The Insurance Exchange In Health Reform: Essential Characteristics
October 14th, 2009
 by
Elliot Wicks
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Insurance exchanges, or “Gateways” as they are called in the Senate HELP bill, are a key element in all of the congressional health reform proposals, as well as the proposal outlined by President Obama in his speech to Congress. The exchange is not some new heavy-handed government regulatory body. Rather, the purpose of the exchange is to make the private market work better and more efficiently.
In this post, I set forth several design principles and insurance market reforms that are necessary if the exchange is to achieve its desired objectives. I then discuss how well these criteria are met in the health reform bills approved by the Senate Finance Committee, the Senate Health, Education, Labor, and Pensions (HELP) Committee, and three committees in the House of Representatives.
The exchange is designed to achieve several important objectives. First, it would provide an easily accessible single point of entry to the insurance market, a place where individuals and small employers could go to choose from a variety of insurers. Second, it would provide people with choice, not only among insurers but also among several benefit plans. Third, it would provide people who buy through the exchange a reliable and objective source of information about the plan options, specifically with respect to plan performance and price, so that people could intelligently judge the relative value of each of the options and choose the plan that best matches their needs and preferences. Fourth, it would create a structure to force competition among health plans to improve plan performance and lower premiums.
These objectives are hardly controversial, and so it is not surprising that the insurance exchange concept has wide support among health policy analysts across the political spectrum. However, if the exchange is to achieve these objectives, it must be carefully structured, and changes in insurance market rules must be crafted in a manner to ensure that the exchange can survive and not become simply a high-risk pool.
Designing A Sufficiently Broad Insurance Exchange
A critical requirement is that the exchange must be a source of coverage for a significant portion of the population. Even if the exchange is easily accessible, provides broad choice, and promotes competition, little will have been accomplished if very few people acquire coverage through the exchange. Although the various proposals seem a bit vague on this issue, it appears that several of them, perhaps including President Obama’s, would limit access to the exchange, at least initially, to only the people who are currently uninsured. This restriction is counterproductive.
The exchange should also be the source of coverage for all individuals who are eligible for tax-credit subsidies. If public funds are to be used to subsidize the cost of coverage for people who could not otherwise afford it, Congress has an obligation to ensure that the subsidies are used to buy coverage of the highest value. The current individual and small-group markets are widely acknowledged as performing poorly in the sense that premiums are high because of administrative diseconomies of scale and because customers are not in a good position to compare the relative value of plan options. If all people buying as individuals, including all those receiving subsidies, and all small groups were to purchase their coverage through the exchange, these problems would be greatly lessened.
At the very least, individuals and small groups should have the option of purchasing through the exchange. A small employer should be able to say to employees, “I offer health coverage through the exchange. Here is $300 per month. Take that money to the exchange and select the health plan that best meets your family’s needs.” It is appropriate, at least initially, to exclude large employer groups, perhaps those with more than 100 or 200 employees. For the most part, large employers can take care of themselves; they have sufficient numbers of employees in the group to spread the risk, so that most of them self-insure, and their administrative costs are relatively low.
Providing Choice And Competition On An Individual Level
A second key element is that people buying through the exchange should individually be able to choose any of the health plans offered. That is, individual employees, not the employer, should be able to select the plan that they find to be the best value. This condition is necessary—not only to make choice meaningful, but also to make competition work. If each insured individual in the exchange can switch plans each year at reenrollment time, the insurers will be under strong pressure to compete by keeping prices down and service levels high. Any insurer that tried to jack up the price to increase profits would lose customers. The same thing would happen to insurers that had consistently poor service levels or low-quality care. The proponents of having a public option in the exchange argue that it is necessary to provide choice and make insurers price-competitive. But if the exchange is structured properly— including individual choice in that structure—effective competition can be achieved even without a public plan option.
