Back in good old 1991, the phrase “a race to the bottom” described the predicted events following one state’s proposals for a set of major medical insurance reforms. Those reforms included:
• Individual major medical would be purchased through a state operated exchange.
• Guaranteed policy issue.
• End to preexisting condition limitations.
• Community rates to assure that no one, young or old, singles or families, would pay more or less than each plan’s standard premium.
• Minimum loss ratio with premium refunds to insureds would insure that no insurance company could make “excessive” profits.
• Five easy to understand standard plans, differing mostly by coinsurance percentage.
• To get rate increase approval, carriers must prove that current rates will harm the plan.
• Carriers can charge only the approved premium rate.
• Risk adjuster mechanism – losses shared between companies.
The theory was that grouping individuals into the public exchange would achieve all these wonderful objectives while substantially lowering individual premium and accepting anyone with serious health conditions.
Sound familiar?
All of these reforms seemed sensible and consumer oriented. I’m sure that best intentions were at play when each was suggested. Combined, these reforms unfortunately served to distort marketplace economics and eventually resulted in a dysfunctional health insurance environment.
Predicting a race to the bottom, critics of the proposed reform correctly predicted:
• Premium increases will quickly become unaffordable.
• Deductibles will increase dramatically.
• Younger people will suffer much higher rates.
• Many will opt out of the new individual health insurance system.
• Competition will cease as carrier after carrier leaves the individual marketplace.
• Plan design innovation will come to an end.
• The risk adjuster won’t work.
• Plans and premiums will be designed to fend off potential insureds – the race to the bottom.
This was twenty-five years ago. Did any of these predictions come true? Yes, all of them. I was among the group of predictors who met with the reformers. We hoped to help them find a successful way to meet their goal. After all, their goal of bringing affordable health insurance to everyone was also our goal.
That state’s plan can serve as our practical example. In 1992, there were about 200,000 individual comprehensive medical plan insureds in that state. By 2012, the number of individuals in comprehensive medical plans dropped dramatically to about 50,000.
The George Santayana quote comes to mind, “Those who fail to learn from history are doomed to repeat it.” Why do we not learn from example? Yogi Berra had it right, “It’s like déjà vu all over again.”
The Exchange Concept
The idea of an exchange is a good one, but only if expectations are correct. An exchange provides choice and convenience, but it does not provide cost savings. Its added administrative requirement actually adds a layer of cost.
A public major medical insurance exchange is not in itself capable of automatic group risk management as is a private employer exchange. Unlike an employee group, a public exchange, open to all, has few tools to prevent adverse selection.
A private employee group exchange is quite different. People join an employee group only when they become eligible employees and leave the group when they are no longer eligible employees. This enrolling and dis-enrolling process is not based on health, but on employment.
In a public exchange, however, healthy people can often remain uninsured, enroll when they feel the need, and quit the plan when they resolve their health issue – a horrific example of adverse selection at its very worst.
It is important we understand how health insurance prices are determined. Some might think prices are divined by magic or by “how much we can charge,” when the reality is that the health plan must collect enough money to pay claims and still remain competitive. The basis for individual premiums is the average cost of care for individuals participating in a plan.
Of course, as the ratio of healthy people in the plan increases, the average cost reduces, lowering premiums. Conversely, the greater the percentage of people making significant claims, the higher the individual premium must be in order to have enough money to pay all of the claims.
Penalty
The penalty for failure to purchase a plan is the antithesis of incentive. In a free society, people are free to make decisions that are in their own best interest. If the penalty for failure to purchase a plan is significantly lower than the price of obeying, many will opt to pay the penalty and stay uninsured. To compound the insult to the plan loss ratio, those who opt out are likely to be the healthiest, thereby producing an element of adverse selection. Obviously, an incentive to participate would have been far more effective.
Means Tested and Adjusted Premium Subsidy
Basing subsidy on income and family structure is a guess at actual need. It does not take into consideration individual financial commitments. Think of failed small business owners that still have ongoing loan payments, extended family commitments, etc. Subsidies are often incorrect and attempts to correct less than effective.
