Issues in Merging the Individual and Small-Group Markets

1. Issues in Merging the Individual and Small-Group Markets Elliot K. Wicks, Ph.D. Health Management AssociatesJanuary 2007

2. Only 5% of Population Has Individual Coverage, 14 Million U.S., 2005 HEALTH MANAGEMENT ASSOCIATES

3. Why merge? Poor individual market performance • For high-risk people, premiums too high or even denied coverage • Due to insurer risk rating/medical underwriting • Coverage sometimes “skimpy” • High deductibles, less comprehensive than typical • Very few insurers participate — risky, not much revenue compared to other markets • Result: many individuals don’t buy coverage HEALTH MANAGEMENT ASSOCIATES

4. What expectations from merger? • Spread risk/costs over more people, bring down costs in individual market, because . . . • Small-group rating rules limit insurer latitude • Can’t deny coverage • Allow less rate variation based on risk • Thus merger expected to reduce premiums for higher-risk people now in individual market HEALTH MANAGEMENT ASSOCIATES

5. Why poor performance in individual market? • Strong danger of adverse selection against the whole market: • Attract too many high-risk people, because . . . • People can partially predict need for medical care • Tend to enter market when expect to incur expense • Violates the insurance principle: high-risk and low-risk people contribute premium to avoid large, unpredictable loss/medical claim. • Premiums would rise, low-risk people would stay out: spiral of adverse selection • Due to voluntary nature of buying insurance coverage HEALTH MANAGEMENT ASSOCIATES

6. People wait to buy individual coverage until they need it, because • Cost is high relative to often skimpy benefits • Many are lower income (no employer coverage), just out of work, maybe poor health, just entering labor force • No employer subsidy • No tax subsidy, unlike employer coverage • So to lower-risk people, may seem not a good value HEALTH MANAGEMENT ASSOCIATES

7. The Voluntary Market Dilemma • Either allow risk-rating and denial of coverage, with resultant hardship for high-risk people, or • Have adverse selection against the market, with consequent likely market failure HEALTH MANAGEMENT ASSOCIATES

8. The Individual Market Problems • Potential for adverse selection against the market, which would cause high premiums • Administrative costs are higher than in other markets • No economies of scale • More expensive to market and service on a one-to-one basis HEALTH MANAGEMENT ASSOCIATES

9. Merging: individuals buy in small-group market with those market rules • The result: high-risk individuals pay less because . . . • Rating rules in group market allow less variation based on risk • Can’t deny coverage to any applicant • But neither individual-market problem goes away: • Still potential for severe adverse selection • Still higher administrative costs to serve individuals • Thus individuals pay less because small groups pay more—mathematical truism if same people covered • Small groups subsidize individuals • Perhaps OK if small-group market is very healthy HEALTH MANAGEMENT ASSOCIATES

10. What would mitigate negative effects on small groups? • If average small-group rates are substantially below average individual rates • If number of people in small-group is very large • If small-group market allows significant risk rating • If merger causes rates for individuals to fall so much that many more low-risk individuals buy coverage HEALTH MANAGEMENT ASSOCIATES

11. What would make the negative effects worse for small groups? • Community rating • Guaranteed issue • Continuous open enrollment • No penalties for prior conditions • Practical problem: How to apply group rating rules to individuals, because rating factors like industry, group size don’t apply. HEALTH MANAGEMENT ASSOCIATES

12. Alternatives to merger • All insurance involves subsidies from (temporarily) low-risk to (temporarily) high-risk people • May be better, fairer ways than merger to spread risk/subsidize, such as . . . • Direct government subsidies to just high-risk people • Vouchers to buy “normal” market coverage • High-risk pools (must be adequately funded, so low enough rates, good coverage, no waiting lines to get in) HEALTH MANAGEMENT ASSOCIATES

13. Alternatives to merger (cont.) • Subsidies from all other insurers (like New Jersey’s “play or pay”) • Government-funded reinsurance in individual market • Pay high-proportion of cost of high-cost cases • If insurers pass on saving, lower price to everybody • Creates “social insurance” program for catastrophic care • But not “target efficient” — aids those already voluntarily paying the whole bill when they buy coverage now • Subsidies from government are probably fairer: risk spread through tax system based on ability to pay. HEALTH MANAGEMENT ASSOCIATES

14. The “ultimate” solution: individual mandate • If everyone must acquire coverage, no potential for adverse selection against the individual market • High-risk and low-risk individual would all be in the same pool all the time • Community rating (adjusted or pure) would work across all markets: • Low-risk people can’t stay out of the market • High-risk people face no premium penalty • Very hard to solve individual market problems without an individual mandate HEALTH MANAGEMENT ASSOCIATES