State health benefit exchanges mandated by the federal Patient Protection and Affordable Care Act of 2010 have been commonly described as online marketplaces where buying a health insurance policy or managed care plan can be done as easily as booking a flight or vacation. Ease of purchase, however, is not the driving policy rationale behind the exchanges. They came about in response to market failure in the individual and small group market segments, particularly in the former. In insurance terms, market failure means the dreaded death spiral of adverse selection.
Insurance fundamentally is about spreading costs across a group of insureds, known as the insurance principle. The principle is based on the law of large numbers. If too few people purchase an insurance or health plan, the law of large numbers is violated and the insurance principle breaks down. For those insureds left in the group, their share of the group’s costs – paid as premiums or membership dues – must be sharply increased. The pool shrinks and only those most likely to use medical services remain since they need coverage, putting further upward pressure on premiums.
There is a limit what any insured can afford to pay. Eventually market failure results and the insurance or managed care plan becomes economically unviable. As plans close, the fewer remaining health plans pass along relentlessly rising medical care costs and the unvirtious cycle proliferates until the entire marketplace is at risk. That was — and still is — the situation the individual and small group health insurance markets leading up to the enactment of the ACA in 2010. Ultimately, health benefit exchanges are an attempt to preserve these markets by concentrating plan issuers and purchasers into a government-sponsored marketplace with incentives and disincentives for individuals to participate in the form of tax credit subsidies and tax penalties, respectively.
Whether the exchanges are able do so won’t be known for several years after the exchanges begin pre-enrolling individuals and small businesses for 2014 coverage starting in October 2013. What is certain is the exchanges as insurance marketplaces – like the failed market they seek to remedy — are also subject to the insurance principle. They must attract sufficiently large numbers of individuals and small businesses if they are to successfully achieve the market aggregation solution that led to their inclusion in the ACA.
Need a speaker or webinar presenter on the Affordable Care Act and the outlook for health care reform? Contact Pilot Healthcare Strategies Principal Fred Pilot by email