Regulatory Redistribution in the Market for Health Insurance
By Jeffrey Clemens
National Bureau of Economic Research, Working Paper 19904, February 2014
In the early 1990s, several U.S. states enacted community rating regulations to equalize the health insurance premiums paid by the healthy and the sick. Consistent with severe adverse selection pressures, their private coverage rates fell by around 8 percentage points more than rates in comparable markets over subsequent years. By the early 2000s, following substantial public insurance expansions, coverage rates in several of these states had improved significantly. As theory predicts, recoveries were largest where public coverage expanded disproportionately for high cost populations. The analysis highlights that the incidence of public insurance and community rating regulations are tightly intertwined.
This paper studies the relationship between two instruments of health-based redistribution: tax-financed public insurance and premium regulations that generate within-market transfers. The economic incidence of these policies is tightly intertwined. Community rating regulations risk substantial adverse selection when large numbers of unhealthy individuals remain on the private market. When targeted at the unhealthy, Medicaid expansions can relieve this adverse selection. Public coverage of the unhealthy can thus reduce the size of the subsidies and/or tax penalties required to stabilize community-rated insurance markets. It can similarly be viewed as a complement to risk adjustment programs.
The 2010 Patient Protection and Affordable Care Act (PPACA) contains regulatory measures including community rating rules, guaranteed issue requirements, and an individual mandate to purchase insurance. Three of PPACA’s features are designed to go farther than previous regulations to induce pooling of the healthy and sick. First, it taxes healthy individuals who forego insurance. Second, it limits adjustment along the intensive margin of insurance generosity. Specifically, it expands minimum coverage requirements and tightens limits on out-of-pocket spending. Third, its guaranteed issue requirements are more stringent than those typically in place across the states.
PPACA’s regulations may result in significant pressure to shift the cost of unhealthy individuals out of the insurance exchanges. The law would generously finance such efforts, as the federal government will reimburse more than 90 percent of the cost of its associated Medicaid expansions. Both the implementation of these expansions and their impact on states’ insurance markets remain uncertain. These issues will be ripe for study as PPACA’s implementation unfolds.
A major problem with financing health care through private insurers is that they will always do whatever they can to avoid insuring people who might need more health care. To prevent insurers from chasing less healthy patients away by charging them much higher premiums, community rating was established in several states. Each person would be charged the same premium regardless of health status. How has that worked out?
In fact, it did not work very well. As high-cost patients enrolled in private plans in greater numbers, premiums went up, and healthier patients dropped out because of the high premiums, which drove premiums even higher because of the concentration of sicker patients (the death spiral of insurance premiums). The net number of people enrolled in the private insurers’ risk pools quite understandably declined.
In some of these states, Medicaid programs were designed to target these high-cost patients, siphoning them off from the private insurers’ risk pools. To no surprise, with the taxpayers picking up the costs of these expensive patients, the private insurers retained the healthier enrollees, and the plans’ membership rates recovered.
This NBER paper notes that the Affordable Care Act contains regulations that “may result in significant pressure to shift the cost of unhealthy individuals out of the insurance exchanges. The law would generously finance such efforts, as the federal government will reimburse more than 90 percent of the cost of its associated Medicaid expansions.”
Why should we support a system that uses a very expensive, administratively complex form of financing health care – private insurers – to cover those with fewer health care needs, while transferring the higher costs of less healthy patients to us, the taxpayers? The issue here is not that taxpayers shouldn’t be financing our health care, but rather that we are retaining a private industry that wastes resources on insuring a less costly, heather population with fewer needs, when a public system would do that more efficiently and at lower cost – simply by placing everyone in the same risk pool.
Community rating is one of those policies in a large complex of inefficient health policies that are designed specifically to keep private insurers in business. Under a single payer system, we wouldn’t need community rating since we wouldn’t break up the financing into individually assigned insurance premiums. With single payer, instead of using individual premiums each of us would be taxed equitably based on ability to pay.
We are overburdened with the costs and workload of endless health policies that are designed to make the highly flawed model of private insurers sort of work for us, though certainly not very well and at an outrageous cost. Let’s dump those flawed policies and enact more efficient and equitable policies that are designed first and foremost to take care of patients. A single payer national health program would do just that.