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Challenges Facing the California Insurance Exchange

When Governor Schwarzenegger signed AB1602 and SB900 last week, California became the first state to initiate a health insurance exchange as required by the Patient Protection and Affordable Care Act (PPACA).  When complete, the California Health Benefit Exchange promises to become the portal enabling uninsured Californians and small business employers to purchase affordable health insurance.  Making this happen, however, will be a challenging undertaking.

Beginning in 2014, states’ health insurance exchanges will form the gateways into many of the benefits of the health care reform legislation.  People who qualify for government-provided health insurance subsidies (at incomes as high as $64,000 for an individual and $88,000 for a family of four) and small businesses will enter the web based insurance marketplace to purchase insurance for themselves, their families, or their employees.  They will choose among 5 insurance plans ranging from an inexpensive basic, catastrophic-only plan, limited to those under 30 years old, to more costly and benefit-rich plans.  The self-employed, unemployed, and others who are working but not insured by their employers can also purchase insurance from the exchange.  The idea behind the exchange is to form a large risk pool which would provide more bargaining power with insurers than any individual or small group acting alone.

Providing accessible and affordable health care is truly a worthwhile goal.  Unfortunately, in the past, other states, including California and, most recently, Massachusetts, have failed in their efforts to do so.  In fact, the Massachusetts Connector Exchange, as part of that state’s health care reform program, has resulted in the highest and fastest rising health insurance costs in the country.

A variety of reasons account for this lack of success.  To begin with, it is difficult for exchanges to offer cheaper insurance rates than the private market.  Insurance regulations, beginning in 2014, will force companies, both in and out of the exchange, to accept all applicants regardless of medical condition.  This will cause all premiums to rise to cover the additional cost.   On top of that, an exchange comes with its own administrative costs, raising the price of each premium it brokers.  (4.5%  in the Massachusetts Connector Exchange.)

The success of an exchange depends on making available as large and as healthy a group of customers as possible to the insurance market it provides.  A large percentage of healthy people offsets whatever costs the chronically ill or catastrophic medical event that takes place within the group.   But aspects of the new California exchange and the PPACA  foreshadow problems here.  As an example, healthy people over 30 years old, who might have other financial needs, are barred from purchasing cheap catastrophic health insurance on the exchange.  Even given a government subsidy, it might be cheaper for them to purchase catastrophic insurance in the private insurance market, a factor that would remove just the people the exchange needs.

Right now, many healthy people forgo health insurance altogether, to save money.  In 2014, however, they must purchase insurance or pay a penalty.  However, the penalty starts small at $95 or 1 percent of income; and even at its highest, in 2016, at $695 a year, it’s considerably cheaper than purchasing insurance. The healthiest people will be the ones most tempted to pay the penalty, and wait to get sick before buying insurance from companies required to sell it to them regardless of their condition.  The exchange won’t hear from them until they join the ranks of the sick.  In order to stay in business, insurance companies in the exchange, will have to raise their rates in response to the greater proportion of sick people in the exchange risk pool.  More people, even those receiving subsidies, will realize they have more to gain by leaving the exchange.

In 1993, California initiated an insurance exchange for small businesses with the same objectives as this 2010 version.  It ended in failure in 2006.  A study, Building a National Insurance Exchange: Lessons from California, sums up the lessons learned from this experience and confirms the validity of the previous statements.  It found that an exchange will have a difficult time achieving its objectives if it cannot be the sole source of coverage for small employers or subsidized individual purchasers.  It also goes on to point out that an exchange is more likely to attract higher risk enrollees which will result in higher overall premium costs.  Furthermore, the overhead of an exchange raises rates still higher. .  Finally, the study found that the lack of choice among plans deterred consumer loyalty.

California has a unique opportunity.  With first-hand knowledge of insurance exchanges and an early start-up, California might set up an exchange that addresses the inherent problems that have brought down previous attempts.  It can be done.  Five years ago, Utah created an insurance exchange that is working.  We’ll look at that next.

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