“Viewpoints” | Incentives, Incentives, Incentives (and Risk Selection)
This is the first of a three-part series on the incentives involved in creating meaningful health care reform. If any major health care legislation is passed in the United States in 2009, it will almost certainly involve some form of an insurance exchange. This post focuses on why policymakers are eager to create an exchange and the detrimental impact of risk selection on true competition in an insurance exchange. The second post in the series will focus on adverse selection, and the third post will focus on over-differentiating insurance products and the need for consumer protection.
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There’s a reason that most proposals for health policy reform in the U.S., no matter the political bent, revolve around creating some form of a health insurance exchange. Some analysts might argue for having a government run plan in the mix, and others might advocate for exclusively private insurers. But when scholars from the Commonwealth Fund, the Brookings Institute, the Heritage Foundation, the Center on Budget and Policy Priorities, and the Urban Institute are all calling for some form of an insurance exchange, you know it’s an idea that policymakers need to take to heart.
On July 16, House Democrats released H.R. 3200, a bill that is an impressive first step towards addressing some of the challenges in U.S. health care. This bill is not perfect, but many of the key elements necessary for meaningful reform are included, like an insurance exchange, an expansion of Medicaid, and vital regulation of the insurance industry. I certainly hope that as H.R. 3200 progresses, the insurance exchange becomes a far bigger component of the bill so that there is real pressure to improve quality and reduce costs. In this post, I want to outline the main principles of an insurance exchange and discuss the vital necessity of including some form of risk-adjustment for insurers in an insurance exchange like the one proposed in H.R. 3200.
An insurance exchange is essentially a regulated market for health insurance where prospective insurees can compare plans on price, coverage, quality, and customer service. Call it an Amazon.com for health insurance. The federal government or a third-party organization would run a Web site with a list of health insurance plans offered in a particular geographic region – for example, at the state level. The government would also define minimum standards that a plan must meet to be included in the exchange. Potential insurees could go to the Web site to figure out what plan is best for them, compare prices, and hear what other customers have to say about the various plans. The Web site could offer general advice, indicate what similar customers purchased, and perhaps even make recommendations about what plan is best given an individual’s particular profile.
Advocates are enthusiastic about introducing an exchange, because it would create real competition in the insurance industry. Insurance companies would be prodded toward more transparency, and there would be sharp incentives to improve efficiency and quality (something very much lacking in the current U.S. health care system). Along the same lines, an exchange would make it far easier for insurees to switch plans if they weren’t happy with their coverage. No more reams of paper to fill out, no more endless calls to lots of potential providers; insurees would simply point and click if they wanted to change plans. Giving insurees more power to exit and switch plans would keep insurers on their toes. The name of the game would be putting consumers on a more equal footing with health insurance companies.
But if an insurance exchange, like the one created in H.R. 3200, is going to work, there’s one subtle element that needs to be addressed: risk selection. Risk selection isn’t sexy or glamorous, and it smacks of policy jargon, but addressing risk selection is a key to creating the type of incentives necessary to improve the way health care is delivered. To that end, the current bill coming out of the House acknowledges risk selection but doesn’t address it sufficiently. Failing to tackle risk selection will likely tamp down incentives for insurers to improve the way they do business.
In traditional insurance, the higher the risk of an insuree making a claim, the higher the premium an insuree will have to pay (that’s why 16-year-old boys’ car insurance premiums are so high). The same holds true in health insurance: the higher the likelihood of falling ill and requiring costly medical care, the higher the cost of insurance coverage. The difference between car insurance and health insurance is that the people who are most likely to be priced out of health insurance are precisely the people who need it the most (e.g., the elderly, the chronically ill, the disabled).
To protect people who need care from getting priced out of the insurance market, health exchanges require that everyone pay the same price for a health insurance plan, no matter what their risk of getting sick. The only factor used to adjust prices for the insuree would be his or her age. This is known, in the terminology of health policy, as applying adjusted community-rated premiums. This would prevent high-risk families and high-risk individuals from having to pay far more than everyone else to receive coverage.
