With regard to Association Health Plans, the hundreds of pages of Capitol Hill testimony the author reviewed presented common messages and common arguments on each side. This section will examine some of the main arguments and seek to determine their relevance to reducing the uninsured in America.

Would AHPs Be Able to Unfairly Escape State-Mandated Benefits? Mandated benefit laws, as we have seen, force buyers of insurance to accept benefits they may not want and may not need. The laws increase the price of health insurance and make it more costly than it otherwise would be. As a result, many healthy people who are potential buyers of bare-bones insurance have been priced out of the market (Dressler, 1999; Wilson, 2000; Weil, 2000).

AHPs would avoid costly mandates and provide healthy people with affordable basic health insurance.

The answer to the question "Is it fair?" is "Fair to whom?" Certainly AHP insurance is fair to the uninsured who have been unfairly priced out the market. Is it fair to large insurers who currently dominate the markets and live under mandated benefit laws? Perhaps not, but two considerations are worth noting.

First, the primary social goal should be insuring the uninsured rather than making large insurers more comfortable. Forced to choose between the two, the needs of the uninsured should come first.

Second, between the two groups, large insurers are much better positioned to deal with the unfairness. For one thing, they already posses competitive advantages in the marketplace, as we have seen. For another, they are politically more powerful. Allowing AHPs to sell mandate-free insurance would undoubtedly put great pressure on state governments to extend this privilege to other insurers and the people who purchase their products. Large insurers would be welcome allies in this noble cause.

Would AHPs Be Able to Unfairly Escape Other Government Regulations? Private health insurance for most Americans is already exempted from regulation by state governments. However, those who buy state-regulated insurance face 50 separate regulatory regimes, with 50 different sets of laws, rules, processes, procedures, language requirements, and the like. In principle, a large company with employees in many states faces many sets of regulations. To free large employers from this potential regulatory nightmare was the goal of the Employee Retirement Income Security Act (ERISA), which exempts firms that self-insure from state regulations. The ERISA preemption allows large companies to conduct business under regulations devised by the U.S. Department of Labor. Since regulation by the Department of Labor is uniform across state jurisdictions, this reduces the firm's legal and administrative costs.

"AHP insurance sold under uniform regulations would have lower administrative costs."

Unfortunately, as a practical matter the ERISA preemption is available only to large businesses. Firms with fewer than 50 employees are not in a position to self-insure. If small firms could buy AHP insurance sold under uniform regulations in all states, they could enjoy the same lower administrative costs now available to large companies. Lack of uniformity among the states with regard to laws and regulations is a problem for AHPs in the same way that it would be a problem for large firms, absent the ERISA preemption. Even if the laws on the books were the same, the 50 distinct insurance commissioners whose job is to interpret the laws each may interpret them in different ways.

There are several estimates of the potential cost savings. Donald Dressler, testifying to the House Committee on Education and the Workforce about insurance services provided to the Western Growers Association, estimated that uniform regulations across state lines would reduce administrative costs by as much as 30 percent (Dressler, 1999). A CONSAD study yielded a range of 5.4 percent to 22 percent (CONSAD 1998). Not long ago, the Congressional Budget Office estimated that the AHP legislation before Congress would reduce premiums for small businesses between 9 percent and 25 percent (Baumgardner and Hagen, 2000).

Lower administrative costs, of course, mean lower premiums and more people insured. By one estimate, there would be a gain of 200,000 additional insured for each percentage decrease in health care costs (Congressional Budget Office, 2000). CONSAD estimates that figure to be closer to 300,000 (CONSAD, 1998). The numbers vary, but the message is clear: lowering the costs of meeting regulatory burdens will lower the costs of health care plans, and that in turn will increase the number of insurers and the number of insured.

Is it fair to allow AHPs access to uniform federal regulation and not allow other insurers the same opportunity? Perhaps not, but large insurers have large legal departments and retain lawyers who specialize in state regulations. That infrastructure is already in place and has been for decades. To require AHPs to duplicate those resources in their infancy is irrational from an economic point of view, especially in light of the alternative of federal oversight by the Department of Labor.

"Uniform federal regulation would protect AHPs against hundreds of frivolous lawsuits."

