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Gaming the Exchanges

In 1993, the state of Texas built an "Insurance Purchasing Alliance" that was very much like a health insurance exchange. A few years later, it was dead. Cappy McGarr, who ran the thing, explains what happened:

[O]ur exchange failed not because it wasn’t needed, and not because the concept wasn’t sound, but because it never attained a large enough market share to exert significant clout in the Texas insurance market. Private insurance companies, which could offer small-business policies both inside and outside the exchange, cherry-picked relentlessly, signing up all the small businesses with generally healthy employees and offloading the bad risks — companies with older or sicker employees — onto the exchange. For the insurance companies, this made business sense. But as a result, our exchange was overwhelmed with people who had high health care costs, and too few healthy people to share the risk. The premiums we offered rose significantly. Insurance on the exchange was no longer a bargain, and employers began backing away. Insurance companies, too, began leaving the alliance.

Texas wasn’t the only state to see its insurance exchange fail. Florida and North Carolina were also unsuccessful. And California, which had the first exchange (established in 1992) and the largest market, shut its doors in 2006. All these state exchanges failed for the same reason: cherry-picking by insurers outside the exchange.

If Congress now creates new exchanges, as seems increasingly likely, it must prevent this phenomenon by setting two national rules: Insurers have to accept everyone and have to charge everyone the same rates regardless of health status.

Both of those rules are in the current plans (insurers can discriminate based on certain characteristics, such as age, but not on health status), which is good. But there will still be a real effort at cherry-picking. Consider, for instance, this description of Kaiser Permanente's new ad campaign:

Kaiser said its 2008 Thrive campaign will move into new areas, including ... “a robust outdoor campaign throughout Northern and Southern California,” ads that dominate gyms like 24 Hour Fitness (on walls, mirrors, water bottles and yoga mats, for example), a major presence in Vallejo’s Six Flags Discovery Kingdom amusement park, the Olympic ads, election-specific commercials and print ads in venues like Time, Newsweek, Sunset and Cooking Light, said Lisa Ryan, Kaiser’s director of national advertising.

Other countries deal with this problem, too, and they've come up with a solution: risk adjustment. More on that a bit later.

By Ezra Klein  |  October 6, 2009; 3:14 PM ET
Categories:  Health Reform  
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Next: Should America Copy the Dutch?


There are almost 1,400 health insurance companies in the United States.

If you live in California, the most populated state, you have your choice of only 13 of them.

Can you explain why changing this would not be a really HUGE boost for competition?

Posted by: WrongfulDeath | October 6, 2009 3:20 PM | Report abuse

Not only have other countries been doing risk adjustment for years, some insurance plans in this country have done it and self-insured plans with multiple options have been doing it for decades. Not a new concept, eminently doable.

Posted by: scott1959 | October 6, 2009 5:58 PM | Report abuse

I thought the nondiscrimination rules only applied to policies offered to individuals. If they apply to group insurance policies as well, how does that affect the ability of employers to negotiate with insurance companies for lower rates, something which I understand larger employers currently do on a routine basis? If the rates are negotiated, I don't see how you prevent an insurance company from negotiating lower rates for employers who have fewer employees with pre-existing conditions.

Posted by: KennethAlmquist | October 6, 2009 7:06 PM | Report abuse

-Kaiser has a serious problem because it's an HMO and young healthy people tend to gravitate instead to high-deductible plans. In the interest of a more proactive, high-efficiency health care system, high deductible plans should be banned.

-Medicare already does some risk adjustment. It is an imperfect system. The main selling point: it's so administratively cumbersome that it discourages smaller less-integrated providers.

-You're never going to get rid of cherry-picking completely. It occurs even at the level of the doctor's exam room. However it's going to get much worse under Obama's plan if any of the cost controls are ever allowed to take effect. A single payer system is by far the best for coping with the cherry picking problem.

Posted by: bmull | October 6, 2009 8:06 PM | Report abuse

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