Skip to main content

Did the Tenth Circuit Just Put the Final Nail in the Coffin for Challenges to the Use of “Statewide Average Premium” in Risk Adjustment Methodologies?

On December 31, 2019, the Tenth Circuit Court of Appeals upheld the Department of Health & Human Services’ Affordable Care Act (ACA) risk adjustment methodology in New Mexico Health Connections v. HHS, No. 18-2186 (10th Cir. 2019), reversing a federal district court's 2018 decision that certain aspects of the administration and risk management formulas used by the Department of Health & Human Services (HHS) were arbitrary and capricious.  It was a fitting end to a decade so defined by health care and, in particular, legal and political challenges to the ACA.  However, whether or not the decision marks the end of serious challenges to the ACA’s risk adjustment program remains unclear.  

Risk Adjustment and the ACA

The ACA’s risk adjustment program transfers funds from plans with lower-risk enrollees (i.e., younger and healthier individuals) to plans with higher-risk enrollees (i.e., older and sicker enrollees) in order to mitigate “risk selection,” which is the process by which an insurer attempts to “cherry-pick” healthy enrollees by structuring benefits, cost sharing, and other plan components in a way that disincentives sicker enrollees from choosing a particular plan.  As we previously blogged about here and here, over the last few years, several small ACA Consumer Operated and Oriented (CO-OP) plans have challenged two particular aspects of the ACA’s risk adjustment program: (1) the decision to administer it as budget neutral, and (2) the use of “statewide average premium.”

For complicated technical reasons (explained in this previous blog post), HHS’s use of statewide average premium (as opposed to, say, the actual premium a plan charges) in the methodology to set risk adjustment transfers can have the illogical effect of increasing a plan's risk adjustment liabilities if, all other factors staying the same, that plan has a lower premium. As a result, the ACA’s risk adjustment program arguably penalizes plans that keep premiums low through smaller payments to providers, management of enrollees’ medical care, and reduced administrative costs.  In sub-regulatory guidance and the rulemaking establishing general standards for the program, HHS justified the use of statewide average premium over alternative methods because the risk adjustment program was budget neutral.  However, nothing in the ACA required that risk adjustment transfers be budget neutral, and plaintiffs challenging the risk adjustment program have asserted that HHS’s decision to administer the program as such is arbitrary and capricious and in violation of the Administrative Procedures Act (APA).

Risk Adjustment Litigation

In early 2018, shortly after a federal district court in Massachusetts upheld HHS’s risk adjustment methodology, a federal district court in New Mexico concluded that application of the statewide average premium was arbitrary and capricious.  Both district courts agreed that the use of statewide average premium complied with the statutory wording of the ACA. The New Mexico district court, however, found that the application of statewide average premium was arbitrary and capricious because HHS had premised its use on budget neutrality but failed to justify why it chose to administer the program as such.

The New Mexico ruling set aside the use of statewide average premium in the risk adjustment methodology for the years 2014 to 2018.  After requesting the district court reconsider its ruling, HHS also suspended risk adjustment payments for plan year 2017, which were supposed to go out during the fall of 2018.  Due to the vocal outcry from ACA plans, however, HHS reinstated the program a few weeks later by releasing a final rule for 2017 (and later, a proposed rule for 2018) providing justification for budget neutrality. 

The practical impact of the 2017 and 2018 final rules was to bifurcate the legal status of the risk adjustment payments between those in which there was no justification for budget neutrality (2014-2016) and those in which there was a justification (2017 and forward).  Thus, when the New Mexico district court reaffirmed its earlier decision in October 2018, the ruling only applied to the 2014-2016 risk adjustment transfer payments.  While the plaintiff challenged the methodology for 2017, HHS was allowed to make risk adjustment payments for that plan year during the fall of 2018.

