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.
The plans did not see any administrative savings, which meant they couldn't offer lower premiums. "The cost of serving small employers and individuals will always be more expensive on a per-capita basis," the report said.
Without the inclusion of most large plans, the exchange will have trouble attracting enough enrollees to command a large market share. As one former director of the California exchange noted, "An exchange is often just one health plan loss away from failure."
The California plan also had difficulty negotiating lower prices, and lacked a captive supply of customers.
But the greatest problem it experienced was adverse selection, the report said.
"People involved in the operations of the California exchange agreed that when there is competition for the same customers within and outside the exchange, the exchange is in 'extreme peril' of becoming a victim of adverse selection."
In the case of PacAdvantage, the exchange attracted a disproportionate number of higher-risk individuals and groups, which meant higher medical claims and higher premium costs.
"People will not buy health insurance through the exchange or stay within it if they can get the same coverage less expensively elsewhere. Eventually the exchange will fail."
The report warned that to protect against adverse selection, the program must not be more lenient in accepting risk in its enrollees than plans outside the exchange. "And it must employ whatever medical underwriting and risk rating practices are allowed in the regular market to avoid becoming a magnet for the unhealthy."
The California exchange also made the mistake of not varying rates based on health status.
The report offered four tips to avoid such pitfalls in the creation of an exchange that might be applied across the nation.
1. An active purchaser exchange will have a difficult time if insurers are able to compete for the same customers outside the market and will have trouble getting and keeping health plan participants and bargaining for lower prices. And it faces the constant threat of adverse selection.
2. An active exchange needs to be the exclusive source of coverage for defined population groups.
3. If the exchange is to compete with insurers selling coverage to the same customers, it should be structured on the "clearinghouse" model. It may be necessary to require health plans to participate and to require them to charge the same price both inside and outside the exchange.
4. The exchange should require insurers to offer a limited number of standardized benefit packages and include a risk-adjustment mechanism.