Revised February 5, 2002

Health Insurance Proposals in Administration's Budget
Could Weaken The Employer-Based Health Insurance System

by Edwin Park

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The Administration's fiscal year 2003 budget released on Monday includes a number of health insurance initiatives, for which the budget allocates substantial resources. Both the principal such initiative and one other significant initiative, however, would be of questionable effectiveness and could materially weaken the conventional employer-based health system through which the large majority of insured Americans obtain health coverage. The two proposals that would pose risks to the employer-based insurance system are:

The Administration also is proposing to extend for four years the time during which states can use funds provided to them under the State Children's Health Insurance Program (to prevent these funds from reverting to the Treasury) and to extend for one year the Transitional Medical Assistance (TMA) program, which provides health insurance to many families that leave welfare for work. These proposals are welcome, but each of them is likely to be inadequate. Because of insufficient federal funding, the number of people insured through SCHIP is currently projected to drop by 900,000 between 2003 and 2006. The Administration SCHIP proposal does not provide any additional federal resources beyond the extension of expiring funds, and would not by itself be sufficient to avert all of this large enrollment decline.

The proposal to extend Transitional Medical Assistance for only one year is puzzling, since this is a well-established program that is an integral part of welfare reform and has been in existence since 1988. The Administration had been expected to propose continuing this program for the same duration of time for which it is proposing to extend the welfare block grant. Since it is virtually unthinkable that Transitional Medical Assistance will be allowed to die after a year, the Administration's failure to include in the budget an extension for TMA for more than one year appears to be a budget gimmick designed to make federal expenditures appear lower in years after fiscal year 2003 than they actually will be.


Tax Credit for the Purchase of Health Insurance in the Individual Market

The Administration is proposing to provide a refundable tax credit to individuals and families not participating in employer-based health insurance or public health insurance. Families with two or more children could receive a tax credit of up to $3,000 annually to pay for health insurance primarily in the non-group market, so long as the subsidy does not exceed 90 percent of the premium cost. Individuals could receive a credit of $1,000. (The tax credit also could be used for health insurance purchased through private purchasing pools or state high-risk pools where such pools exist). The credit would not be available to families with incomes above $60,000, and the subsidy would begin to phase down once a family's income reached $25,000. (Similarly, individuals making $30,000 would not be eligible for the credit, with the subsidy beginning to phase out when an individual's income reached $15,000.)

Under the proposal, the credit could be issued in advance (rather than waiting until a family or individual filed a tax return after the year was over); insurers would reduce the premium cost by the size of a family's credit and be reimbursed by the federal government. States would also have the option of letting certain tax credit recipients purchase coverage in their Medicaid or SCHIP managed care plans (or through their state employees' health plan if no managed care plans are available), but there would be no requirement that states do so.

Intensifying the risk that many firms might not offer coverage is the recent return of a high rate of inflation in health care costs, which are now rising at double-digit rates in many areas. Institution of the tax credit could provide a rationale for some employers seeking to cut costs to drop or not to institute coverage.

How A Tax Credit for Health Insurance In the Individual Market Could Undermine
Employer-Based Coverage: A Simplified Example

Assume a company provides a comprehensive health insurance plan to its two employees. John is a 28 year-old man with a healthy family of three. The cost of a family coverage plan for John through the employer-based system would be $3,000. Mary is a 45 year-old woman with a family of three that has a history of chronic, serious medical problems. The cost of a plan for Mary is $12,000. However, because both workers are in the same health insurance pool, the health insurance cost through the company averages to $7,500 a year. Since the company subsidizes 80 percent of the cost of health insurance, it would contribute $6,000 per year for the cost of health insurance and the workers would pay $1,500 a year.

If John instead buys health insurance for his family in the individual market, he might be able to purchase a policy that costs $3,600. (This is a little more than the cost of a plan in the employer-based system, since individual insurance is usually more expensive than employer-based coverage for the same level of coverage.) Because he and his family are in excellent health, they can obtain a policy in the individual market. Under the Administration's proposal, with a tax credit of $3,000, John can save $900 a year by dropping his employer-sponsored plan and buying a plan in the individual market. (His net cost is $3,600 minus $3,000, or $600, while he currently pays $1,500 for his employer-based plan.)

