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No, Obamacare isn’t a ‘bailout’ for insurers

The term “bailout” is back. Specifically, Republicans are calling a feature of the Affordable Care Act — the risk corridor funds designed to share losses if insurance companies have greater than expected losses — a “bailout.” As such, conservatives are demanding that they be repealed.

What stands out to me is that nobody is saying what a “bailout” actually entails. Can the academic literature help us here? Yes, in fact. Banking, bankruptcy and finance scholars have tried to piece together a definition of bailouts, and perhaps this could help move the conversation forward.

This is a special issue, because as business professor David Moss elegantly demonstrates, the history of the government has always been bound up with its powers of risk management. And, he argues, there have been three big waves of risk-management innovation. The first came in the 19th century, with a focus on business. The 1800s weren’t an entirely laissez-faire period; there was actually substantial government public-policy innovations such as the limited-liability corporate form, the money stock and bankruptcy law. This later evolved into a 20th-century focus on risk management for workers, and then a third wave about providing insurance for all people. Things like Social Security and the corporate charter aren’t thought of as “bailouts,” so what differentiates them?

Law professor Cheryl D. Block gives a starter definition of “bailout” in Overt and Covert Bailouts: “[A] bailout is a form of government assistance or intervention specifically designed or intended to assist enterprises facing financial distress and to prevent enterprise failure.”

According to Block’s definition, bailouts are a form of a government subsidy. But not all subsidies are bailouts. And she specifies three types of subsidies that aren’t bailouts: Bailouts should be distinguished from incentive subsidies, designed to promote a specific behavior such as marriage or savings. Bailouts should also be distinguished from relief subsidies, or the government’s role in providing types of insurance from, say, disasters. And bailouts also aren’t support subsidies, or things such as price supports, which are designed ultimately as a form of regulation of markets. These things all may be good or bad ideas, but they belong in a different category from bailouts.

Can we get more specific? In her paper “Financial Crisis Containment,” law professor Anna Gelpern compared the ways countries respond to financial crises. What she found was a remarkable consistency across many different countries and times. In times of crisis, the government tries to contain damage by suspending regulations, by rewriting or otherwise not enforcing contracts and by redistributing losses, especially to taxpayers.

More specifically, these actions are special rules that go into effect only when a firm is already about to fail, and the moves are decided on a case-by-case situation (that is, bailouts are ex post and ad hoc). We already have rules and laws that are designed in advance to allocate losses when firms go under, ranging from the numerous chapters of bankruptcy to the limited liability corporation itself. However bailouts are not put into place in advance. They are executed only after a firm is about to go under, as when the financial system went into panic mode in fall 2008.

In 2008, some firms were also treated one way while other firms were treated another way. This gives bailouts the appearance of being ad hoc. Bear Stearns received a bailout from the government, but at the last minute Lehman Brothers didn’t and the rest of finance did. This arbitrariness often benefits the powerful at the expense of the weak and cal also look like a large power grab by both the government and private agents.

If bailouts are so unpopular, why do they happen? Sometimes the reasons are explicitly political. During the Vietnam War, the government bailed out the military manufacturer Lockheed. Sometimes bailouts are done to address national emergencies. After 9/11, the government bailed out the airline industry, which had its flights grounded because of concerns about terrorist attacks.

But those aren’t what we generally think of when it comes to bailouts. Usually bailouts are put into place to prevent a situation in which the failure of one firm leads to problems or a collapse for the economy as a whole. The usual metaphor for this kind of systemic risk is a row of dominoes, where one failure causes failures for other firms. Another metaphor, borrowed from epidemiology, is contagion, where failures at one business affect everyone. One example of this is bank runs, where the failure of one bank makes everyone rush to pull their money out of other banks. A version of this happened with the capital markets and Wall Street during the crisis.

Bailouts are also carried out to protect people who are doing business with the failing firms. This is a particular problem for financial firms. Because of their size, these companies will often have numerous counterparties, and because of their leverage they will need to be able to make consistent payments. Because functioning markets shut down in panics, liquidation processes that require market valuations are also difficult to carry out.

So should the Affordable Care Act's risk corridors be considered “bailouts”? It’s telling that the risk corridors aren’t going to be done after the fact, with the government waiting until losses happen to decide whether and how much it’s going to react. Indeed the risk corridors expire after a few years. So in that sense, these policies aren’t arbitrary and after the fact in the same way that the financial market bailouts of 2008 were.

Risk corridors are also a feature of Medicare Part D and as such represent a common risk- management technique when it comes to private insurance. As Yevgeniy Feyman argues, “any conservative reform plan for universal coverage will have to use similar methods of risk adjustment.” And As Scott Gottlieb writes in Forbes, it’s easier to understand risk corridors as a deliberate subsidy that functions as part of an overall system of aid. As such, it falls into the category of support subsidies that function as regulation, which removes it from Block’s definition.

It’s important to be careful with the words here. Bailouts mean a certain thing, and there’s reasons to find them unjust and unsettling. But conservatives want to blur that definition into all government actions, which in turn is simply used to discredit the state. That easy temptation should be avoid.

Mike Konczal is a fellow at the Roosevelt Institute, where he focuses on financial regulation, inequality and unemployment. He writes a weekly column for Wonkblog. Follow him on Twitter here.