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Focus on the Exchanges

It is important in nearly any political argument to win both the battle of ideas and the battle of substance. In the recent debate over the Affordable Care Act, conservative opponents have done an excellent job of drawing attention to the individual mandate’s circumvention of our basic American liberty to use our resources how we consider best. While such arguments strike an emotional and spiritual chord with Americans, they alone cannot get the job done. The effects of the mandate are abstract and cannot be quantified. They are enough to rile up those of us who recognize the truth of President Reagan’s haunting maxim that “freedom is always one generation away from extinction,” but they are insufficient to win over those who confine the argument purely to quality and availability of healthcare. Luckily for conservatives, we can easily win that argument too, but in order to do so, we must shift focus from the emotionally touchy subject of the mandate to the fuzzy economics of insurance exchanges.

The idea of an ‘insurance exchange’ is far from new in America. The concept of putting ceilings on premiums and floors on services in exchange for the privilege of access to a special market of participants has shown up in various levels of government for years. We have seen it at the state level with Gov. Romney’s Massachusetts Health Connector, up to the federal level through the Federal Employee Health Benefits Program. Exchanges with more liberalized requirements have also been adopted in specialty programs like prescription drug coverage in Medicare Part D. While exchanges claim to increase market competition, though, they can only do so if companies are actually allowed to behave according to market forces. The idea of an ‘exchange’ under the Affordable Care Act moves far away from this ideal.

For the purpose of this article, we will consider an ‘exchange’ as not only the competitive framework made so people can shop health plans, but as also embodying the restrictions and requirements that come with it. For in reality, the problem lies not in the exchanges at all, but the fact that they are combined with stifling regulations as a condition of entry – namely guaranteed issue and premium controls.

Why will exchanges such as those under the ACA limit competition? First, the basic economics: Under the Affordable Care Act, insurers are required to make coverage available to the previously uninsurable, and are mandated to set premiums based on average costs.  In practical terms, the requirement of covering anybody who desires coverage sets a floor on the products offered. Premium controls (pricing based on average costs or ‘community rating,’ and requiring the most expensive premiums be no more than three times as expensive as the cheapest) constitute a rigid price ceiling. Within these confines, insurers cannot “price insurance premiums to match applicants known actuarial risks,”[i] and are therefore being coerced into irrational economic action. Within this context, the Obama administration still expects that competition will carry the day in expanding insurance coverage and keeping premiums low. But, at the same time that the government is creating, with great ceremony, a vehicle for honest and open competition, it is limiting the means by which such competition can flourish.

In other words, government is expecting competition to occur in a market in which the terms of competition are being further and further restrained. How will competition work when there is so little to compete with? By imposing price-setting requirements in order to enter an exchange, the ACA destroys a firm’s motivation to be an independent, creative economic actor. This not only threatens a future malaise in the industry, but also further diminishes any small leverage an insurance company previously had over keeping medical costs low for its participants. As plans become more and more similar, companies will find less and less ground on which to differentiate themselves. Questions of dealing with health providers to keep down costs will fall increasingly to the government.

But also, in the future, all it will take to drive all private insurers out of business is for one popular politician to raise a “rent-is-too-damn-high”-style revolt over the (now artificially) onerous insurance premiums. The result will be a gradual choking of private involvement in the insurance industry as the government mandates lower premiums without lowering costs.

Exchanges in Action

Both in the aftermath of the ACA and before its passage, the track records of exchange-type price-setting organizations have been alarming. Before the law, in Massachusetts, studies including one by the Cato Institute have noted that the institution of a health exchange has created a strong trend toward increasing premium costs and more turning to government for answers. In the 96% of insurance business in the state that has operated within the Health Connector, premiums have increased, including an increase of 21-46% for insurance offered through an employer[ii]. (10) The study also notes the increasing phenomenon of government insurance subsidies “crowding out” private investment in insurance – the evidence for whether this is due to the presence of a new handout, or higher insurance premiums, is inconclusive. What is conclusive, though, is that the presence of an exchange-type system has reduced competition – government subsidies function further to satiate the consumer who would otherwise be looking for the lowest price. Massachusetts offers a great example of a two-pronged attack on competition: setting requirements for participation on insurance companies, and simultaneously paying consumers with government funds, inhibiting the consumer end of competition.

In the aftermath of the ACA, examples of similar phenomena are already being observed in the special market of college student health insurance. Student premiums, which have been historically low due to the relative health of that demographic, are skyrocketing in response to the expectations of new coverage requirements under the ACA. Rather than allowing insurance firms to tailor their coverage to what students wish to purchase, new coverage costs much more. Prominent examples have occurred already for next academic year at SUNY Plattsburgh (premiums multiplying by three times) and the University of Puget Sound (twelve times)[iii]. Several Catholic colleges, over both the contraception issue and high costs, have dropped healthcare coverage altogether[iv].

These problems do not even mention another fundamental problem with the exchange system – that premiums can also be driven up by causes other than the economics of healthcare. The difficulties of extending coverage over a large geographic area, for example, already plague the federal health insurance exchange set up for government employees. This system can serve as a harbinger, according to a recent study in Health Affairs, that high health care costs for consumers will likely follow from the establishment of a national exchange and varied levels of competition in different geographical areas[v].

While the Affordable Care Act’s individual mandate is enough to make the blood of any ideological conservative boil, it is equally important to make the point that the law’s exchange system will make economic life more difficult for everyday Americans. While the individual mandate purports to mitigate the ACA’s problem of increased risk, it is very unlikely to be enough to offset the negative effects of the exchange system and increased regulation of insurance companies’ abilities to innovate. Not only does the ACA do little to address the underlying problem of high healthcare costs due to consumers’ removal from the payment process – it reduces what little motivation our insurers had left to do this for us. Instead, we need to address what is really driving America’s healthcare crisis most – high service costs.

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