Improving the Individual Health Insurance Market

Published in the National Journal expert blog on health care, November 17, 2008

People purchasing health insurance in the individual market face double-jeopardy: Unless they are eligible for the self-employment tax deduction, they must pay for coverage with after-tax dollars, and they also face the full plethora of state insurance mandates and regulations. Despite these encumbrances, the individual market functions much better than conventional wisdom assumes. Lifting burdens on the individual market – rather than adding new ones – could enable it to become an important base for expanded health coverage.

Policy changes that are needed include allowing the purchase of health insurance across state lines to create a more competitive market, strengthened guaranteed renewal protections, and new purchasing arrangements to help those with pre-existing conditions obtain coverage. In addition, new tax subsidies to help the uninsured buy coverage could, if properly structured, power-boost the purchase of more affordable, portable coverage.

A reality test: Before policymakers attempt to fix the individual health insurance market, it is important to get a clearer picture of what is actually happening in this sector where an estimated six percent of privately-insured people obtain coverage. Prevailing wisdom holds that “there is agreement that the market for buying health insurance as an individual doesn’t work well,” and some argue that this market is hopelessly expensive and dysfunctional.

However, actual research demonstrates otherwise. Mark Pauly and Brad Herring¹ looked not just at hypotheticals, as some surveys have done, but at actual people shopping for and purchasing insurance in the individual market. They find there is more pooling of risk in the individual market than commonly believed: “Analysis of new data…shows that actual premiums paid for individual insurance are much less than proportional to risk, and risk levels have a small effect on obtaining coverage.” They also found that the premiums that higher-risk people actually paid were only, on average, about 1.6 times those of lower-risk people.

Caution ahead: Policymakers should be very cautious about adding more regulatory burdens to this market. We can look at the evidence in states that have tried various levels of regulation of their health insurance markets, especially with community rating and guaranteed issue, to see the impact. Efforts by state legislators to “fix” the individual market often backfire.

Community rating, for example, means that lower-risk purchasers pay a higher price for insurance than people with greater risks. This is a formula for adverse selection, especially in a guaranteed issue environment. People have an incentive to wait to purchase health insurance until they need medical services rather than pay an artificially high price for continuous coverage they may not use. This leads to an increase in the number of people without health insurance, the opposite of the desired result. Pauly finds that, “The effects of adverse selection in nongroup markets are most severe in states with community rating and guaranteed-issue rules for the individual market.” Others argue that these problems could be mitigated if an individual mandate for purchasing health insurance were to be imposed, but that would be a very heavy political lift in the current environment.

Three recommendations to improve the individual health insurance market:

A national market for health insurance: Giving people more options to purchase coverage across state lines would generate a much more competitive market so people are not trapped by the expensive mandates and regulations in their states.

University of Minnesota economist Steve Parente and colleagues showed² that opening up competition among the states for health insurance would mean an additional 12 million people could get health insurance without any new spending by the federal government (an important consideration in the current fiscal climate). This would allow people trapped in states with community rating, guaranteed issue, and excessive mandates to shop for policies in other states where premiums are more affordable and policy options are more flexible. Some may select a high-deductible plan, but people should have a range of options to find the ones that best suit their needs.

Critics charge, however, that this would open up the Wild West of unregulated health insurance where people would be faced with policies that don’t cover even the most basic medical needs. But every state regulates its health insurance markets to assure, not only the solvency of companies offering the coverage, but that the policies actually offer responsible insurance coverage.

Allowing interstate commerce in health insurance would lead to larger pools and more competition among companies offering coverage, spreading risk and reducing costs. Health insurance companies are worried about disrupting their current books of business if healthy individuals can opt out of their current pools to find more affordable coverage elsewhere. But bringing millions more people into the market will expand their pools. Further, new programs to give those with higher-health risks better options for coverage will further stabilize the market.

Guaranteed renewal protections: After the initial purchase, almost all individual insurance is “guaranteed renewable” at class-average rates. That means that insurers cannot increase premiums differentially based on health risk for people seeking to renew their policies. Pauly and others have shown that people in individual markets are largely protected against future reclassification risk. Guaranteed renewability stabilizes markets by providing an incentive for people to purchase health insurance when they are healthy and to maintain continuous coverage. This HIPAA protection should remain in force and be strengthened where necessary.

Expanding access: At least two groups have developed plans that would enable people with pre-existing conditions to enter the insurance market and obtain coverage at affordable rates. America’s Health Insurance Plans³ and the National Association of Health Underwriters⁴ have developed plans that would allow more people to obtain private insurance by cross-sharing risk among companies participating in a specified market. In addition, federal funds could supplement state funds to create more functional high risk pools in the states. When properly structured, these risk pools, coupled with a mechanism for guaranteed access to insurance, could produce a more stable health insurance market.

Some people will need special assistance because their health risks are above normal, their incomes are low, or both. A guaranteed access program also could be a mechanism to provide additional subsidies to them.

The individual market for health insurance is more functional than commonly believed. The challenge for policymakers is not to repeat the mistakes of states that have been overly aggressive in regulating their individual insurance markets. Rather, they should allow more flexibility, more competition, and sensible protections. This means allowing people to buy coverage across state lines, allowing all policies to be guaranteed renewable at reasonable rates, and creating new guaranteed access programs. Combine this with new subsidies to individuals for the purchase of health insurance in the form of refundable tax credits and we could open a new interstate highway to expand access to health insurance in the individual market.

ENDNOTES

¹ Mark V. Pauly and Bradley Herring, “Risk Pooling and Regulation: Policy and Reality in Today’s Individual Health Insurance Market,” Health Affairs, May/June 2007, 26(3): 770-779, at
http://content.healthaffairs.org/cgi/content/abstract/26/3/770.

²  Stephen T. Parente, Ph.D., Roger Feldman, Ph.D., Jean Abraham, Ph.D., and Yi Xu, B.A., "Consumer Response to a National Marketplace for Individual Insurance," University of Minnesota, June 28, 2008, at http://www.hsinetwork.com/National_Marketplace_7-21-2008%20FINAL_Blind.pdf.

³  “Guaranteeing Access to All Americans,” America’s Health Insurance Plans, at
http://www.ahipbelieves.com/media/AHIP%20Guarantee%20Access%20Plan.pdf.

⁴  “Healthy Access Plan,” National Association of Health Underwriters, at http://www.nahu.org/legislative/healthyaccess/plan.pdf.