Being under uniform federal regulation would protect AHPs against hundreds of frivolous potential lawsuits based on compliance with conflicting state regulations (Dressler, 1999; Turner, 2002; McIntosh, 2002). Having a uniform federal jurisdiction rather than 50 different jurisdictions drastically reduces the legal and organizational costs for small businesses, giving them the competitive advantage that large self-funded corporations have enjoyed for years.

Would AHPs Destabilize Insurance Markets? There are two issues here that are hard to separate. We will consider each in turn.

First, the existence of monopoly power is itself a market failure. Monopoly output is restricted compared to competitive output and monopoly prices are higher than competitive prices. The result is a social welfare loss (Amato, 1988; Bennefield, 1998; Canary, 2001; Gupta, 1994). Entry into the market is a way to correct that market failure - as competition lowers prices and expands output. What the dominant firm sees as destabilization, however, the new entrant and its customers see as competition. The status quo will, of course, be disturbed. The economic question is: Will people be better off?

Second, the small group market already suffers from instability, courtesy of unwise regulation. Because of state and federal laws, every state in the union has guaranteed-issue legislation requiring insurers to accept all comers, regardless of health status. Almost every state has some form of premium restriction as well (rate bands, community rating, etc.). These regulations keep the premiums artificially low for the sickest groups and artificially high for the healthiest.

As a consequence, small groups have an incentive to "game" the system. That is, they have an incentive to remain uninsured and avoid paying expensive premiums while everyone in the group is healthy, then immediately purchase insurance if a member of the group develops a serious illness. This activity causes the overall pool of people who are insured to be sicker than otherwise and contributes to the overall rise in the cost of insurance. Moreover, the more costly insurance becomes, the greater the incentive to game the system. The more serious version of this spiral is called a "death spiral," because with each iteration conditions get worse.

Mark Litow, representing the Council for Affordable Health Insurance, opened his testimony before the U.S. House Committee on Small Business with this observation (Litow, 2002):

The small group market is in very bad shape. That is so because of a continuing series of incentives… [that were] seriously exacerbated by the use of community rating or rating bands and guaranteed issue as implemented during the 1990s. These incentives have caused skyrocketing premiums in the market combined with a gradually decreasing proportion of eligible groups being insured.

Regulations are worse in some states than in others. Raymond Keating, Chief Economist, Small Business Survival Committee, testifying before the U.S. House Committee on Small Business, comments on the aftermath of community-rating and guaranteed-issue legislation by saying (Keating, 2002):

The results are completely predictable - much higher insurance costs, and fewer insured individuals. And that has been the case in the states that have imposed guaranteed issue and community rating.

For example, New Jersey imposed guaranteed issue in the individual market in legislation passed in 1994. From December 1994 to January 2002, among four insurers offering family coverage during this period, monthly premiums increased by 556 percent (Aetna), 344 percent (Blue Cross Blue Shield NJ), 612 percent (Metropolitan Life), and 471 percent (National Health Insurance).

In Kentucky, after the state adopted guaranteed issue and community rating in 1994, 45 insurers fled the state and premiums skyrocketed. Also in 1994, a similar scenario played out in New Hampshire in response to passing guaranteed issue and community rating.

"Ironically, state reforms have led to fewer people being insured."

Ironically, state reforms designed to make it easier for people to obtain health insurance more often than not have led to fewer people being insured. For example, a study by Schriver and Arnett (1998) concluded that the 16 states that had been most aggressive in regulating their health insurance markets through guaranteed issue, community rating, and other directives had uninsured rates that rose eight times faster than the 34 states that were less regulatory. Wayne Nelson of Communicating for Agriculture and the Self-Employed explained the consequences in testimony before the House Committee on Small Business (Nelson, 2002):

Many of the federal and state reforms that were enacted in the 1990s with the intent of helping the small group market have backfired and actually done harm. Also, several states have tried reforms in the individual market, tried to make them more like the employer market with disastrous results. Some state legislatures believe[d] that simply legislating that every insurance company had to offer insurance to anyone at any time, regardless of their medical conditions, could really solve the problem. And this has led to sky-high premiums and no competition, with many companies leaving states that have guaranteed issue in the individual market. [Emphasis added.]

"In the United States, we are making it easy for people to get insurance after they get sick."

In the United States, we are making it increasingly easy for people to get insurance after they get sick. As a consequence, they have no reason to buy insurance while they are healthy. Increasingly, there is no relationship between the premium charged and the risk transferred by those who pay that premium.

