Private Exchanges: Getting Ready For Individual Health Insurance to be The Standard

Professor John H. Cochrane of the University of Chicago had an op-ed in The Wall Street Journal on December 25, in which he gave a brief description of (among other things) a market in which individuals buy their own health insurance — and not from an ObamaCare exchange.

privateAccording to Professor Cochrane: “…we should transition to fully individual-based health insurance.” This is the Holy Grail of free-market reformers, and likely unattainable as long as ObamaCare’s political opponents are unwilling to take the risk of a reform that can be twisted as “taking away” employer-based benefits. (Although, as I have described in a previous post, the task would not be impossible if free-market reformers improved our communications skills.)

In Professor Cochrane’s approach, each individual would buy health insurance that actually combines two policies. The first would cover the beneficiary for catastrophic illness and accidents this year. The second, called health-status insurance, is insurance against being underwritten again in future years.

Traditional employer-based coverage is re-underwritten every year (sometimes within limits prescribed by state laws). Before ObamaCare, individual insurance was never re-underwritten, but that fell apart if the beneficiary switched insurers. Healthy beneficiaries found it easy to switch insurers, but people who became sick were forced to stay with their plans, even if they preferred to switch.

ObamaCare addresses this problem by forcing health insurers to accept everyone, without regard to health status, at the same premium (with some variation for age). With Professor Cochrane’s health-status insurance, a patient who is diagnosed with an expensive condition, who wants to move from one insurer to another, takes with him a sum of money (from the previous insurer) that will cover the higher premiums. The whole model is best explained by Professor Cochrane in a paper he wrote in 2009.

How can we get there, in a world where everyone who promotes the idea will be accused of “taking away” citizens’ employer-based benefits? The ground is being prepared with a relatively recent innovation: Private health-benefit exchanges.

According to a recent survey sponsored by a coalition of employers’ groups, 45 percent of employers have or are considering using private exchanges to offer health benefits to their employees before 2018. A November survey by David Franklin of the independent equity research firm Blueshift reported similarly high interest in private exchanges.

Most employers going into private exchanges are self-insured. That is, they take advantage of a federal law (ERISA) to avoid buying state-regulated health insurance and bear all the risk of medical spending for their beneficiaries. The health benefit is managed by a third-party administrator (TPA) or health insurer on an administrative-services only (ASO) basis. The most important thing to understand is that the insurer does not bear actuarial risk, as they usually do for smaller groups. (The employer can buy re-insurance to limit its risk.)

An employer wishing to use a private exchange, organized by a benefits consultant, can retain self-insured status. However, some experts surveyed in Mr. Franklin’s report thought that this was unlikely to persist. A private exchange provides a mechanism for an employer to make a fixed contribution to an employee’s coverage, which he can use to select a health plan from a portfolio on the private exchange. For the employer continue to bear the risk of high medical claims in such a situation makes little sense, according to some experts, including sources with whom I have spoken.

So, what’s emerging is large employers contributing fixed dollars to employees for them to buy state-regulated insurance from a portfolio in an exchange organized by a benefits consultant. To clarify: ACME, Inc., for example, has employees all over the country. Those employees are covered by a national, self-insured, ERISA plan, likely administered under a national contract with a benefits consultant. The benefits consultant has assembled a national network of providers by renting a large number of local provider networks. All the medical claims flow through the consultant to ACME for payment.

In the new world, the consultant organizes an exchange and solicits insurers in states where ACME has offices to join it. Employees now have a choice of state-regulated plans. ACME gives each employee a fixed contribution to pay premiums.

If private exchanges continue to grow as anticipated, it is easy to see how they could ease the transition into a future of individual health insurance, post-ObamaCare.

Say an employee in Northern California quits ACME and joins ZIPPY, Ltd. There’s a chance that ZIPPY uses the same benefits consultant, or that the consultant who organizes ZIPPY’s network in Northern California has almost the same portfolio of insurers in its exchange as the previous consultant did. In that case, there need be no disruption of coverage whatsoever. The employer making the defined contribution changes, but the beneficiary’s plan stays the same.