And while community rating is essential, charging everyone the same price for insurance coverage, irrespective of their risk of illness, creates other types of problems. With community-rated premiums, unless insurance companies are adequately compensated for taking on high-risk insurees, insurers have every incentive to focus only on attracting the insurees at lowest risk rather than improving the provision of care. This phenomenon is the essence of risk selection.
Think about it for a moment. If an insurer is forced to charge $1,000 per insuree for each year of insurance coverage regardless of the insuree’s health risk, the insurance company has an incentive to search out individuals whose average health costs per year are far less than the $1,000 cost of the coverage. This process isn’t immoral on the part of insurance companies. It is simply common sense for a publicly traded company focusing on the bottom line.
While insurance companies are unlikely to outright discriminate against high-risk potential customers (though they possibly could), evidence from Australia tells us that what they can and will do is try to appeal to insurees who they think will have low risks and low costs. For instance, they might try to woo healthy potential customers by including additional perks – like gym memberships, for example – that are usually only appealing to healthier individuals. Similarly, they might try to offer benefits packages that were particularly attractive to the healthy, but not to the chronically ill. Risk selection provides a quick and dirty way for insurers to cut costs, but it blunts the incentives needed to improve efficiency and change the way we deliver health care.
One mechanism to get around risk selection is to compensate insurance companies for taking on high-risk patients – in jargon terms, to risk-adjust payments to insurance companies. In several European countries, like Germany and the Netherlands, governments force insurance companies to shift funds between one another to compensate companies who take on high-risk patients. This is an effective strategy to make sure that insurers don’t simply seek out low-risk insurees, but the prospect of private companies shifting funds between one another to promote “solidarity” and avoid risk selection seems unlikely to be palatable in the U.S. (1,2)
There is, however, an alternative strategy that could be successful in the U.S.: tax subsidies for insurance companies taking on high-risk patients. Each insurer participating in the exchange would have a “risk score” that captured how risky their insurance pool was. Similar to the way that other countries risk-adjust, the risk score could be calculated based on age, ethnicity, employment status, previous health care expenditures, and geographic location. The higher the “risk score” for a particular insurance company, the greater their tax subsidy, and thus the lower their tax liability. The program could go so far as to pay insurance companies an additional sum for taking on high-risk patients. Using this type of system would effectively reverse the incentives created by a health insurance exchange: insurance companies would now be rewarded for taking on high-risk patients.
With a risk score system in place, insurance companies would be incentivized to compete on quality and not simply on who could attract the healthiest patients. A risk score system would reward adventurous insurers who took on high-risk patients and were innovative with their care. It would also keep taxes up on insurance companies who took the easy way out by seeking to avoid high-risk insurees.
Any successful reform in the U.S. is going to need to expand coverage and reduce costs. Expanding coverage, from a policy perspective, is not a difficult task: you simply pay for more coverage. Similarly, cutting costs is not too hard: you just provide less care at the expense of quality and patient satisfaction. The tricky part for any reform is to reduce costs by increasing efficiency and improving quality. That’s where incentives come into play. To increase efficiency, policymakers must continue to focus on embedding the right type of incentives in the U.S. health care system so that insurance companies are focused on quality and not just on the quick ways out, like risk selection.
“Viewpoints” blog postings are intended to allow non-Altarum Institute authors to pose their own opinions and policy positions in the realm of health care and health policy. As a leading nonprofit health care research and consulting institute dedicated to improving human health, Altarum encourages open discussion and debate about the many challenges in health care today. All postings to the Health Policy Forum (whether from employees or those outside the Institute) represent the views of the individual authors and/or organizations and do not necessarily represent the position, interests, strategy, or opinions of Altarum Institute. Altarum is a nonprofit, nonpartisan organization. No posting should be considered an endorsement by Altarum of individual candidates, political parties, opinions, or policy positions. Read more.
References
1. van de Ven WP, Van Vliet R, Lamers L. Health-Adjusted Premium Subsidies in the Netherlands. Health Aff (Millwood). 2004;23(3):45–56.
2. van de Ven WP, Beck K, Van de Voorde C, Wasem J, Zmora I. Risk adjustment and risk selection in Europe: 6 years later. Health Policy. 2007;83(2):162–179.
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