But if John drops out of his employer's plan, then only Mary is left in her company's health insurance pool and the average cost of insurance for the firm rises from $7,500 to $12,000. If the company continues to subsidize 80 percent of the costs of health insurance,, the employer contribution toward her insurance would rise to $9,600 because John is no longer available to bring the average cost of insurance down. Accordingly, Mary's premium would rise from $1,500 to $2,400. It is likely that Mary would be unable to afford this higher premium and continue to participate in her employer's health insurance plan. She and her family could be eligible for a $3,000 tax credit to buy health insurance in the individual market. However, because of her family's medical history, she may be denied coverage entirely or face unaffordable premiums, even with the tax credit.

On the other hand, Mary's company may be unable to increase its contribution to the costs of health insurance. It might balk at increasing the company contribution by $3,600 per year (making it more likely that Mary would be unable to afford the employee contribution) or decide against offering health insurance altogether, knowing that Mary has the tax credit available to purchase coverage in the individual market.

In this very simple example, John has used his tax credit to buy insurance in the individual market but since he already had insurance, there is no net reduction in the number of uninsured people. On the other hand, it became much harder for Mary and her family to retain their job-based insurance once John was no longer part of her insurance pool. She might end up losing her coverage because her company's premiums became too expensive or her company decided to no longer offer health insurance. Because of her family's medical history, Mary may be unable to find affordable insurance in the individual market and she and her family could become uninsured.


Expansion of Medical Savings Accounts

Established under a limited demonstration project scheduled to expire at the end of this year, MSAs are tax-advantaged personal savings accounts available to the self-employed and employees at small businesses who are covered by high-deductible health insurance policies. Funds in MSAs may be used to pay for a wide range of out-of-pocket health care costs. They also may be retained in the MSA accounts and placed in investment vehicles such as stocks and bonds, with the investment earnings accumulating tax-free in the accounts. The funds may be withdrawn for non-medical purposes upon retirement. As a result, MSAs can be used as a tax shelter.

Despite the findings of an array of analyses by respected research institutions that widespread use of MSAs could destabilize the health insurance market (findings the demonstration project has failed to dispel), the Administration is proposing a package of MSA changes that have long been pushed by insurance companies that sell MSA policies and conservative policy institutions. The Administration proposes to repeal most current protections and limitations on MSAs, to make MSAs more lucrative as tax shelters for affluent, healthy individuals (and hence more attractive to such individuals), and to allow unlimited expansion of MSAs across the country. The risks of such a course are great.


Other Health Insurance Proposals

The Administration's fiscal year 2003 budget also includes several other health insurance purposes. These proposals are more beneficial.

The first such proposal would extend until 2006 the availability of more than $3 billion in funds that have been provided to states under the State Children's Health Insurance Program (SCHIP) but have not yet been spent. Under current law, states that receive unspent SCHIP funds that have been reallocated from other states must return those funds to the U.S. Treasury if they do not use them within a certain period of time, usually one year. Because of a mismatch between the time when the unspent funds have been reallocated to states and the time when a number of the states that have received these funds will need them, some states will not be able to use all of the reallocated funds within the required timeframe. Some $700 million of these funds are expected to revert to the Treasury at the end of this fiscal year, and an additional $2.3 billion are expected to revert at the end of fiscal year 2003. Yet state SCHIP programs will badly need these funds in years after that.

An analysis the Office of Management and Budget conducted last year projected that if more SCHIP funds are not made available, states will act within a few years to reduce by 400,000 the number of children they insure through SCHIP. In the budget released today, OMB has updated this analysis and now projects that in the absence of more federal SCHIP funds, enrollment will be reduced by 900,000 between 2003 and 2006.

As noted above, the second helpful proposal would extend for one year the Transitional Medical Assistance (TMA) program. TMA is scheduled to expire at the end of the current fiscal year.