Wednesday, August 5, 2009

Health Insurance Exchange and Public Option

OK, here's how far I have come in understanding health insurance reform:

The era of health care reform is here. The first big step will be health insurance reform. Health insurance is only part of the problem, so health insurance reform can only be part of the answer. Nonetheless, health reform will lift a significant burden for the nation, and if done correctly, will enable further reforms to happen in the rest of the health care system.

Understanding the Health Insurance Business

If the health insurance system were a true free market, we would expect the pubic to benefit as competition proceeded, courtesy of the “hidden hand.” But that is not how the health insurance business works. Instead, the market is structured so that as companies prosper the public suffers. The trick of reform will be to reshape the market so that as companies compete the public benefits. I think this can be done by the current proposal, the Health Insurance Exchange (HIE). I also think that adding a Public Option (PO), health plans sponsored by government in competition with private plans, would help positive competition even further. Let me explain why.

The Current System

In the current system, there is no fixed price for a given policy. Instead, the price of each insurance policy, whether group or individual, is set by negotiation. This is called “experience rating.” If there were a single price for all comers, it would be called “community rating.” Decades ago Blue Cross/Blue Shield had community rating. When private companies entered the field they used experience rating. The Blues then had to also do experience rating, or they would have gotten all the bad risks (“adverse selection”).

In the current system, health insurance is a highly concentrated industry, with only a handful of major players nationwide and few local competitors. In any local area or even a state, one company can have 80% of the business. Competition is thus very muted.

In a perfect market no one company or individual has power; that is a prerequisite for the market to work. In health insurance, the insurance companies frequently have very significant power, and so do the hospitals. Occasionally, so do other providers such as doctors, but not usually. Large buyers of insurance sometimes have power as well; individuals, of course, never do. Given this playing field, it is clear that the theoretical advantages of market competition don’t have a chance of being realized.

How Health Insurance Companies Make Their Money

So, how do the companies make money?

Vis-à-vis Patients

Most importantly, insurance companies seek to identify the best risks and insure them, and to reject the worst risks – this is called “cherry-picking.” The companies spend a great deal of money underwriting policies to identify who is a good and bad risk so they can price the policies differentially, and they can not offer policies at all to some. The companies can also frequently be “price givers” rather than “price takers,” because groups and individuals in an area often have little choice of company. So, prices rise, profits rise, and groups and individuals can find themselves without a choice at all.

The companies also make money by rejecting policies retroactively (this is called “dumping,” or “rescissions”). When a patient gets sick the insurance company withdraws the policy on the grounds of an unrevealed preexisting condition. Thus, an insured patient becomes uninsured and the insurance company is not liable for the medical expenses.

The companies also write policies cleverly, exploiting their superior knowledge of policy details. Policy purchasers are confused not only by the “small print,” but even by the basic terms of deductibles, coinsurance, and exclusions from coverage. When illness strikes, patients frequently discover that they are under-insured.

The companies reject specific procedures and treatments for patients. There is as yet no independent and authoritative authority to determine which treatments and procedures are valuable. Thus, practitioners make their decisions and the insurance companies get to authorize or reject. Insurance companies probably feel more defensive than offensive in trying to curtail the proliferation of tests and procedures, but the battle for authorization piles up overhead and patients are caught in the middle.

They neglect customer service. Concentrated industries offer few consumer alternatives and can get away with this.

They pay less when a patient chooses an out-of-network provider. This contract provision is rather straight-forward, but recent lawsuits have clarified that the companies have compounded their gain by illegally overestimating the amount the patient is compelled to pay by using faulty cost data.

They market their products either through brokers or directly themselves, using the usual marketing techniques. There is no reputable central source of information and evaluation of these policies for buyers to turn to, only salespeople. Again, overhead is significant.

Vis-à-vis Providers

The great majority of policies are now either HMO’s or PPO’s, both of which require the insurance company to assemble a roster of physicians, hospitals, laboratories, etc., that “accept” that insurance. The companies assemble their networks by contracts that specify payment rates.

In negotiating with physicians, there are usually only a few insurance companies in any single area. The physicians, however, are many, and are forbidden by anti-trust law from negotiating as a group. The insurance companies make their money here by tough negotiating against the atomized physicians.

After the contracts are established and services rendered, physicians try to maximize their billings but must adhere to detailed rules of coding their services. The insurance companies make money by delaying, denying, and down-coding (estimating a service complexity at less than the claim) payments. The physician/insurance battles are legendary; the overhead of personnel salaries on both sides funding this war is also legendary.

Some hospitals have local monopolies or oligopolies and can do very well in negotiating with the insurance companies. In other areas where there are many small hospitals, the insurance companies again make their money by being more concentrated than the providers. In either case, with small numbers of negotiators, efficiencies rarely result, and it is more common for both entities to take their advantage and simply boost the price to the public.

Administration-only Services

Large employers frequently self-insure and use insurance companies for their provider networks, policy benefit structures, and claims payments. In contrast to the above situations, this function appears to be more typical of the general business world.

In sum, then, we can see how little the health insurance market resembles the ideal of “perfect competition.” No hidden hand works to serve the public as the industry strives for profit, accumulates overhead, and doesn’t serve the public interest much at all.

