Designing the New Health Insurance Exchanges

“State officials worry that sick people will gravitate to the [new health insurance exchanges established under the Affordable Care Act], while healthier people who do not need subsidies will buy insurance outside [them],” the New York Times noted on Saturday.  Such an outcome, known as adverse selection, could ultimately drive up the cost of coverage in the exchanges significantly and threaten their long-term viability.  A report from Health Policy Analyst Sarah Lueck explains how states can design their exchanges to minimize the risk of adverse selection.  The introduction to that report is below; you can read the full report here.

The health reform law (the Affordable Care Act) relies primarily on states to establish health insurance exchanges — marketplaces that provide affordable, good-quality coverage options to individuals and small businesses. But it gives states substantial flexibility in how they structure the exchanges. This paper recommends four steps that states should take when setting up their exchanges to minimize the risk of “adverse selection,” which could prevent the exchanges from operating effectively and which has been one of the principal reasons that some past state-based exchanges have been unsuccessful.

Adverse selection — the separation of healthier and less-healthy people into different insurance arrangements — will occur if a disproportionate number of people who are in poorer health and have high health expenses enroll in coverage through the insurance exchanges, while healthier, lower-cost people disproportionately enroll in plans offered through the individual and small-business markets outside the exchanges. If that occurs, the cost of exchange coverage will be higher than the cost of plans offered in outside markets. That would drive up costs not only for consumers and small firms purchasing coverage through the exchanges, but also for the federal government, which must provide premium subsidies to enable low- and moderate-income people to afford coverage in the exchanges.

Higher premiums would depress participation in the exchanges by individuals and small businesses, particularly by those people and firms that can obtain better deals in outside markets. That, in turn, could raise premiums even higher in the exchanges and could ultimately result in their failure over time.

While the health reform law contains provisions to help guard against adverse selection, states can provide further protection by undertaking several actions that the health reform allows but does not require them to take:

• making the rules for any insurance markets outside the exchange consistent with the rules that apply inside the exchange;
• requiring insurers to offer the same products inside and outside the exchange;
• merging the individual and small-group markets over time; and
• ensuring that risk-adjustment and risk-pooling requirements work effectively.