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Why the individual market doesn't work


The graphic above comes from a survey the Kaiser Family Foundation conducted among adults who purchase health coverage on the individual market. What the survey found was a broken market: People with health insurance don't think they can shop around to buy new health insurance because they or someone in their family has a preexisting condition and the market is too complicated. And if people don't feel able to shop around, the market doesn't work.

The good news is that the Affordable Care Act actually solves these problems: Preexisting conditions are no longer relevant and the exchanges make for a much more straightforward shopping experience. The bad news is that it's still a few years away.

By Ezra Klein  |  June 21, 2010; 2:40 PM ET
Categories:  Health Reform  
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Here are my questions, Ezra: First, with the 3:1 age, 1.5:1 smoker rating, requiring 20-something bachelors buy significantly more coverage and a significantly higher rate than they are current paying (A 64-year-old male on average has medical costs 5-7 times that of a 24-year-old male. For women, I believe this ratio is 3:1.), how will the paltry individual mandate penalty not lead to an adverse selection death spiral? Won't this just again price people out of health insurance as they won't have the cross-subsidy from young, healthy people.

Second, by making employer participation in the Exchange voluntary, how are you going to prevent firms with healthier workforces from being more likely to continue offering health insurance to their employees while those employers who have more trouble getting health insurance from being more likely to dump their employees onto the Exchange? And how does this not create an adverse selection death spiral?

It seems to me in order to prevent the Exchange from becoming a dumping ground for employers with older, sicker workforces, you either have to (1) require all firms having under 500 employees to dump their employees on the Exchange or (2) replace the employer tax exclusion with a tax subsidy to purchase health insurance on the Exchange and only on the Exchange.

Posted by: moronjim | June 21, 2010 3:08 PM | Report abuse

And of course, the disadvantage of the community rating, is that it encourages moral hazard. Someone who doesn't exercise or eat vegetables will be discouraged from doing so under the community rating since he/she will still get the same rate as the person who does exercise and eat healthy.

At some point, you have to make a value judgement of whether not rewarding undeserving people (which the community rating does) outweighs punishing people because of their circumstances (which the individual insurance market and "prevention and wellness" discounts do). No economic textbook can teach this. I side with Ezra and believe that not punishing people because of their circumstances outweighs not rewarding undeserving people.

Posted by: moronjim | June 21, 2010 3:19 PM | Report abuse

The number 2 and 4 reasons listed are the inability to find a better price or coverage. That doesn't mean it is difficult to switch, it's just means you don't want to.

Posted by: MrDo64 | June 21, 2010 3:57 PM | Report abuse

moronjim, very good points. I'd also add that Ezra is quite mistaken about how much better things get under PPACA. The design of the subsidies, tax credits, coverage requirements, employer vouchers, employer penalties, etc, all make it very confusing to understand. By request from upper management I've spent a great deal of my work time over the last few months becoming the resident expert on all of the new rules, and even for someone like me who knows this market really well it was very confusing. The average Joe is never going to understand all of this.

And what's more is there is a whole new set of perverse incentives created by these new rules. The average employer cost per employee fluctuates wildly based on average employee income, number of employees, cost of coverage, etc, because the various rules do not always line up that well together to make a smooth curve. Helping employers navigate this market is going to create a whole new market for employee benefit consultants and/or insurance agents to help them navigate the laws (In fact I am seriously considering doing some moonlighting on the side helping employers figure out the tax credits that start this year, I just need to figure out if I'd be doing anything illegal since it's essentially offering tax advice and I'm neither an attorney nor an accountant).

A side effect of these perverse incentives will be a lot more employers dumping employees onto the exchange when it makes financial sense to do so, and the government will be selected against in that regard. It's not all that difficult to create a simple spreadsheet to model the costs and figure out the optimal employer behavior, and of course optimal for the employer means worst case for the government, which is going to blow the CBO projections to hell.

All of this of course is more about the employer market, but right now things are pretty easy for people with employer coverage. They don't have to shop for insurers and compare plans. But a lot more of them are going to get dumped on the individual market now, so while that market might be a little easier than the current one, it's still tougher for these people than the employer coverage they have now.

Posted by: ab_13 | June 21, 2010 4:27 PM | Report abuse

I am surprised that such a small number of the respondents blamed lack of choice for the reason not to switch. In my state, the number of providers for individual plans can be counted on the fingers of one hand. As a result, folks here tend to shop, find the best value for their individual needs, and then feel locked in.

Posted by: Patrick_M | June 21, 2010 4:41 PM | Report abuse

The reason that the individual market doesn't work is not because it CAN'T work, it's because the rules are set up for it to fail. We have an employer-based health care system, which makes individual markets smaller and less efficient than they would be in the absence of such a system. To suggest that an individual market cannot work in health care, the way it does in auto insurance, homeowner's insurance, or any number of other products is just silly.

Posted by: MDA123 | June 21, 2010 4:42 PM | Report abuse

I fail to see why not being able switch insurers due to pre-existing conditions indicates the market is "not working". Is the market for life insurance broken because you can't switch policies after you get terminal cancer? Is the market for homeowners insurance broken because you can't switch policies while your house is on fire?

