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In the Nation's Interest

Health Insurance Exchanges: Key to Progress, or Doomed to Fail?

The United States will not achieve a sustainable health-care system unless it can slow the growth of costs. Though providing coverage for all Americans is a moral imperative, the nation cannot sustain health care even for those who have it now if costs continue to grow at today's pace. What's more, the entire federal budget is threatened by rising health costs.
On July 16, 2009, the Director of the Congressional Budget Office affirmed this concern, saying that the bills under active consideration in the Congress not only fail to solve the long-term cost problem, they actually make it worse.

There is no silver bullet to solve this problem. Contrary to many claims, preventive care will not reduce total health-care costs. The simple reason, research shows, is that the cost of administering tests and preventive care to everyone will equal or exceed the savings from the much smaller number of illnesses that would be prevented. We should expand preventive care because it would improve people's lives, not in hope of large savings.

Forcing doctors and hospitals to work in a public plan, and paying those providers below-cost Medicare reimbursement rates, would not reduce the growth of costs. Price controls do not reward the innovation and efficiency that we need to achieve continuing reduced costs in the long run. Rather, they breed only avoidance and manipulation - such as when doctors respond to reduced reimbursements for individual treatments by diagnosing more problems and delivering more treatments. Any savings from such a strategy will be short-term only, and outweighed by inefficiencies and wasted resources.

Likewise, health information technology (IT) will not save money in a fundamentally inefficient system, where it merely documents bad practice in digital form. Health IT must be a part of a streamlined, more-efficient health-care system to contribute meaningfully to cost control.

But how do we get a streamlined, more efficient health-care system?

CED believes that competition among private insurance plans to serve cost-conscious consumers is the key. Because the current employer-based system most often provides employees with no choice among health insurers, and no ability to save money if they choose a less-expensive, more-efficient plan, there is no real competition in health insurance at the individual level. Plans are designed to suit employers, not people, who therefore find themselves in one-size-fits-all systems that do not provide the kind of care they want. What is even worse, the one-size-fits-all insurance plan is almost always a fee-for-service system, which provides the worst incentive: the more services, the more fees.

Instead, CED has advocated a new system of regional health-insurance exchanges, which would work like the Federal Employees Health Benefits Plan under which Members of Congress (and all other federal government employees) get their care. In this system, the exchange presents each household with a menu of choices of private health-insurance plans. Each household can choose the plan that it wants - so it is not limited to the plan that an employer happens to offer, it can keep the savings if it chooses an economical plan, and can keep the plan of its choice when the breadwinner changes jobs. Ultimately, CED advocates giving every household a credit that can purchase the low-priced plan in its region at no out-of-pocket cost. If the household wants a more-expensive plan, it can purchase it for the incremental cost only. In that way, consumers will be free to choose from a range of plans on the basis of quality and price. Evidence from similar arrangements in practice today (including Stanford University, the Wisconsin state employees system, the University of California, Wells Fargo, and Hewlett Packard) indicates that usually 80 percent of employees choose more-efficient systems, and so choice yields both consumer satisfaction and lower costs.

But to move our nation's enormous health care industry, now one-sixth of the entire economy, it will take more than a few efficient employer arrangements scattered across the country. Rather, it will take a substantial share of the overall population purchasing insurance through the exchange so that insurers and providers are primarily driven by competition over quality and price in that market. We need a system where competition, not the uncompetitive employer market or fee-for-service Medicare, is the fundamental fact of life for all insurers and providers. CED's health-reform project director, Alain Enthoven, and his colleague David Riemer, explained what is required in a column that appeared in the New York Times on June 25, 2009.

We might be encouraged because the main House and Senate bills now being considered in Washington all provide for health "exchanges," under differing names. However, an analysis of the details of the provisions in these bills makes clear that the exchanges may well be set up for failure - as mere stop-gaps for people who cannot obtain coverage in employer groups. The chances are far too great that exchanges created on these terms will not fulfill CED's vision: to drive competition and innovation in health-care delivery, and contribute to a sustainable system that can cover all Americans for the long run.

