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1 Simple Picture That Explains Why When Obamacare Says "Jump," Insurers Ask "How High?"

Have you ever tried to get your health insurance company to do something that it really didn't want to do? If you have, my guess is that it didn't go so well.

When it comes to the Affordable Care Act, commonly known as Obamacare, some health insurers appear to be pushovers. Typically, insurance companies require payment before a policy goes into effect. Not for Obamacare. If you have a Jan. 1 effective date, your first payment can be as late as Jan. 10. Big insurers including Aetna (NYSE: AET  ) and Cigna (NYSE: CI  ) acquiesced to the federal government's "request" for this grace period.

Why is it that when Obamacare says "jump," insurers ask "how high"? One picture provides the likely answer.

Source: Affordable Care Act, section 1342. 

This picture illustrates how the "risk corridor" provision of Obamacare works. The health insurers that chose to participate in the health insurance exchanges have a not-so-silent business partner -- Uncle Sam. 

The Department of Health and Human Services, or HHS, sets a target cost for health insurance sold on the exchanges. If an insurer incurs higher medical costs than expected (more than 3% higher than the target cost), HHS subsidizes the insurer's losses. If medical costs are much higher than expected (8% or more above the target cost), the subsidies are turbocharged.

Take WellPoint (NYSE: ANTM  ) , for example. The nation's second-largest health insurer stands out as one of the most vested in Obamacare, participating in exchanges in every state where the company operates. If WellPoint runs into steep medical costs that are 20% more than what is targeted, the company will actually only lose less than 8% thanks to the HHS risk corridor subsidy.

Insurers are willing to jump through nearly any hoop that Obamacare throws into their paths, because the government controls the purse strings to the risk corridor program. When President Obama announced that plans that had been canceled because of Obamacare's minimum benefits requirements could be reinstated, one of the first messages put out was that the risk corridor payments would be sweetened.

Of course, even the promise of extra money couldn't magically evaporate all of the significant issues with the last-minute change. Aetna was one big insurer that balked, stating that there simply wasn't enough time to clear all of the regulatory hurdles to reinstate the canceled policies.

With this limited downside from the risk corridor subsidies, is the business partnership with Uncle Sam a smart business move that rewards investors? Maybe not.

For one thing, we have only focused on the right side of the picture -- where medical costs are higher than the target amount. The problem for insurers is that their partner isn't just a giver -- he's a taker, too. If medical costs are too much lower than expected, insurance companies must pay the federal government a portion of their good fortune. That's above and beyond regular taxes on profits.

Also, losing money isn't a good thing for a business, regardless of whether or not that loss is cushioned somewhat. At least one analyst, UBS' A.J. Rice, predicts that WellPoint will lose around $236 million in 2014 because of Obamacare. Those losses could be even worse if the lower-than-expected enrollment experienced thus far results in fewer healthy Americans signing up for insurance.

This very concern kept the biggest health insurer in the country, UnitedHealth Group (NYSE: UNH  ) , largely on the sidelines when it came time to participate in the Obamacare exchanges. CEO Stephen Hemsley warned that initial enrollees could have "a pent-up appetite" for medical care. 

Some insurers might like the free money, but many Americans don't. A survey by Investors Business Daily found that 65% of respondents oppose a "federal bailout" of insurance companies that lose money because too few healthy individuals enroll in Obamacare plans. There could be considerable public pressure to limit the risk corridor program.

Even if not, the current risk corridor payments won't last forever. Obamacare phases them out in three years. In the meantime, health insurers could find out what children discover at an early age: You can get tired after jumping for a long time.

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Read/Post Comments (7) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 07, 2014, at 10:28 PM, altmd71 wrote:

    The ACA, which was supported by the insurance companies without even knowing what was in it and are now inexorably connected to it, is going to be their demise. If he breaks them he can then purpose a single payer system it which they can be he third party administrators with contracts with the government. The liberal/progressives are not stupid. They have a plan and it is going well so far.

  • Report this Comment On January 07, 2014, at 10:56 PM, fr0sty wrote:

    And those turbocharged subsidies will be exactly what continues to drive healthcare costs higher and higher. Docs and hospitals will charge more because they know insurance will pay for it. Insurance will pay for it because they know we'll foot most of the bill.

  • Report this Comment On January 07, 2014, at 11:21 PM, LongHaulInvestor wrote:

    Blue Cross Blue Shield has been all in, I applaud them for that. If the market fails, they will go down - as will Humana, Aetna, United Health Group, etc. No one will be exempt. If the new model succeeds, BCBS will be in the catbird's seat. If you're a HEALTH INSURANCE company, the only logical choice is to go all in. Anything else is folly. Yes - if the market fails, the other companies may fail less spectacularly. What consolation is that? They will still fail. Get some cojones and get in the game!

  • Report this Comment On January 08, 2014, at 6:27 AM, wrevansii wrote:

    The Obama administration and the health insurers should be prosecuted under the Rico statutes for racketering.

  • Report this Comment On January 08, 2014, at 7:24 AM, Barmil wrote:

    Insurance companies do not fail, they will remain at the tax payer expense.

  • Report this Comment On January 08, 2014, at 10:41 AM, time4revolution wrote:

    Say NO to insurance company bailout. Their greed got them into bed with the devil. Let them live with the consequences. Reps should attach NO Bailout to the debt limit negotiations. Make Obama choose between insurance companies and debt limit.

  • Report this Comment On January 08, 2014, at 4:00 PM, Knightfang wrote:

    The system is no longer 100% rigged by insurances companies who want sick customers dead rather than alive.

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Keith Speights

Keith began writing for the Fool in 2012 and focuses primarily on healthcare investing topics. His background includes serving in management and consulting for the healthcare technology, health insurance, medical device, and pharmacy benefits management industries.

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