Serving The Public Interest Better – The Health Insurance Exchange (HIE)

The whole point of a “Health Insurance Exchange” (HIE) would be to change competition into a system that actually worked for the benefit of the public. The HIE would present a menu of insurance choices to buyers, both individuals and groups. There would be Level I, Level II, Level III, and Level IV benefits, with each company offering complying with the benefit requirements at each level. There would be no “cleverness” allowed.

The costs would vary, and some offerings might have extra features above the specified level – add-ons, if you will. So at Level I you could choose company A with its network of providers, or Company B with its network, etc. The companies would be required to accept all comers at a common price (“community rating.”) Riskier groups and individuals would be subsidized (several techniques are available, from private and public sources), so no company would suffer adverse selection. Lower income individuals would be subsidized – in essence, they would have a modified voucher. The HIE would be available to individuals and small groups at first, and later to larger groups.

Just establishing this new exchange system would solve several of the health insurance problems. It would:

• Increase insurance accessibility, and thus greatly reduce the numbers of uninsured.
• Eliminate the problem of portability.
• Reduce under-insurance.
• Increase transparency of policy provisions, and thus protect patients from exploitation.
• Eliminate patient dumping.
• Reduce costs in the insurance system by:
o Eliminating the overhead of underwriting.
o Reducing the overhead of marketing.

Attracting patients would now center on price, additional coverage offered, patient service, and choice of provider networks. Profitability would center on efficiency of operations, both internal to the insurance company, and in the efficiency of care delivered by the company’s network.

On the other hand, the HIE would not fix some of the existing insurance problems:

• Conditions of negotiation with doctors and hospitals.
• Payment wars between providers and insurance companies.
• Insurance company\patient wars over coverage for procedures.
• Excessive concentration in the health insurance industry.

Still, even if there were still problems, one can see that having a HIE would be a great deal better than the current system. The HIE would not solve the problems of cost and quality – but changing the health insurance system cannot fix everything.

The Public Option

Now the question arises: given a HIE, would the public and the system of health care be even better served if one of the options were to be a government sponsored non-for-profit plan (the Public Option, or PO) that competed with the other offerings?

What do we mean by a PO? It is not yet decided what form Congress has decided the PO will take, but the most probable form would be a non-profit governmental entity governed by the same rules as the private companies. That is, the PO would have entries at each level of the HIE at a price decided on by the entity, but the price could not be so low as to cause a deficit in its budget.

What would be the virtue of a PO bound by the same rules as the private plans? The common explanation is that the public plan would “keep the private plans honest.” This must mean that the government plan would be honest, cut no special deals with any party, nor overpay its executives. Others have said the government could get “volume discounts.” It is hard to understand what this means, since commodities form very little part of health care. If it means that a large governmental plan could coerce favorable contracts with physicians because of size, that would be possible but not desirable, since short-lived profits from lower prices, as opposed to real efficiencies, would sooner or later cut into quality. With hospitals on the other hand, it may be that by combining payment systems with Medicare and Medicaid actual efficiencies in billings could be effected with resultant decreases in costs.

So let us assume that a government plan would differ from the private plans only in sponsorship. What is the virtue in that? First of all, it would lessen the degree of concentration of health insurance. Competition would thus be improved.

Second, private companies negotiate differently with providers than do governmental entities. The PO would probably offer a single price for services rendered to all providers, and accept all providers who wanted to sign up under those terms. The private companies might want to play the game differently – they might want to sign up only certain providers, as they would be freer to do so than would the PO. Thus, the private companies might have innovative plans with networks that would attract consumers, perhaps even at a higher price – there should be no law against paying for luxury. Some might pay primary care physicians more; others might pay specialists more. They might have different practice restrictions. Private companies could experiment with the Medical Home, with Accountable Care Organizations, etc. In this scenario, the HIE would allow for differentiation of product while at the same time ensuring a good quality lowest denominator. If the private plans were to go bankrupt and fail, the PO would always be there for the consumers who were with the failed plan.

Third, the PO might be more typically bureaucratic than some other private companies, who might be more innovative in their administrative functions. Thus, this private company could charge the same as the PO but still make a profit, and the public would be better served.

Fourth, before it sunk into traditional governmental mediocrity, the spirit of the PO might at first engender some innovations that the somnolent private companies were not capable of coming up with. If they could not match the PO, they would deserve to fade from the scene. If they felt themselves challenged to compete, counter-innovations might result.

Fifth, the PO might be better able to respond to national priorities than the private plans. For instance, there is a national shortage of primary care practitioners. The PO might be more likely than the private plans to respond to this priority by boosting the pay of primaries.


In sum, if pains were taken not to unduly advantage the PO, it might well be that including it in the HIE would result in a more vibrant competitive field that would wind up actually benefiting the public. In fact, the PO is such a good idea, it might be good to have multiple PO’s competing in one arena – one perhaps Federally sponsored, one state sponsored, and others cooperatives as have been mentioned in the Senate Finance Committee.

It is hard to see that too much competition at first among both private and public entities would be a problem. Everyone realizes that health insurance reform is only the beginning of health care delivery reform. Using the HIE and including a PO might well set the stage for further reform and evolution using free competition that actually works for, instead of against, the public interest.

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