"Powering Up" Insurance Exchanges

With the likelihood diminishing that Congress' health care reform legislation will include a "public option," the principal hope for expanding health insurance coverage among small businesses and individuals rests with the creation of health insurance exchanges. Through these new entities, small businesses and individuals seeking coverage would have access, via the Internet, to a range of different health plans offered by a wide range of insurance companies, and could shop, compare, apply for and purchase their coverage on-line.

The problem is that these entities are easier to imagine than they are to build and manage. And the track records of many states which have experimented with the formation of such entities in the past...in Texas, Florida, California, and North Carolina, for example...suggest that exchanges face some genuine market-related challenges to their success.

This week in the New York Times, an op-ed piece by the founding Chairman of the Texas Insurance Purchasing Alliance traced the history of his own experience with a state-sponsored, non-profit exchange. While the exchange enjoyed some success over its first three years (1993-1996), it was out of business by 1998. The principal reasons for the exchanges eventual failure were:
...participating insurers, who could sell coverage both outside and within the exchange, used the exchange as a "dumping ground" for customers with unfavorable health profiles, while taking the better-risk groups for themselves;
...the state's political leadership changed, from a governor who founded and advocated for the exchange (Democrat Ann Richards) to a governor who de-emphasized the importance of the exchange (George W. Bush), and;
...ultimately, the exchange was unable to establish enough market share to be able to negotiate effectively with insurers, and without the support of the political leadership, the exchange was forced out of business.

The author's conclusion: "If Congress now creates new exchanges, as seems increasingly likely, it must prevent this phenomenon by setting two national rules: Insurers have to accept everyone and have to charge everyone the same rates regardless of health status.

Such rules would force insurers to spread risk. But enforcement would also be difficult. Every aspect of health insurance — from the rules for underwriting and setting premiums to the marketing of policies — would need to be monitored stringently to prevent companies from steering all bad risks to the exchanges."

It's best to think about the powers needed by exchanges to be considered in the context of three market realities:
1)...The health insurance market is highly concentrated. In most local communities, three or fewer health insurers control 70% or more of the market; in many communities, one health insurer enjoys market share of 90% or more. This condition severely limits competition, which leads to higher prices for small companies and individuals;
2)...State insurance regulations in most states have established "rating corridors" which govern the ranges in prices which insurers may charge different groups for the same health plans. Most insurers say that these rules do not permit them to provide special deals to groups or organizations which purchase coverage "in bulk," thus giving them the chance to duck the formation of group purchasing arrangements which might require them to become more efficient, and;
3)...Unlike large, self-insured companies, whose health plans are administered by insurers for less than 10 percent of claims costs (and typically 5-6%), administrative costs for smaller groups can average 33-37 percent of claims, which translates into 25-27% of premium costs. The administrative costs for individual health plans can be as high as 30-40% of premium costs.

If we're going to create insurance exchanges that work for small businesses and individuals, here's what we have to do:
1)...Policymakers must state that engendering a higher degree of competition among insurers is a matter of good public policy, and exchanges must have the ability to attract new competition into state and local markets through the development of interstate arrangements. If insurers in Iowa can offer coverage to small companies in Ohio at a lower cost than Ohio insurers can, those Iowa insurers ought to be able to participate in an Ohio exchange;
2)...The federal government must explicitly require the states to examine any existing regulations governing the pricing and underwriting of small group and individual health plans, and in establishing exchanges, establish rules which encourage the aggregation of small businesses and individuals into large, more actuarially credible groups. Insurers will hate this, and will claim that doing so will affect competition. But in states where one insurer controls 90% of the market, how can the effect be anything but positive?;
3)...Even in an environment in which insurers might be required to establish some sort of community rating, guaranteed issue arrangement, those elements of insurance premiums not related to medical risk...that is, administrative costs...must be subject to negotiation between insurers and the exchange. The best way to reduce and control small group health costs is to reduce that administrative cost ratio through the use of technology, a reduction in marketing and sales expenses, the development of "universal" application forms, and the simplification of underwriting, and;
4)...Given market conditions as they currently exist, and the magnitude of technical, process, and cultural challenges facing the insurance industry in the next 3-5 years, there will certainly be a considerable period of transition, as a re-configured private market integrates with expanded Medicaid and other programs to provide access to health care for those close to the poverty line. But in order to add a sense of urgency to the implementation of needed reforms, legislators would be extremely wise to make provision for the development of a "public option," in the event that the industry's efforts don't meet with some agreed-upon performance targets for greater access and more effective cost-containment. Absent such a "doomsday machine," it's likely that insurers will merely temporize, take advantage of the regulatory process, and then do the absolute minimum required by regulations they themselves will write...which is how we got here in the first place.

Taking these steps would enable insurance exchanges, over time, to use their presence in the marketplace to reduce market-related inefficiencies, bring down administrative costs, become stronger competitors, and lead ultimately to a reduction in the rise of small group and individual health insurance costs, both within and outside the exchanges.