As years go by, the culture will change. If potential employees already have plans that they like, they will be less likely to join employers that don’t have those plans on their exchanges. Consultants will anticipate this by ensuring that almost all insurers in an area are available in their exchanges. People will begin to think of health insurance as their personal asset, not a benefit granted by their employers.

Once this cultural change has taken place, we will be a long way towards our goal of freeing every American to choose health insurance that suits him, instead of his employer or the government. Free-market health reformers should cheer the rise of private health exchanges.

Comments (15)

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  1. Devon Herrick says:

    Personal and portable health insurance that travels with a person from job-to-job is a great idea. However, there are problems with the current arrangement of subsidies in the exchange for individuals not offered coverage through work. These policies attempt to force young people to pay more than their expected costs so older, less healthy individuals get a price break. A better solution would be to charge actuarial fair premiums but force young people to cross-subsidize their “older” selves (instead of older strangers). A majority of the premium dollars a young person pays for health coverage should fund a health savings account for their later use — not fund someone else.

    • Jimbino says:

      Your idea is a good one, except that the “older-self” benefit would have to cover persons who migrate to a foreign country when becoming older or retired and vice versa.

      I have retired to Brazil, and even my Medicare benefit is useless there.

      An actuarially sound health-insurance policy would also have to charge women some 87% higher premiums. That will never fly in our socialist country.

      In the meantime, the best advice for a young, healthy, single and childfree male is to go bare: take jobs only as a sole-proprietor, in a very small company, part-time, as an independent contractor or as a consultant. Drawing benefits at a large corp is only a means to cross-subsidize sick, old, female, married breeders.

      All the young man needs to do to avoid paying an Obamacare tax is to monitor his withholding so that nothing ever remains in the hands of the IRS at year’s end.

    • Sabal says:

      That sounds a lot like social security and look how that has turned out. Can the government really be trusted with our money? I think you have a great idea assuming it is something people get to choose instead of being forced into.

  2. VN says:

    “(Although, as I have described in a previous post, the task would not be impossible if free-market reformers improved our communications skills.)”

    Hear, hear!

  3. Lucy says:

    The idea of health status insurance is really interesting and seems to make so much sense — would love to hear more about this in the broader media!

    • Jimbino says:

      Lucy,

      You have to realize that “insurance” that doesn’t discriminate on the basis of pre-existing conditions, age, sex, and race isn’t insurance at all.

      There is a science of risk-assessment upon which insurance is based. It is called Actuarial Science.

      Obamacare, like SS and Medicare, is a vehicle for distributing wealth from the young to the old, from the healthy to the sick, from the enterprising to the indolent, from the male to the female, from the single to the married and from the childfree to the breeder.

      • Dewaine says:

        Dead on. Also, at a certain point, there isn’t enough money to steal. We can’t provide infinite health care resources for all. Our universe is subject to scarcity constraints, so “universal health care” is a costly pipe dream.

        • Jimbino says:

          Right Dewaine,

          And if you are a young, healthy, single and childfree working man, you’d have to be a dingbat to participate in Obamacare.

  4. Trent says:

    “we should transition to fully individual-based health insurance.” This is the Holy Grail of free-market reformers, and likely unattainable as long as ObamaCare’s political opponents are unwilling to take the risk of a reform”

    The decreased bipartisanship is not good for anyone, why do they not understand this?

    • Jimbino says:

      No Trent,

      Individual-based health insurance is NOT the holy grail. The holy grail is self-determination in a free market. In a free market, an individual has the right NOT to buy whatever product.

      Insurance is a religion–a superstition–that lots of folks, notably Jesus of Matt 6:25ff, the Amish and Mennonites, and I do not subscribe to.

      Food, shelter, sex and a nearby bathroom are as important as health. Would you subscribe to Obamafood, Obamahouse, Obamasex and Obamakloo?

