Obamacare's Insurance Exchanges Will Foster A Race To The Healthcare BottomCommentary by John C Goodman
September 25, 2013
The ObamaCare health insurance exchanges are supposed to open for business on October 1. There is a strong suspicion the 37 exchanges to be operated by the federal government will not be ready on time. Even when they do open, the administration is lowering expectations about what will happen next. Despite huge subsidies and despite daily publicity, these exchanges are expected to enroll only 11 million of 48 million uninsured Americans next year.
For anyone who has been living under a rock, here is the back story. The Affordable Care Act (ObamaCare) will require most Americans to obtain health insurance beginning January 1, 2014. You can be subject to a tax penalty if you fail to do so. If you don’t get health insurance from an employer or a government program, you are required to obtain it from a health insurance exchange, an online market where you can choose among competing health plans. If the administration’s estimate is anywhere near correct, three-fourths of the uninsured will ignore this mandate.
Those who do enroll may not be happy with their experience. We now know quite a lot about how these exchanges are going to function and the picture doesn’t look good.
Attracting the healthy, avoiding the sick. In most states today insurers are allowed to charge individuals premiums that reflect their expected health care costs. This practice is no different than it is in life insurance, casualty insurance or most any other kind of insurance. In a free market, you expect to pay premiums that are actuarially fair.
The Affordable Care Act will end this practice. Instead, insurers will be required to practice a form of community rating, under which the healthy and the sick will all be charged the same rate.
You don’t have to even be in the business to understand what kind of incentives that creates for the insurers. If the healthy are overcharged so that the sick can be undercharged, then insurance companies can expect to make profits on the healthy and losses on the sick. This means that it is in the self-interest of every insurer to attract the healthy and avoid the sick.
How do you do that? One way is to design plans that on the surface redistribute resources from the sick to the healthy.
Traditional insurance theory holds that patients should pay out of pocket for expenses that are small and over which they have a great deal of discretion. Insurance, on the other hand, should pay for expenses that are large and over which patients don’t have a lot of discretion. The insurance being offered in the exchanges turns that theory on its head, however.
Under a typical California plan, for example, patients will make only nominal copayments when they see a doctor, get a blood test or an X-ray exam ― activities that are often discretionary and the source of a great deal of unnecessary care. But if they go into a hospital (where patients have almost no control over what is done or what anything costs) they will be charged from 10% to 20% of the total bill. For an individual earning only a few thousand dollars above the poverty level, a hospital visit will cost $2,500. For a lower-middle income patient, the charge will be $6,350. A moderate income family can end up paying hospital expenses of $12,500 ― every year!
Clearly this plan will be attractive to people who don’t plan to enter a hospital and unattractive to people for whom a hospital stay is likely.
Race to the bottom on access to care. Think of an insurance plan as having three main components: (1) a premium, (2) a list of covered benefits and (3) a network of doctors, hospitals and other providers. Under the Affordable Care Act, there is very strict regulation of benefits ― right down to free contraceptives, questionable mammograms and non-cost-effective preventive procedures. At the same time health plans have been given enormous freedom to set their own (community rated) premiums and choose their own networks. They are using that freedom in yet another way to attract the healthy and avoid the sick.
In the ObamaCare exchanges, the insurers apparently believe that only sick people (who plan to spend a lot of health care dollars) pay close attention to networks. Healthy people tend to buy on price. Thus, by keeping fees so low that only a minority of physicians will agree to treat the patients, some insurers are able to quote very low premiums. They are banking on attracting the healthy and they may even have the good luck to scare away the sick.
Community rating is what makes this strategy work. In the ObamaCare exchanges, if I am healthy why wouldn’t I buy on price? If I later develop cancer, I’ll move to a plan that has the best cancer care. If I develop heart disease, I’ll enter a plan with the best heart doctors. And these new plans will be prohibited from charging me more than the premium paid by a healthy enrollee. (See a more comprehensive analysis.)
As a result, we are getting a race to the bottom on access ― with private plans in the exchanges looking increasingly like Medicaid, just as they do in Massachusetts.
The Obama administration doesn’t seem to be bothered by this development. In fact they have been touting the fact that the premiums have been lower than expected, even though the reason is that the networks are narrower and skimpier than expected.
Think how different this is from what we were promised. During the 2008 election, every serious candidate for the Democratic presidential nomination repeated the “universal coverage” mantra repeatedly ― and on the left “universal coverage” means universal access to care. No candidate even hinted that access to providers might not be any better than it is under Medicaid.
Perverse incentive for insurance buyers. The penalty for not obtaining insurance is relatively small: $95 or 1% of your income in 2014. In future years it becomes larger, but for most people it will never come close to the cost of the health insurance they are required to buy. Further the enforcement mechanism is weak. All the IRS can do is withhold your income tax refund. It can’t garish your wages or attach an asset or even require you to pay a higher tax. And if you manage your affairs smartly, you will never be owed a refund.
As a result, the great fear of the Obama administration (and indeed the entire health insurance industry) is that millions of healthy people will decide not to enroll. This possibility is made more likely by a long, complicated enrollment form and an arduous enrollment procedure. Unless you are really sick and need health insurance right now, the temptation will be to wait to enroll until you have a health care problem. To make matters worse, the healthy, remember, are being over-charged from the git-go.
In Massachusetts, people who game the system are called jumpers and dumpers. They wait until they are sick to enroll (jump in). Then, after they get the care they need and get their medical bills paid, they dump the plan and disenroll. Of course, if the only people who have health insurance are people who are sick, the cost of insurance will go right through the roof.
To combat this possibility, the Obama administration has launched a desperate offensive ― attempting to enlist professional athletes, Hollywood actors, rock stars, librarians and anybody and everybody who can help persuade the healthy, especially the young and healthy, to join up. We’ll see how successful that effort is.
A better way. ObamaCare is not the only health program in this country that requires insurers to accept all comers, regardless of health condition, and forbids charging higher premiums to people with higher expected health care costs. That’s the way Medicare Part B (doctors’ services) works, as well as Medicare Part D (drug benefit) and Medigap insurance. None of these programs has a mandate or any penalty for not enrolling. Yet they all discourage gaming. In general people have to sign up when they are eligible and if they don’t they face higher (in some cases much higher) premiums when they do enroll.
If we structured ObamaCare the same way, there would be no need for a mandate and no need for a great many other bureaucratic burdens.
But to avoid other problems, we must do more. We must jettison the whole idea of community rating. This is preventing insurers from presenting buyers with real (risk-adjusted) tradeoffs between price and access or price and benefits. It’s this artificial pricing that causes a race to the bottom, not some inherent defect in the market.
What about pre-existing conditions? There is a better answer for that as well. It is called “change of health status insurance.” People would be able to buy insurance that protects them against the cost of getting a pre-existing condition — including paying the extra premium should they need to switch to another health plan.