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Thoughts on Health Exchanges and Pre-Existing Conditions

John on November 3, 2009 at 12:50 pm

Now that the bill is on the verge of passage, Ezra Klein is finally having some doubts about the perverse incentives the exchanges might create:

I’m a longtime proponent of the exchanges, but key to their functioning is their ability to serve a population that’s not entirely low-income…[I]t’s not clear that they’ll be particularly competitive if they’re primarily serving a subsidized population.

Megan McArdle has some reactions to his post. She expresses surprise that Ezra is concerned about maintaining “price signals” which is another way to say not having excessive (and often unpredictable) market controls by government. Frankly, she’s not half as surprised as I am. After all, this is the same guy who said he wishes he could sign all private insurers out of business with the stroke of a pen.

I tend to see this more as the first salvo in the next battle, i.e. the expansion of the exchanges to include ever-more of the population. Ezra more or less confirms this in a comment to his own post, writing:

Ah yes, if only there was a blog somewhere, where some weird guy had been endlessly whining about how the exchanges needed to be opened to more people…

You’ll be seeing lots of this sort of argument just as soon as they finally manage to get the camel’s nose under the tent…

Even more interesting are some of the comments on Megan’s post. This one in particular got me thinking:

[T]here’s an incentive (with guaranteed issue, and no pre-existing condition ban) even for people who are unsubsidised to pay into the cheapest possible unsubsidised plan that gets them out of paying the penalty tax, and then jump into the most expensive plan as soon as anything goes wrong…

Each provider sets the prices on a given plan based on actuarial tables about what it will cost them, on average, to cover the cost of illnesses (plus salaries, overhead, etc). So a cheap plan is cheap because it covers less or because it has higher co-pays, or both. An expensive plan is expensive because the insurer expects to have to shell out more in the aggregate to meet his stated obligation. But under both the average and top plans, some people get sick and some people won’t. Those that do are subsidized by the premiums of those that do not.

Now add “no penalty for pre-existing conditions” into the mix. Now you can change plans after you get sick from a cheap plan to a pricey plan. If it were you, wouldn’t you do so? I would.

The response is that we can put time limits on people’s opportunities to switch plans, sort of like we have now with annual opt-ins. However under the current system, opting in to a new plan would be restricted by pre-existing conditions.

You have end-stage renal disease. Sorry, that’s a pre-existing condition. No moving into a Cadillac plan for you.

But under the new rules in the exchange, you may have to wait some period of time, maybe a year or less, but when you decide to “opt-in” to the exchange version of a Cadillac plan they have to take you. This is so, even though they know the cost of covering you far exceeds what they charge in additional premiums.

In a relatively short period of time, say five years, all the really sick people gravitate to the pricey plans. Sure they’re expensive but, again, the added premium is less than the cost of care, so it’s a net benefit.

From the insurers side, you suddenly go from a situation where 25% of those enrolled will require major medial treatment, to a situation where 75% will. Where is the money to cover the added cost going to come from? There are only two options:

  1. The cost of the pricey plan skyrockets to account for the fact that so many of the “insured” are already ill and require expensive treatment.
  2. The cost of the pricey plan is subsidized by people from the less expensive plans offered by the same insurer. In other words, the cost of the non-Cadillac plans goes up to help offset the outlays at the top.

Frankly, I’m not even sure if #2 is legal or ethical and yet I wouldn’t be surprised if this is what happens, especially in the government plan. As I noted before, the public option is going to offer three or four tiers of coverage from basic to premium plus. Once all the really ill are getting premium plus, the cost of basic is going to have to go up. Either that or the cost of premium plus becomes so expensive that only the very wealthy can afford it.

So we either end up with a two-tiered system where only the very wealthy can get great coverage. BTW, this is not what we have now as most of the so-called Cadillac plans belong to union members and government employees.

The other option is a system where middle-class Americans pay more for average coverage so the very ill can have Cadillac plans. Somehow this doesn’t seem fair.

Neither option looks good, but I don’t see any alternative once pre-existing conditions are removed as a consideration.

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