Providing Meaningful Choice Through A Limited Number Of Standardized Options
A closely related necessary condition is that all participating insurers must be required to offer a limited number of standardized benefit plans. Unless benefit plans are limited in number and standardized, the choices people face in comparing one plan relative to another are just too complicated. It is virtually impossible to make a rational choice if there are many different benefit plans, all offered at different prices. Effective competition will not exist. But if all insurers must offer perhaps five or six standard benefit plans, the process of comparing the relative values of different insurers’ offerings becomes manageable. The least comprehensive plan would be the minimum level of coverage needed to meet the requirements for the individual mandate and would presumably cover all essential services but with considerable consumer cost sharing. The more comprehensive plans would differ primarily with respect to the levels of cost sharing. This approach would not need to preclude allowing plans to offer additional benefits as “riders,” but it would be essential that these be separately priced so that the price-value comparison among plans remains manageable.
The structure of the remaining elements of the exchange depends upon what model the exchange takes on. One model has the exchange acting as a bargainer, negotiating with health plans to get the best possible deal by promising to contract only with those insurers that provide high-value plans. This is the approach that large employers use. The other model has the exchange be essentially passive, not directly negotiating with health plans but serving more as a clearinghouse that offers all health plans that meet minimum conditions for participation.
Experiments with insurance exchanges at the state level strongly suggest that any exchange that is designed to be a bargainer cannot succeed unless it is the exclusive source of coverage for the people it represents. If there is competition for the same customers inside and outside the exchange, it is very likely that the exchange will end up with a disproportionate share of higher-risk people, so that it will not be able to negotiate lower prices. Insurers have strong incentives to cherry-pick the low risks and channel higher-risk people to the exchange, knowing that some of them will choose coverage from other insurers. If, on the other hand, the exchange is the exclusive source of coverage for a large number of people, such as all those receiving tax-credit subsidies or all people buying as individuals, a number of problems are solved. Insurers will generally be willing to participate in the exchange because that is the only way they can get access to this large chunk of business. The exchange does not have to worry about being a victim of adverse selection because it is the entire risk pool for this population group.
It seems unlikely, however, that there will be the political will to require some of the people who could benefit from buying coverage through the exchange, such as all small employers, to use the exchange as their exclusive source of coverage. This means that there will be competition for the same customers inside and outside the exchange, so the exchange may need to be structured as a clearinghouse rather than as a bargainer. If the exchange is to avoid becoming a victim of severe adverse selection, a number of rules have to be in place.
It is important to understand that in these circumstances, the exchange cannot separately pool risk. Contrary to common wisdom, being big does not protect the exchange from becoming a big pool of high-risk people. If an exchange, no matter how large, were to offer coverage on a community-rated basis and not exclude people with prior health conditions while insurers operating outside the exchange continued to “rate up” higher-risk people and deny coverage to those with pre-existing conditions, the younger, lower-risk people could get a better deal outside the exchange. The exchange and its insurers (including any public plan) would end up with all the older, sicker, more costly people, and the exchange would become financially unviable.
Protecting The Exchange Against Adverse Selection
There seems to be a consensus, however, that health reform should include provisions to prohibit all insurers operating in the small-group and individual markets from denying coverage to people with preexisting conditions or charging more to those with poorer health. But this is not sufficient to protect the exchange from becoming a victim of adverse risk. All of the proposals would allow insurers to vary premiums based on age, in some cases by as much as a ratio of 4:1. If the exchange made the mistake of not rating based on age while other insurers did, it would become a big pool of older (and consequently less healthy) people. But even if the exchange varied rates based on age in the same way as insurers operating outside the exchange do, it would still be in danger of getting a disproportionate share of higher-risk people. Experience with the exchange experiments at the state level shows that insurers find many subtle and not-so-subtle ways to steer higher-risk people to the exchange. The only way to protect the exchange against adverse selection is to require insurers to include all the people they insure, both those inside and outside the exchange, in a single risk pool so that the prices are identical for people being insured inside and outside the exchange.
Further, the insurance market rules must require that any insurer that chooses to participate in the individual or small-group markets must offer coverage within the exchange as well as outside it. If insurers are permitted to sell coverage only outside the exchange, they will find ways to draw off the lower-risk people, leaving the exchange with a disproportionate share of high-risk, costly enrollees. In other words, all insurers must be required to participate in the exchange.
Setting and enforcing the rules that govern the sale of health insurance across the entire individual and small-group markets should not be the responsibility of the exchange. The rules that need to be in place—limiting risk-rating, preventing denials of coverage, ensuring renewability—are essential even if there is no exchange. Congress should not tie them to the exchange.