The Tenth Circuit Ruling

In upholding HHS’s use of statewide average premium for 2014-2016, the Tenth Circuit asserted that the “administrative record is replete with reasoned explanations for why HHS chose to use the statewide average premium in its formula.”  In particular, the court cited several examples in a 2011 white paper issued by the Center for Consumer Information and Insurance Oversight (CCIIO) and HHS's 2014 final rule implementing the program.  Further, the court noted, there were no comments during the rulemaking process opposing HHS’s use of statewide average premium.

The Tenth Circuit also found HHS’s decision to administer the risk adjustment program as budget neutral to be permissible.  Citing the fact that all of the alternative methodologies explored by HHS in the 2011 white paper also assumed the program would be budget neutral, the court reasoned that the administrative record showed that HHS “would have signed its program to be budget neutral even if it had used the plans’ own premiums rather than the statewide average premium in its formula.”  Further, the court concluded, budget neutrality was not a policy goal requiring justification, but rather a funding constraint that stemmed from the fact that “the program lacked any funding authorization.”  HHS could not have violated the APA when it designed the risk adjustment program as budget neutral, the court argued, because “it lacked funding to do otherwise.”  The APA only requires a justification when an agency exercises discretion.  HHS was under no obligation to explain its decision-making in this case because there was no exercise of discretion.   

The absence of a funding source in the statutory language authorizing risk adjustment is particularly significant and in many ways has been the catalyst for much of the risk adjustment litigation.  Appropriations law requires a "valid appropriation” to have both a directive to pay and a source of funds.  Similar to the statutory language authorizing the ACA’s cost-sharing reductions and risk corridors, however, the drafters of the ACA failed to include the proper funding source while drafting the legislation.

The Tenth Circuit appears to have taken the lack of a funding source at face value, but the oversight was arguably an unintentional result of the unconventional process by which the ACA became law.  When the Senate first passed its version of the ACA in December 2009 with a party-line vote, the then-ruling Democratic Party had a 60-vote “supermajority,” meaning the Republicans did not have enough votes in the Senate to filibuster the legislation. (See John F. Cogan, "The High Cost of Good Intentions: A History of U.S. Federal Entitlement Programs" (2017).)   One of those votes was casts by the temporary replacement for the late Senator Ted Kennedy, who had passed away during the summer of 2009. When the Republican candidate, Scott Brown, unexpectedly won the seat a few weeks later during a special election, the Democrats lost their supermajority in the Senate.

The Democratic House of Representatives had not yet passed its own version of the ACA at the time.  To avoid having the Senate vote once more on the final bill, the House adopted the full text of the Senate’s bill, which no one had expected to be the final draft of actual legislation signed into law. The House then had to rely on the Senate to pass a “corrections bill” to address any changes the House wanted to the final legislation.  The Senate used a parliamentary tactic called budget reconciliation to pass the corrections bill, but the corrections bill failed to address the lack of funding source for risk adjustment and other programs either due to a drafting oversight or because of Senate restrictions on what provisions can be included in a reconciliation bill.   Either way, it appears that HHS decided to administer the program as budget neutral – in essence relying on payments into the program to cover all the payments out – in order to avoid running afoul of appropriations law.

The Final Word on Risk Adjustment?

As noted above, the Tenth Circuit ruling upholds the risk adjustment methodology for the plan years of 2014-2016.  The plaintiff’s challenges to the methodology for 2017 and 2018 were considered moot due to HHS's issuance of superseding rules that included a justification for statewide average premium and budget neutrality.  The plaintiff still has the option to request the Tenth Circuit rehear the case en banc and could also the appeal to the Supreme Court. However, it is unclear whether the Court would have the stomach for another ACA case at the moment with Texas v. Azar looming in the background, especially since there is currently no circuit split over the legality of the ACA risk adjustment methodology. 

Subscribe To Viewpoints


Xavier represents clients in the health care and life sciences fields on health care regulatory and fraud and abuse matters. He also handles Medicare and Medicaid reimbursement issues in transactions and business arrangements.