      Why have insurance if you can just buy the product? You will note that insurance has the effect of raising the prices of the things insured. And worse, it is just another vehicle available to the socialist gummint for redistribution of wealth.

  5. Hal says:

    “Free-market health reformers should cheer the rise of private health exchanges.”

    I sure am

  6. Smith says:

    government run exchanges screwed us all.

  7. Jack Towarnicky says:

    Some comments based on decades in employee benefits.

    First, private “exchanges” are nothing new. Choice of health coverage, even across different vendors/ insurers, dates back to the 1970′s. Many of us were introduced to a crude version of this by the HMO Amendments Act of 1973, authored by Teddy Kennedy and signed into law by Richard Nixon. It contained something called “dual choice”. What will be interesting is whether the crude forms of “private exchange” developed today (with 5 levels of coverage and 5 vendors, 25 choices) will survive – given American’s demonstrated inability to effectively choose the best, most cost effective option for our needs when offered even two choices. Watch the defaults here – is the default to
    “no coverage”, the option closest to the “status quo” or to a “bronze/catastrophic” coverage option!!!

    Second, defined contribution schemes came into greater use following the Tax Reform Act of 1978, with the addition of Internal Revenue Code Section 125, and subsequent laws (Tax Reform Act of 1986) and regulations that confirmed the tax preferences in cafeteria plans. I have used a variant of “defined contribution”, private exchange methods / schemes since the early 1980′s.

    Third, employers who offer private exchange coverage will be in two groups – those who retain the “defined dollar” approaches so prevalent today and an ever growing minority who acknowledge the impact of Health Reform and adopt a “defined contribution” approach. Defined dollar occurs where the employer contribution to those electing family coverage is greater than the employer contribution to those electing single coverage. Defined contribution, on the other hand, is where the contribution is the same regardless of whether you elect coverage or what tier or coverage you elect. Defined contribution is not very prevalent today, but is likely to gain traction now that PPACA regulations confirm that “affordability” is only measured with regard to the single tier of coverage and that a “spouse” is not a dependent for purposes of the employer shared responsibility rules.

    Fourth, I doubt large employers will give up the financial advantages of self-insuring. Why have workers incur the 5+% differential in cost (state insurance premium taxes, state benefit mandates, new taxes on insurers added by PPACA in 2014, mandates to cover all “essential health benefits”, etc.) Instead, look for employers to deploy stop loss coverage (from a fiduciary perspective) and as needed, adjust employee contributions based on claims experience. It happens today … just not so directly. Remember, no one need enroll for the employer to avoid the PPACA employer shared responsibility penalty taxes – only that coverage be offered.

    Fifth, with respect to “portability”, nothing precludes an employer from mimmicking coverage options available in the public exchange or private exchange. However, portability is a policy wonk concern, not so much that of an employer. I find it hard to believe that employers are interested in attracting individuals away from their current employers with the promise to offer the same coverage you had at your prior employer – given the potential diversity of coverage options selected by other employers. That is, perhaps the employer is less interested in potential hires who have such a high priority when it comes to health coverage that they would reject an offer of employment just because of a change in vendors. And, if that were to become an issue, nothing precludes the employer from adding the desired vendor – say a Kaiser HMO.

    Sixth, the current version of “successful” exchanges deals with Medicare Advantage options – open networks, government subsidies, etc. Let’s see whether “private exchanges” without government subsidies and regulations can succeed – and, for whom.

    Seventh, and finally, look for some employers to reposition their coverage to manage cost by managing enrollment – repositioning their plans so that for some, coverage under a spouse’s employer’s plan, a parent’s plan, a former employer’s plan or a public exchange becomes more attractive – particularly if some or all of the “defined contribution” can be used for other purposes where individuals “opt out”. That is, the investment an employer makes in offering a private exchange suggests a commitment to maintaining health coverage as a rewards priority. We have seen this in the past as an ever increasing portion of the total rewards pie has been spent on health coverage. Will that trend continue or will we see Sein’s law apply: “If something cannot go on forever, it will stop”?