Ridge Rd, 2nd Floor, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to Pfizer Inc (PFE) and to Merck (MKGAY) on both securities-related and non-securities-related topics

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