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Policymakers Can Learn From California's Failed Insurance Exchange

Cheryl Clark, for HealthLeaders Media, August 14, 2009

Policy wonks idealizing the idea of health reform through the creation of a national insurance exchange should see a cautionary tale in California, where just such an ambitious effort in that state crashed and burned in 2006.

Launched in 1993, the Health Insurance Plan of California (HIPC) offered small employers several standardized insurance products sold by a variety of plans. Initially a government agency, it was turned over to the Pacific Business Group on Health in 1999, which named it PacAdvantage, and eventually enrolled 150,000 people, according to a recently released report by Elliot K. Wicks of Health Management Associates.

The report was prepared for the California Healthcare Foundation.

However, a variety of problems, including the fact that the exchange attracted higher-risk enrollees, contributed to its failure and it was terminated in 2006.

"Over the past 15 years, California gained extensive experience in designing and operating just such an exchange, an effort that ultimately proved unsustainable," according to the report, "Building a National Insurance Exchange: Lessons from California." The report drew upon interviews with eight officials involved in the creation and management of the exchange.

The effort used the "active" purchaser model, in which large employers negotiated and selectively contracted with insurers in exchange for large numbers of enrollees. A market both within and outside the exchange sought to attract the same customers.

It tried to provide an easy-to-navigate single point of entry where insurance plan seekers could go to select among several plans. It would also provide objective information about price, benefits, and plan performance.

It also sought to reduce the cost of coverage by centralizing market functions, enroll employees, and collect and distribute premiums to insurers. And it tried to command lower prices and foster market competition. Participating insurers were required to offer standardized plans, but compete with each other on price, quality, and service.

However, the report explained, "the actual experience of the California exchange taught some hard lessons. It showed that none of these objectives is easily achieved."

"If there is competition for the same customers inside and outside the exchange," the report warned, "the exchange will be unable to offer lower prices on a sustained basis for at least four reasons:

  • Some health plans may refuse to participate.
  • Economies of scale in administration are hard to achieve.
  • Participating health plans will not give the exchange a lower price.
  • The exchange is likely to attract higher-risk enrollees.

"Insurers do not particularly like the head-to-head competition that is the feature of the exchange concept, in part because they could lose any given enrollee to a competitor in any given year," the report said. The people most likely to switch are the healthiest enrollees who are less costly, less attached to particular providers and have fewer qualms about switching to another health plan to save a few dollars."

Another important problem for the California plan was its size. At the program's peak, the 150,000 individuals enrolled was a tiny percentage of the small group market, the report said.

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