Will ObamaCare's Exchanges Encourage Health Insurers to Prioritize the Healthy and Slight the Sick?


ObamaCare creates a network of health insurance exchanges—state-run marketplaces through which individuals can purchase subsidized, regulated insurance. Today, the administration released a first draft of its proposed exchange rules.

He wants you.

In theory, the exchange requirements make possible some of the law's sweetest benefits: Inside the exchanges, insurers are forced to sell policies to all comers, regardless of preexisting conditions, and are strictly limited in terms of how they can charge different prices based on health history.  

The problem with these regulations, essentially price controls, is that they they stack the financial incentives against the sick.  For insurers, the best way to increase their bottom lines is to cherry pick the healthiest—and thus the cheapest—individuals. Because insurers aren't allowed to charge more to enroll those likely be sicker and more expensive to cover, they stand to make far more money if they successfully sign up and keep a larger pool of healthier individuals. The costly sick, meanwhile, become financial liabilities, and insurers inevitably end up working to encourage those individuals to change plans as soon as possible, perhaps by providing them with stingier benefits and poorer service.

This happens despite the fact that the rules are designed to facilitate equality amongst enrollees, regardless of health. But even within regulated environment that resemble the exchanges, insurer cherry picking is well documented. As John Goodman, president of the National Center for Policy Analysis, explained in his book Lives at Risk, plan providers operating under such rules offer benefits likely to attract healthy people, like sports club memberships, but avoid or dump services that will attract sick and expensive individuals.

Last year's health care overhaul attempts to deal with the problem through a system known as risk adjustment—a system of forced financial transfers from plans that enroll more health individuals to plans that enroll more of the sick. The idea is to smooth over the incentives to cherry. As Bloomberg reports, today's proposed exchange regs lay out the risk adjustment guidelines:

The rules create a "risk-adjustment" program that would take money from insurers in a state with low-cost patients and give it to plans whose customers run up the highest bills. The policy applies both to insurers selling coverage within the exchanges and those operating independently.

"The risk-adjustment program serves to level the playing field, both inside and outside of the exchange," the government said in a description.

The problem is that there's quite a bit of evidence that risk adjustment doesn't work. Not only does it fail to put a stop to cherry picking, it can actually end up making things more expensive overall.  

In a 2010 working paper, a quartet of authors from Stanford, Princeton, the U.S. Treasury, and the University of Maryland took a look at risk adjustment in within Medicare Advantage, which offers seniors a selection of regulated private plan alternatives to fee-for-service Medicare. In 2004, Medicare advantage began using a risk adjustment model in hopes of reducing cherry picking. It didn't work. "Our research finds that favorable selection, and consequently overpayments, have not fallen appreciably since the introduction of the most comprehensive model of risk adjustment in 2004," the paper concludes. 

Noting that last year's health care overhaul calls for a similar sort of risk adjustment amongst the private insurers operating through the exchanges, the authors write that "in light of the results presented here, one question is how well a risk adjustment mechanism will reduce adverse selection in the exchanges." Indeed, risk-adjustment may be even more difficult within the exchanges. "A comparable data source does not exist for the commercial market," they write, "which leads to the question of how risk adjustment will be implemented, and whether one can reasonably expect it to perform near the level of Medicare's model." In a related publication for the National Bureau of Economic Research, meanwhile, the same group of authors note that another side effect of risk adjustment was actually to make Medicare more expensive overall. 

The comparison between Medicare Advantage and the exchanges isn't perfect. Within the Medicare Advantage program, insurer cherry picking leads to sicker enrollees ending up on traditional Medicare. No such option will exist within the exchanges. So if risk adjustment fails in the exchanges, what might happen? According to the authors of the paper, "possible alternatives are lower quality care across the exchange for high risk individuals as plans seek to avoid them, or perhaps the emergence of plans that do provide quality care to high risk individuals but at higher premiums that incorporate the increased risk that risk adjustment misses." Given the choice, higher premiums and better service seem like the better outcome, but with the insurance regulations and the law's rate review requirement, it's not clear how much pricing leeway insurers will have—which may mean that lower quality is the only remaining option.