Executive Summary: Community Rating Failed

TOS.02 — The Other Side

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Community rating is not a victim of level funded’s growth. It is the cause of it. The ACA’s adjusted community rating for the small group market, effective January 1, 2014, prohibited premium variation based on health status, gender, or claims history. The design intent was to cross-subsidize sick groups through the excess premiums of healthy ones. The mechanism has a structural weakness that Rothschild and Stiglitz identified in 1976: pooling heterogeneous risks in a community-rated market is not a stable equilibrium when participation is voluntary and a cheaper alternative exists for lower-risk groups. They exit. The pool sickens. Premiums rise. More exit.

The argument that community rating did not produce this spiral rests on Buchmueller and DiNardo’s 2002 study of New York’s 1993 community rating reforms, which found no adverse selection death spiral in data through 1996. That finding deserves direct engagement, not dismissal. Two structural differences separate 1990s New York from the ACA small group market. First, New York in 1993 had no scaled exit vehicle for healthy small groups. Level funded was not yet a mature marketed product with ERISA preemption providing clear federal protection. Second, New York’s adverse selection manifested as HMO growth rather than outright exit as healthy groups moved to lower-premium managed care. The pool restructured. It did not collapse.

The ACA small group market started with the exit vehicle already at scale. By 2014, level funded was available from multiple national carriers and TPAs, actively marketed to groups with favorable health experience. CMS estimated in 2014 that 65 percent of small group employers offering insurance would face premium increases under ACA community rating rules, creating an enormous addressable market. A 2018 study in the Journal of Risk and Insurance found that lower-risk employers subject to premium rating restrictions had a predicted probability of self-insurance approximately 18 percentage points higher than otherwise similar higher-risk employers.

The enrollment data documents the outcome. Fully insured small group enrollment fell from approximately 17 million in 2013 to approximately 10 million in 2023. Oliver Wyman’s analysis of NAIC filings found a 26 percent decline from 2016 to 2023 alone. KFF Health System Tracker analysis of 318 small group insurer rate filings for 2026 found a median proposed premium increase of 11 percent. Anthem Health Plans of Maine reported a 11.9 percent single-year enrollment decline and projected a further 10 percent drop. This is the adverse selection spiral operating in real time, produced by community rating, not by level funded.

The limit of this argument requires honest acknowledgment: the employers who remain in community-rated small group plans are largely those whose health status prevents level funded underwriting qualification or who lack administrative sophistication to move. Their position does not improve if community rating collapses without an explicitly funded replacement mechanism. The ACA’s permanent risk adjustment transfers funds within the community-rated pool; it has no mechanism to draw from outside it. The current architecture nominally preserves community rating while allowing systematic exit by those who fund it, producing the worst possible outcome: the subsidy exists in name while its funding base erodes. That is not a market failure. It is the predictable consequence of a subsidy mechanism built on voluntary participation.