If Congress structures insurance exchanges along these lines, these new mechanisms for making the market work better can provide people with meaningful choice while helping to constrain growth in insurance premiums.
It may be helpful to see how closely the three major proposals now being considered in Congress match the features necessary to ensure that the exchange achieves the intended objectives.
Senate Finance Committee Proposal
The treatment of insurance exchanges in the Senate Finance Committee bill comes close to meeting the standards described above.
It appears that the exchange would be the exclusive source of coverage for people receiving subsidies, and perhaps for all people buying coverage as individuals rather than through employers. In addition, the exchange would be an option for employers with up to 50 (and later 100) employees. All insurers operating in the individual and small-group markets would be required to participate in the exchange and to offer at least the second and third tier of four standardized products. Also, the bill requires that insurers charge the same price for the same product inside and outside the exchange.
One potential problem with the definition of the standardized products in the Senate Finance Committee proposal is that it could allow too much variation in product design. All insurers operating in the individual and small-group markets are permitted to offer only four standardized plans. The categories of services that all four standardized plans must cover are specified, but beyond that, the standardization is defined in terms of the portion of medical costs the plan must pay for, called the “actuarial value.” In the bill, the required actuarial values for the four tiers of standardized plans are 65 percent, 70 percent, 80 percent, and 90 percent. While the intent is almost certainly to provide some flexibility in plan design, the problem with the actuarial value test is that it could leave too much discretion to insurers to vary the specific benefits within each category. The result could be such a proliferation of options that it would be impossible for consumers to make valid price-value comparisons. It would be critical that someone have—and use—the authority to make sure that this does not happen by limiting the extent of variation within each actuarial value category. The bill appears to give this authority to state insurance commissioners.
The proposal requires the exchange (or the HHS Secretary) to provide a standardized format for presenting insurance options in the state exchange and to rate insurers based on price and quality.
Unlike in the other two congressional bills, the exchange would apparently not negotiate with health plans on price and could not exclude any health plan (as long as the minimum conditions for participation are met). Rather, it would serve more as a clearinghouse for eligible people seeking coverage.
Senate HELP Bill
The Senate HELP bill falls somewhat short of meeting the standards outlined above, especially in its restrictions on insurers’ offerings.
The exchanges (called Gateways) would be the only place people receiving tax credits could go to use those credits. Gateways would also apparently be available to small employers with 50 or fewer employees and to individuals. Individual employees would select the plan in which they would enroll, a condition necessary to facilitate effective competition.
The provisions relating to standardized benefits seem less adequate. The HHS Secretary could define plans that are eligible for the tax credit, but there seems to be no standardization beyond that. There appears to be no requirement that insurers participate in the Gateway, and insurers can sell plans outside the Gateway without any apparent restrictions on benefit design. Moreover, the Gateway is a separate risk pool; that is, there is no requirement that insurers offer the same price for the same product inside and outside the Gateway. This creates a danger that the Gateway will experience adverse selection.
Tri-Committee House Bill
Under provisions of this bill, only individuals who are not covered by a qualified employer plan are eligible to get coverage through the exchange, which clearly limits the number of people buying coverage. People receiving tax-credit subsidies must buy through the exchange, and an auto-enrollment mechanism is established to ensure enrollment by those who might not otherwise enroll. The smallest employers (10 or fewer employees) may also participate initially, and in subsequent years, slightly larger employers become eligible (although it is not clear whether this applies only to employers not already offering coverage).
Under the bill, the exchange can solicit bids and negotiate, which presumably means it can exclude plans that are deemed not to provide good value. It must also provide information to consumers to facilitate choice. A national commissioner defines the basic benefits that all plans in the exchange must offer; they may then choose to offer three levels of “enhanced” benefit plans, each with decreasing levels of cost sharing. Insurers are apparently able to offer coverage outside the exchange without restrictions regarding benefit plans and without a requirement that they charge the same price for identical coverage inside and outside the exchange.
Summary
Of the three major proposals, the Senate Finance Committee proposal seems to contain most of the features outlined above as being necessary to foster effective competition among health plans and to avoid adverse selection against the exchange. It is weaker in one respect than the other two options are: it does not give the exchange the power to negotiate with insurers.