What are the problems with the exchange proposals now on the table? Here is an overview:

Too small - the states
The current health-reform bills would at least allow, if not dictate, that the exchanges be organized at the state level. From the very start, that divides the eligible population into 50 parts. For the very largest states, that will not pose a serious problem. But for smaller states, the population could well be too small to encourage active insurance company participation and true competition. Compounding this problem could well be excessive complexity from differing state systems and regulations. CED recommends a national system that is divided on a regional basis, where adjoining and similar less-populous states could be combined (but in some instances highly populous states might be divided into coherent insurance markets).

Too small - eligibility
Unwisely, in our judgment, the Congressional proposals explicitly attempt to build upon the current employer-based health-insurance system. CED believes that the employer system has institutionalized much of the inefficiency in today's health care, as explained earlier. By attempting to preserve the employer system, the Congressional bills would keep most households out of the exchange, reducing the percentage of people in any market who would be eligible. For example, the Congressional bills would restrict participation in the exchange to very small firms. However, Enthoven and Riemer believe that at least 20 percent of any market would need to be in exchange to generate true, effective competition. A smaller share would reduce the leverage of that more-competitive part of the system, and maintain the inertia in the current employer-driven portion.

Adverse selection
Not only would the current Congressional proposals make the populations in the exchanges too small, they would also populate the exchanges disproportionately with sicker people, which would increase costs and make competing in the exchange less attractive to insurance companies. The reason is that eligibility to participate in the exchange would be quite restricted - beyond very small employers, to people who are not offered "affordable" health insurance in the workplace. People who cannot obtain affordable coverage elsewhere will be disproportionately sick and thus expensive to insure. Offering those people coverage is a high priority, but it should be done by including them in a very large risk pool - not by isolating them in a small pool that their costs will dominate. If the exchange population is perceived as disproportionately expensive to cover, private insurers will choose not to enter that market, and there will be less competition and less innovation - in other words, less of what the nation needs most. In CED's vision, the exchange would serve a larger, more typical population - in other words, a stable risk pool that can support active competition and innovation.

Ironically, the motivation to keep the exchange population small is totally perverse - a true case of unintended consequences. The original Congressional bill drafts received troublingly high cost estimates from the Congressional Budget Office (CBO), leading the author Committees to try to hold costs down. Under these proposals, if employers provide coverage, the federal government does not pay subsidies. However, for insurance purchased in the exchange, the government does pay subsidies, based on household income. Thus, the authors have been trying to modify their bills to keep people in employer coverage, and out of the exchange. CED believes that it is vital that health reform be fully paid for, so that it does not increase what is already an excessive federal budget deficit. However, holding down the cost of the bill by pushing people into inefficient employer coverage, while keeping them out of and thereby crippling what could be innovative competition in an exchange, is truly counterproductive. We need a broader and clearer view of what health reform must achieve.

The downside of a deficient health reform is huge - quite possibly even worse than inaction. The worst case would have an expansion of coverage under the current, inefficient system, paid for with policy steps that otherwise would be best suited to reduce the budget deficit. The cost of the current health-care system would be higher, the already unsustainable rate of growth of costs in the coming years would be no less - perhaps even faster - and the deficit would be even more unmanageable than it is today. Finally, with the political process exhausted from a major engagement on health care, and a strong motivation to wait and see how the new law would work, it likely would be years before these problems would be addressed - over which time the public debt would grow even further out of control.

CED has mapped out a manageable, smooth transition to a system of market-based universal health insurance - with both the transition and the ultimate system built on a health-insurance exchange. This mechanism holds great promise. But it must be structured so that there is a large, sound and stable risk pool of households purchasing insurance on the basis of quality and price. The current efforts in the Congress show every sign of falling far short of that standard.

Commentaries are the views of the authors and do not necessarily represent policies of the Committee for Economic Development.