The subsidy is available only through the public exchange, not individual purchase made off the exchange. This distorts the marketplace even more. Many require subsidy because of health issues. Our exchange-based subsidy pushes adverse risk into the exchange.
Lower and modest income Americans are forced into the exchange by the power of the subsidy and probably forced to accept a specific plan within the public exchange. They might have preferred a plan offered outside the exchange but were unable to afford it without the subsidy. At worst, this forcing of modest income Americans into the subsidized exchange works to create two American economies, widening an already damaging social divide.
Minimum Loss Ratio
In our example state exchange, the Minimum Loss Ratio, or as I like to call it, “The Premium Maximizer” assured carriers that they could either break even or lose. If they should lose, there would be no making up for the loss. The only self-defense for an insurer would be to charge the most, refund the overcharge, cross fingers, and hope to stay in business.
Standardized Plans
Standardized medical plans mean the end of private sector plan design innovation. This needs no explanation. A free market depends, in part, on innovation to serve the interests of its customers.
Competition
In the last ten years, we have often heard the words, “too big to fail.” While that phrase might be in our health insurance future as the number of health insurers shrinks, the catch phrase for our example should have been, “too small to sustain.” Assume you were the leader of a small to medium size health insurer that served the public nobly with solid plans, competitive rates, somewhat profitably for many years. You want to do the right thing. You participate in the adverse-selection-afflicted public exchange. How many millions of otherwise wisely spent health care dollars are you willing to lose before you give up on the dysfunctional marketplace?
If the marketplace shrinks to one, two, or even three health insurance plans, we lose the most powerful tool to contain costs—a competition. As happened in our example state, everyone moves each year to the cheapest carrier. How do the other fully staffed carriers survive their administrative costs with no premium income?
Death Spiral
As health plan claims increase, prices rise. The laws of price and demand certainly apply. As prices rise, some healthy people will decide to opt out. The average rate climbs and with it premiums rise. As the prices rise, more drop out and premium rate increases spiral out of control.
Fixing it …. Can we?
Subsidy
The most impressive element of the Affordable Care Act was the subsidy for individual health plan purchase. This is also the most important element to correct. The subsidy should be a flat amount available to all, for any plan that meets a minimum standard, in an exchange or not. It should not be means tested. It is important to have healthy people in the mix, even if they have higher than average income, even if they are wealthy. Management of the subsidy is straightforward. The health plan receives the subsidy monthly on behalf of the participant in the form of an advanceable tax credit. This will work for employer self-insured and insured groups. It will also work for individual plan purchase. A flat subsidy will not require an army of IRS agents.
Consumers will decide which plan they want to use their subsidy to purchase. It is likely that some will want a plan that costs the same amount as the subsidy. Carriers can design such a plan. Others will decide to purchase a plan that costs more than the subsidy. They can pay the additional premium themselves.
Understand the Role of the Employer
Employers provide group benefits for their employees because they want to hire and retain good people. It is not due to a paternalistic desire to manage the personal lives of their employees.
Understand the Role of Profit
Profit is not a dirty word. In a free society and a competitive marketplace, profit is the logical motivator and reward for creating customer satisfaction. Consumer satisfaction with health insurance will result from competitive price, good service and fast claim payment. Therefore, potential for profit is vital to reform plan success. Profit allows carriers to build surplus, to take risks, to modernize, to offset losses, and to serve their clientele.
Understand the Role of Self-Interest
In a free society, consumers act in their own self-interest. If health care reform respects and engages that, it has a chance for success.
Understand the Importance of Innovation
Reform must not pick winners and losers. Rather, a successful reform plan will allow and promote flexibility, which will give rise to innovation.
Competition
To promote competition, it will be important to create an environment where it becomes profitable for small and medium size health insurance companies to enter the market.
Who will fix it?
Bad ideas in the private sector fail. Bad ideas in the public sector too often get more funding. In the private sector, someone’s wallet is at risk. Private sector reaction to market forces can be immediate. We need a private sector focused solution.
