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California Report Raises Issues About Insurance Exchanges

While the debate over the public plan option continues, little attention has been paid to the health insurance exchanges that are part of the leading proposals now before Congress. Judging by the conclusions of a recent report from the California Healthcare Foundation, that might be a serious error of omission.

Modeled after the Federal Employee Health Benefit Program (FEHBP), the insurance exchanges are designed to help individuals and small businesses obtain coverage at group rates. But they do not require people to buy insurance through the exchange unless they're receiving federal subsidies. This could be a big mistake if an exchange tries to negotiate rates with health plans, the CHCF report indicates, because health plans will offer lower rates to healthy people outside the exchanges. The result will be adverse selection for the plans in the insurance markets. As the average risk of the people who seek coverage there worsens, rates will go up and health plans will exit.

This was the scenario that occurred in the Health Insurance Plan of California (HIPC), a now defunct statewide insurance exchange that offered a menu of plans to small firms and individuals. When it was founded in 1993, HIPC was state-run; a few years later, the operation was turned over to the Pacific Business Group on Health, a business coalition. HIPC tried to replicate the big-employer model by negotiating and selectively contracting with health plans in return for a large group of enrollees. Unfortunately, HIPC never had more than 150,000 members, so it lacked clout with health plans and could not get them to offer lower rates than they did outside HIPC. Many plans refused to contract with HIPC, partly because individuals and employees could switch plans within the exchange. And, with fewer plans to choose from, fewer people sought insurance inside HIPC, and an increasing number of those had health problems. HIPC went out of business in 2006.

The CHCF report's author, economist Elliot K. Wicks, interviewed several people who had extensive knowledge of the HIPC and the California insurance market. One lesson they drew from the experience is that if a government-sponsored exchange is going to be an active purchaser, it must require certain groups of people to obtain insurance within it; even then, plans in the exchange can be hurt by adverse selection unless their premiums are risk-adjusted.

Instead of competing with the insurers while offering their plans, an exchange could be a passive clearinghouse like FEHBP or a "hybrid market organizer" like the Massachusetts Connector, which requires standard benefit packages and encourages plans to provide value-added features. In those cases, however, it may be necessary to require plans to participate and to charge the same prices inside and outside of the exchange, the report said. But the Massachusetts Connector hasn't had to do either of those things.

The FEHBP has been a favorite health reform model of Democrats for decades. But the difference between that government program and the proposed insurance exchanges is that federal employees must buy their insurance through the FEHBP if they want the government to pay part of the premium. The only group that would be required to do that under the current reform proposals are people who receive government subsidies to buy insurance. I wonder whether those folks will be sicker than average, and if so, whether the exchanges will suffer from adverse selection as health plans lure away healthier people with lower rates.