Such a market is inherently unstable. Moreover, virtually any self-interested act by any participant in the market is likely to add to that instability. The answer is not to limit competition. The answer is to change the regulations that cause the instability in the first place.

Do AHPs Unfairly Compete by Engaging in Risk Selection? Closely related to the issue of stability is the issue of risk selection. Critics maintain that AHPs will use unfair methods of risk selection. By this they usually mean that AHPs will "cherry pick" and seek good risks while avoiding bad risks. What critics rarely acknowledge is that there is no such thing as a good risk or a bad risk independent of price. What the term "good risk" means is someone who is paying a premium substantially greater than the expected costs of that person's health care. In other words, a good risk is someone who is profitable because he or she is being overcharged. Conversely, "bad risks" are people who are charged less than the cost of their care. Accordingly, these people are unprofitable.

The business of insurance is the business of pricing and managing risk. Competition in the insurance marketplace tends to ensure that risk is priced accurately. Thus in a competitive market, every new person in a plan will tend to be charged a premium that reflects the expected costs of that person's health care at the time of entry into the plan.

New entrants into almost any market seek to sell to the most profitable customers. The reason these customers are profitable is that they are being overcharged by the insurers already in the market. In seeking to better meet the needs of these customers and give them a better deal, new entrants should be regarded as heroes and encouraged to provide the best, lowest-cost, richest product they can. In any normal market, that is exactly the way they would be viewed. However, in health insurance the tradition is to scorn new entrants for "cherry picking." Yet cherry picking is nothing more than trying to satisfy consumer needs better than a rival. Moreover, the dominant insurers routinely practice various forms of cherry picking. For example, segmenting the market by client demographics is cherry picking. Insuring certain market segments and not insuring others or refusing to write policies in a given market or state is cherry picking. In fact, many large insurers built their businesses in this way.

The foundation concepts of underwriting are risk measurement, risk assessment, risk selection, and risk classification. The largest underwriting departments are found in the largest insurance companies and for good reason. Underwriting and risk pricing is exactly what an insurance company is supposed to do. Rates charged for health benefit packages must be approved by the underwriting department, based on risk measurement, sophisticated actuarial models, and predictive risk assessment. When an insurer excludes certain individuals or firms from a plan, the decision is made based on risk selection, which enables the insurer to offer a more competitive product at a lower cost to the risk pool it chooses.

"Many major health insurers have withdrawn from the small group market and from the individual market."

Many major health insurers have withdrawn from the small group market and from the individual market in various states. When an insurer quits writing business in a state, it exercises the ultimate risk selection technique - avoiding the market altogether. Short of leaving the market, large insurers select risks in other ways. Do they take any person or group irrespective of their state of health and without waiting periods? No. The prospective subscriber must meet certain underwriting requirements before being covered. For example, insurers usually refuse to insure a group unless at least 75 percent (the minimum "group participation ratio") of employees who are eligible enroll in the plan. As a result, a small group in which a significant number of employees choose not to participate will be refused insurance. Insurers will also refuse to insure a group if the employer does not pay a certain share of the premium (usually 50 percent or more). All of these practices involve risk selection. All are designed to attract healthier and avoid less-healthy groups.

It is likely that AHPs will use the same underwriting techniques to fashion health care plans that suit the needs of their membership. They may even contract with a large insurance underwriter to assist in the design and delivery of benefit plans that fit their needs. There is no credible evidence that the AHPs will engage in more selection activities than do existing insurers.

Would AHPs Avoid Socially Desirable Cross-Subsidies? The view that the goal of insurance companies is to measure, assess, price and manage risk is not universally held. Some would like to use the private health insurance system to achieve a sort of private sector socialism in which insurers take from those who are healthy in order to give to those who are sick. Mary Nell Lehnhard, representing Blue Cross Blue Shield (Lehnhard, 2002), expressed this view when she said:

To address wide variations in premiums charged to particular groups based on health status, all states adopted risk-spreading requirements that assured cross-subsidization between low- and high-cost groups. These rules set limits on what an insurer could charge its sickest group compared to its healthiest group (both within a single product and across all products offered by the insurer). Insurers are now forced to pool all their business; this assures cross-subsidies and prevents insurers from pricing their products in a manner that avoids high-cost small employers.

"There must be imperfections in the market in order for cross-subsidies to exist."

