A Formula for Successful Health Insurance Exchanges

I awaited the 2010 election before writing this article, as there was a possibility that the seven-month-old Patient Protection and Affordable Care Act (the “Act”) would be repealed by a new Congress. The election results, however, indicate that this new legislation will remain in force.

There are significant sections and aspects of the Act that have questionable consequences, the sum total of which, I believe, may well spell the demise of American health insurance  as we know it. I elaborate on this in the concluding section of this article, but my premise is simple: When you can wait until you are sick to buy health insurance, you have effectively eliminated the concept of insurance. Organizations we call health insurance companies or health plans will ultimately be relegated into the category of utilities.

I also believe that the endgame of the new Act will be essentially a single-payer system, with the cost of private health insurance too high but for a very small portion of the population. That endgame is probably closer than the general public realizes. Expert consensus gives 2020 as the proximate date when 95% of American health care will be paid for by the Federal Government.

Until such speculative time, there is a very real and present need to organize a fair, uniform, and viable system for the health-care access of the U.S. population as envisioned by the Act. One short cut--reducing the entry age into Medicare—has thus far seemed too big a political pill to swallow. 

Rather, a nationwide system of state health insurance exchanges (the “Exchanges”) is outlined in the Act. I am generally very much in favor of the approach, if quite skeptical of much of the initial tack taken toward pricing the goods and services offered at Exchanges, several of which I elaborate upon in the following section. I believe, nonetheless, that Exchanges are the first step toward national health care as we see it in Canada or the UK.

How the Exchanges Could Work and be Successful

First, I note that the Exchanges will operate much like the 1960 Federal Employees Health Insurance Plan. All legal citizens of a state are given equal access to the Exchange, thereby eliminating the need for employer-based health insurance. To preserve the federal tax deductibility treatment of premiums, employers would voucher employees’ premiums to the Exchange in the same way the federal government pays for health benefits for their employees. This is provided for in the Act.

Pre-existing conditions would be covered as proposed in the ACT. Premiums have to be appropriate, based on independent studies by the Exchange’s actuaries. However, actuarial principles have been ignored in the ACT. This is a flaw that the new Congress could amend by allowing age-based premiums and guaranteed actuarial-based premium increases.  

Health insurance companies are licensed by states. This makes selling health insurance a privilege not a right. The states will have the power to compel all health insurance companies licensed therein to participate in the Exchange. All existing health insurance programs in the state would be folded into a single program, eliminating disparity between the employed and unemployed.  Sole access to health insurance would therefore be through the Exchange. Insurance companies that did not want to participate could withdraw from the state.

No sales commissions or add-on fees would be allowed (except to payroll companies for processing vouchers). There would be no need for brokers. No advertising would be allowed, which would eliminate the advantage to companies with larger advertising budgets. Enrollment and premium collection would be through the Exchange, thereby eliminating this administrative burden to the insurance companies. It will also be easier to track who has coverage.

The lack of expenses for commissions, advertising, enrollment, and premium collection will make the amount needed for company expenses to be greatly reduced. Ninety percent of premiums would be used for medical claims. Insurance companies are still at risk requiring billions of dollars in risk capital called “surplus” and therefore, need to have a return on capital. However, company profits in excess of 4% of premium will be returned in the form of reduced future premiums.

The Exchange would offer limited plan options so that consumers can make easy comparisons. Tools and education provided by the Exchange would help consumers judge which plan might best fit their needs. To provide a basic level of affordable coverage, one of the offered benefit designs must include a plan option with Medicare A, B, and D levels of benefits, with maximum reimbursement to providers equal to RBRVS (Medicare rates). This is to provide a base benefit that should be affordable. State-mandated benefits would not be required in this plan. The Exchange would rate and publish the companies’ performance through independent surveys of participants and expert reviews of medical outcomes.

Enrollment will be online, at kiosks located in all enclosed shopping malls and in certain government buildings. People who have not enrolled will be automatically enrolled when seeking care. The penalty for not enrolling would be equal to their age-based premiums from January 1, 2014 forward. Other privileges, such as having a driver’s license, would be suspended until the premiums are paid. I admit that these are severe penalties, but Exchanges only work if everyone participates.

All Federal subsidies will be used to help people purchase within the Exchange, and the Exchange will comply with the U.S. Secretary of Health’s mandates.  

If the above is followed in its entirety, Exchanges could provide coverage to everyone as the country moves into a national health plan. The transition would be easier since all residents of the states would be enrolled in the Exchanges, Medicare or Medicaid.

