Locke Lord QuickStudy: CMS Acknowledges Value of Quota Share Reinsurance for MAO Plans and Proposes New Rule to Establish Reinsurance Standards

The Proposed New Reinsurance Rule
Readers of our prior QuickStudies on this topic are aware that since 2017, the long-standing use of quota share reinsurance by Medicare Advantage Organizations (“MAOs”) with respect to their Medicare Part C business has been questioned, and in several cases disallowed, by CMS.  During the past several years, our firm and clients and other participants in the Medicare Advantage marketplace have shared with CMS their concerns about the legal uncertainty resulting from CMS’ lack of specific guidance on whether or not it will allow MAOs to continue to engage in quota share reinsurance transactions.  

On February 5, 2020, a proposed rule by CMS was filed and made available for public inspection, found here (the “Proposed New Rule Notice”).  As part of the Proposed New Rule Notice (to be published in the Federal Register on February 18, 2020) CMS states that it intends to implement a new regulation (42 CFR §422.3) to formally establish reinsurance standards for the Medicare Advantage program in order to remove “any uncertainty on the permitted utilization of reinsurance” by MAOs (the “New Reinsurance Rule”).  CMS acknowledges in the Proposed New Rule Notice that based on the many comments it received from participants in the Medicare Advantage marketplace and discussions it had with the National Association of Insurance Commissioners, that the use of reinsurance is beneficial.  Among other things, CMS states that reinsurance provides “financial stability for the MA organization, which in turn can lead to enhanced competition and consumer choice, especially in small and mid-sized market areas.”

CMS is proposing to implement the New Reinsurance Rule under the authority of Section 1855(b)(1) of the Social Security Act (the “Act”), which states that an MAO “… may obtain insurance or make other arrangements for the cost of providing to any enrolled member such services the aggregate value of which exceeds such aggregate level as the Secretary specifies from time to time.”  As we previously noted in our comment letters to CMS, this particular exception to Section 1855(b) does not on its face relate to first dollar proportional reinsurance but appears to relate to excess of loss reinsurance which is non-proportional reinsurance.  Nevertheless, CMS proposes that its interpretation of Section 1855(b)(1) allows an MAO to “obtain insurance (that is, reinsurance) or make other arrangements for the cost of providing basic benefits to an individual enrollee the aggregate value of which exceeds $10,000 during a contract year or [more importantly for purposes of this QuickStudy], alternatively, such costs may be shared proportionately on a first dollar basis, the value of which is calculated on an actuarially equivalent basis to the cost of the insurance for costs that exceed $10,000 in a contract year” (emphasis supplied).  CMS also proposes that if the MAO “chooses to purchase pro rata coverage that provides first dollar coverage, the price of that coverage cannot exceed the cost of the option of purchasing stop loss insurance for enrollee health care costs that exceed a threshold of $10,000 in a contract year.”  

CMS further states that the foregoing conditions would only apply to reinsurance of the costs of providing basic benefits and not supplemental benefits offered by MAOs, nor will the New Reinsurance Rule impact the other exceptions in Section 1855(b)(2) through (4) of the Act.  At this time it is unclear whether such language means reinsurance is not allowed under the other exceptions or that any such reinsurance would not be subject to the conditions set forth in the New Reinsurance Rule.

Although CMS does not expressly refer to quota share reinsurance in the New Reinsurance Rule, its references throughout the Proposed New Rule Notice to “pro rata insurance coverage that would provide first dollar coverage” and “such costs may be shared proportionally on a first dollar basis” have to mean that it is referring to quota share reinsurance coverage.

Issues and Opportunities Associated with the New Reinsurance Rule
Although the New Reinsurance Rule is a welcome development in light of the legal uncertainty MAOs have operated under during the past several years, we believe that, as worded, there remains a considerable amount of uncertainty on what the foregoing conditions mean as they relate to quota share reinsurance and how their satisfaction can be confirmed by MAOs and their representatives on a case by case basis.  Thus, we question whether quota share reinsurance arrangements could ever qualify under the New Reinsurance Rule, as currently drafted.  The inherent problem is the proposed condition that the value of the insured risk under a quota share reinsurance arrangement have a value that is actuarially equivalent to costs that exceed $10,000 under an excess of loss reinsurance arrangement (the “Actuarially Equivalent Condition”), as well as the proposed requirement that such quota share coverage be priced at an actuarial value not to exceed the cost of purchasing excess of loss reinsurance for medical expenses exceeding $10,000 per member per year.  

We are not sure what the Actuarially Equivalent Condition actually means, or how it will be interpreted and applied by CMS, and how it can be confirmed by MAOs and its representatives when entering into quota share reinsurance arrangements.  Furthermore, excess of loss reinsurance and quota share reinsurance are priced very differently in the reinsurance marketplace.  Generally, pricing for excess of loss reinsurance is based on a percentage of premium which the reinsurer’s actuaries believe is necessary to cover the anticipated loss to the reinsured layer (plus expenses and profit margin).  Pricing for quota share reinsurance, on the other hand, is the agreed upon quota share percentage of premiums being ceded to the reinsurer from the first dollar (less a ceding commission for the ceding company’s expenses) in exchange for the reinsurer sharing in all claims at the same quota share percentage.  

Based on CMS’s statement in the Proposed New Rule Notice “of the need to ensure that MA organizations are not transferring all the risk of providing services to enrollees to a third party that is not under contract with CMS,” we question whether CMS is concerned about “fronting”.  Fronting, as we previously explained in our comment letters to CMS (see above link to our prior QuickStudy), is a quota share reinsurance arrangement whereby a MAO cedes one hundred percent (100%) of the risks of its Medicare Part C business to a non-CMS approved insurer.  While we noted in our comment letter that a handful of states view fronting arrangements unfavorably as attempts to avoid statutes prohibiting insurers from transacting business in their state without obtaining a certificate of authority, such states nonetheless do not prohibit all quota share reinsurance transactions but instead require that the licensed ceding company (in this case, the MAO) retain a minimum percentage on the risks being reinsured with an unauthorized insurer (i.e., at least a ten percent (10%) quota share retention of such risks).  In light of our concerns about the New Reinsurance Rule, perhaps CMS should instead consider as a condition for permissible quota share reinsurance that a minimum quota share percentage of risk be retained by the MAO.  This would align with CMS’s stated intention to allow reinsurance on risks that exceed a specified threshold in a manner that is customarily used in quota share reinsurance and that can be easily confirmed by MAOs and their representatives when entering into quota share reinsurance arrangements and by CMS when reviewing such arrangements.

Finally, CMS, recognizing that the “reinsurance marketplace is complex and evolving,” is soliciting comments regarding the New Reinsurance Rule generally and the specific $10,000 threshold being proposed for stop loss insurance/excess of loss reinsurance.  And, more importantly, whether the flexibility CMS is proposing for the use of quota share reinsurance “that [is] actuarially equivalent to a $10,000 threshold is sufficient to serve the goals outlined [in the Proposed New Rule Notice].”  Additionally, CMS seems to be signaling that it is considering not subjecting reinsurance transactions within an insurance holding company system to the conditions set forth in the New Reinsurance Rule.

It is critical that MAOs and their representatives provide thoughtful and comprehensive comments to CMS on the New Reinsurance Rule by no later than the deadline set forth in the Proposed New Rule Notice (5 p.m. on April 6, 2020) to ensure that the final New Reinsurance Rule sets forth clear and unambiguous standards pursuant to which MAOs may continue to participate in quota share reinsurance transactions.  

We will continue to monitor the issue and will report back on any new developments.