In order for one group to serve as a source of cross-subsidy for another group, however, there must be imperfections in the marketplace. Competitive markets do not have cross-subsidies because competition insures that each buyer is charged a price that reflects the expected cost of services he or she consumes.

For one group to subsidize another for any reason means that one group is paying too much and the other is paying too little (Boyes and Melvin, 2002; O'Sullivan and Sheffrin, 2001). It is easy to understand how a large, dominant firm has the capacity to cross-subsidize among client bases, since economies of scale and scope afford the firm excess or redundant resources. It is not easy to understand why that philosophy should be imposed on everyone else.

Would AHPs Siphon Off the Healthiest Customers at the Expense of the Sick? This issue is closely related to the previous one. We list it separately in order to draw attention to some special problems in the small group market. Mary Nell Lehnhard explains the Blue Cross Blue Shield position this way (Lehnhard, 2002):

… what we are concerned about is that AHPs will raise the cost for our small employer pools by making it very attractive for healthier groups to leave the pools, whether it is us or another insurance company, and join an AHP where there are no mandated benefits, and they do not need those benefits. The people who need the benefits would stay with the state-insured pools and make the costs go up for those sicker small groups.

Notice again the implicit assumption that healthy groups should subsidize the sicker groups. The tacit goal is to overcharge the group that has fewer claims so that the group that incurs the higher claims can be undercharged. In other words, BCBS is arguing that healthy people should be forced to pay a higher premium for their health plans in order to support or subsidize the less-healthy people. This is another way of saying that healthy employees should be penalized for their good health and the unhealthy rewarded for their bad health.

In fact, there is a problem in the small group market. However, that problem is not caused by unfair competition, and it will not be solved by suppressing competition.

"The structure of the smaller group market is not the result of normal market forces."

We noted above that the market for small group insurance today is in most respects dysfunctional. One sign of that dysfunction is that small firms cannot buy the kind of health insurance that is routinely sold in the individual market. For example, when an individual buys insurance he or she is guaranteed the right to remain in the insurance pool indefinitely. Each year, premiums are likely to increase, but they increase the same percent for everyone in the pool. Those whose health condition has worsened cannot be kicked out or singled out for special premium increases.

Once insured, each person in the pool is treated the same and premium increases are the same for all, regardless of subsequent health history. This is the true meaning of the concept of insurance. Once in the pool, premiums for the ill and unhealthy increase no faster than for the healthy.

Things are very different in the market for small group insurance, where people generally cannot stay in an insurance pool for more than a year. At the end of the year, the small firm and its employees are kicked out of the pool, re-rated on the basis of changes in its employees' health status, and allowed to reenter the pool only if they pay the new rates. Firms with employees who develop costly illnesses are forced to pay higher premiums the following year precisely because some have become ill.

Another sign of dysfunction is asymmetry in the market contract. Basically, at the end of a one-year insurance period, the insureds can leave one insurer and give their patronage to another. The reverse is not true. Because of guaranteed issue, the insurer cannot leave the insured by refusing to renew the group. If both sides of the market were allowed to sign longer-term contracts, stability would be greatly enhanced.

The structure of the small group market is not the result of normal market forces. It is the result of unwise regulation. The solution to the problems in this market is to reform the unwise regulations, not to stifle competition.

Would AHPs Make Fraud, Insolvency and Abuse More Likely? Critics assert that the Department of Labor (DOL) has inadequate experience and resources to monitor AHPs and prevent fraud, insolvency and abuse. What the critics overlook is that the DOL already oversees 2.5 million job-based health plans, covering 131 million workers, retirees and their families (Chao, 2003). Put another way, most of the people with private health insurance in the United States already rely on the DOL for oversight and appear to be no worse off for the experience.

"The Department of Labor oversees 2.5 million job-based health plans, covering 131 million workers, retirees and their families."

One source of concern regarding the formation of Association Health Plans has been the increasing number of allegations of fraud and abuse by the Multiple Employer Welfare Arrangements (MEWAs). The MEWA is an association-type arrangement similar to the Association Health Plan but distinct from it structurally and legally; it does not meet the ERISA definition of an employee benefit plan and is not certified by the U.S. Department of Labor. It may be regulated by states. MEWAs that are fully insured and certified must meet only broad state insurance laws regulating their reserves.