Why the Exchanges Currently Envisioned Will Not Work or be Successful\

There are two principal actuarial rubrics in pricing health insurance that have been ignored in the Act:

• “Community rating” means that everyone buying insurance pays the same price, irrespective of gender and health status. By 2014, all state Exchanges will require community rating. Anyone participating today in markets requiring community rating, however, soon learns that such health insurance is very expensive. For the moment, the new Act does allow a 3-to-1 difference in premiums. For example, a 22-year-old may pay $200 per month, while a 60-year-old may pay $600. This may seem a reasonable spread, but the true actuarial value could be far closer to $100 for the 22-year-old and $1,000 for the 60-year-old. While failure to hew to true actuarial value will initially skew the attractiveness of the Exchanges to the more elderly, once the risk pool is dominated by the latter, monthly premiums may well rise to $400 for the 22-year-old and $1,200 for the 60-year-old. Almost anyone in his or her twenties will be priced out.
• The second consideration is “anti-selection,” which means that people select coverage against the interests of the insurance companies. Exchange membership, as currently outlined in the Act, is open to anyone, irrespective of health status. Since the annual penalty ($650 for singles and $2250 for families) for not buying insurance is no deterrent to ignoring the mandate of buying insurance, many people will wait until they are sick to buy. The Exchanges’ premiums will quickly spiral upward: Insurance industry history is riddled with examples of Exchanges that failed to make insurance affordable, the best current example being the Commonwealth of Massachusetts. Compounding this danger is the certainty that high-risk pools currently being formed will be dumped into the Exchanges in 2014.

Insurance companies need to have a “spread of risks.” Awareness of this principle and its successful implementation is central to a successful Exchange. Premiums have to be appropriate, based on independent studies by the Exchange’s actuaries. The Act, however, does not allow for this and that failure should ultimately put any Exchange out of business. Quite simply, Exchanges will eventually be disproportionally filled with older and ill people unless the Act is amended.

Insurance companies must be allowed to charge actuarially based rates that guarantee the solvency of the insurer. When restrictions on premium increases are mandated for political reasons, as has been the case in Massachusetts, the sole alternative is that insurance companies must be relieved of any “surplus,” as defined above, to guarantee solvency. The state would then have to be the guarantor.

To avoid the anti-selection that is promoted by eliminating preexisting conditions, enrollment would have to be mandatory, with penalties equal to 100% of the applicable premium. For example, a single premium of $6,000 would have a fine of $6,000 instead of the $650 dollars in the Act.

The Death of Employer Health Insurance

The Exchanges were legislated essentially as places for people who did not have access to employer-sponsored health insurance. People with lower incomes would receive federal subsidies to buy health insurance. The coverage in Exchanges may be limited to coverage defined by the Secretary of Health. Wealthy individuals, who do not qualify for subsidies, may opt for richer benefit plans that provide greater access to healthcare. This is the nature of the insurance market in the UK. The Act promised less expensive insurance to individuals and the small business community. To date, this has not been the experience of the exchange (called “the Connector”) in Massachusetts, where small-business health insurance is still very expensive.

The only surviving reason for a business to offer health insurance is to attract employees. Under the Act, there is no penalty for small businesses (50 or fewer employees) not to provide insurance. After 2014, such businesses will not need to provide health insurance to attract employees and will allow their employees to enter the Exchanges and receive Federal subsidies. Such small businesses could provide a higher salary to offset the loss of employer-sponsored health insurance. In such a scenario, the Exchanges would put all small employers on an equal health-care footing for attracting employees.

The consensus within the health insurance industry is that large employers with older employee populations will also cancel sponsored health insurance and funnel their employees into the Exchanges, if the Exchanges offer lower premiums. This will further skew the population of the Exchanges to an older average age, which will make premiums rise sharply.

The math of the subsidies is also heavily weighted to the creation of two health-insurance castes in the U.S. Those making over $90,000 will have richer benefits with better access to care. Those making less than $90,000 will be in the Exchanges, which may have very restrictive access to providers as a strategy to keep premiums affordable.

The Exchanges may be successful if they adhere to actuarial principals and do not succumb to political whims.

About the Author:

After selling his health insurance company in 2007 Mr. Thomas established Continental Underwriters, which assesses corporate initiatives in reducing the cost of healthcare. Continental’s main client is the Leapfrog Due Diligence Cooperative, an organization representing over 2,200 large employers. During his 41 year career in health insurance he has spoken at dozens of conferences, been an expert witness and industry arbitrator. He has also instructed hundreds of CE courses.