Posted by: ab_13 | June 21, 2010 5:12 PM | Report abuse

ab_13, excellent analysis!

Your explanation is good reasoning of what has happened here in Massachusetts. I mean -- the prices are just plan outrageous on the Connector. Obviously some of it is mandated benefits. Only in Massachusetts could my aunt's friend be able to afford for all three of her children to be neonatal births as only the Bay State requires coverage of unlimited in vitro fertilization attempts. Even New York doesn't require coverage of IVF (although they do require some infertility coverage).

But on the Connector, a 93% AV HMO policy (Gold Tier) costs a 55-year-old couple with two children anywhere from $1,625/mo. (Tufts) to $2,500/mo (BCBSMA). I mean -- there's no way health insurance costs that much in the large group market here in Massachusetts. I mean -- some employers -- even though only the small group market is allowed on the Connector and the rating rules, minimum benefit packages, etc. are the same in the small group as in the individual market -- there has to be a significant amount of anti-selection against the Connector.

Yeah, for those currently in employer-based coverage who get dumped onto the Exchange, life is going to get much tougher for them even though they'll have far more choices than they currently have simply because the subsidies and the amount done to control all the risk pools (Exchange vs. employer-based health insurance and the plans inside the Exchange) are so inadequate. Risk-adjustment alone won't suffice to ensure the risk-pools within the Exchange won't get out of whack. I mean -- we have to deal with the small problem that those with the most expensive health problems (i.e., Crohn's disease, HIV, diabetes) are likely to select the most generous plans while those who are the healthiest are likely to select the least generous plans.

Posted by: moronjim | June 21, 2010 5:26 PM | Report abuse

again they don't bother to seperate this out by state (which isn't necessarily KFF's fault) but Ezra should note this. Mass for example has NO pre-ex and some other states like my own of NJ have very limited pre-ex. Still they (MA) and we have issues. I think if you're expecting 2014 to be this wonderful, bountiful treasure trove of choices and options you've got another thing coming. Again expectations should be tempered but when they're trying to stay afloat in 2010 and 2012 I doubt that's the road the Dems will take. I'm thinking they're realizing the American people will have a limited memory of their "talk" at this time.

How are those high risk pools coming along? Aren't they due out this week???

Posted by: visionbrkr | June 21, 2010 5:55 PM | Report abuse

ab_13, I think Ezra meant "not fair and just enough" rather than "not working." It's not exactly like you can control whether or not your child has diabetes the way you can control whether or not you take good care of your car. Having diabetes, Crohn's disease, HIV, etc. is just a bit more expensive over one's lifetime than having your house burn down or getting into an auto accident. With life insurance, we already have survivor insurance in Social Security.

Obviously, insurance is different than any other market in that it works because of the failure of the free market.

Health insurance is an even more different animal than all other forms of insurance in that the lower your income, the more insurance you need. Not so with life insurance, homeowner's insurance, auto insurance, etc.

Posted by: moronjim | June 21, 2010 6:35 PM | Report abuse

Agreed with most of the comments here. It isn't a market failure when businesses decide against entering into money losing transactions by paying for pre-existing conditions.

Health insurance isn't even insurance, it's a prepaid expense plan - and if the company offering the plan knows that you are going to spend far more than the initial upfront payment, there's no reason they should offer you that plan.

True insurance would be something much more catastrophic and event driven - you get diagnosed with stage 3 cancer, the claims adjuster comes out, decides that in accordance with your policy you have damage coverage for $250,000, cuts you a check and then goes home. Or you have a heart attack, and that triggers an insurance claim of $40,000. Or your kid was diagnosed with type 1 diabetes and your claim of $300,000 is paid. Now this type of insurance could get complicated with defined benefits for many different diagnoses, and fraud certainly would be an issue, but this would be real insurance.

It would be much more akin to auto insurance, where if you total someone's car a check gets cut based on the damages. An auto insurance plan which mechanics fill to fix damages and to which tire shops send bills for tires and Jiffy Lube sends a bill for oil - after all, we want to encourage regular oil changes because its good for the car - isn't really insurance either.

There might be good reasons to get people on a pre-paid medical plan so that they get regular checkups and their appropriate diagnostic tests, but it isn't insurance. If we are going to do it, we might as well set a fixed proportion of GDP to spend on it, rather than making open-ended promises to pay providers based on services rendered - that's going to drive us to bankruptcy.

Posted by: justin84 | June 21, 2010 6:59 PM | Report abuse

Justin84: It is a market failure when there are externalities (in this instance, community health benefits from having insurance) that the market doesn't account for. There are certainly market failures in the health insurance market, but just not when

Agree with MrDo64 though: people not wanting to switch because they can't find better coverage/price is a good sign.

Posted by: rellojello | June 22, 2010 2:36 AM | Report abuse


See my last paragraph (externalities would fall under one of the 'good reasons' to get people on a pre-paid medical plan).

That said, people not being able to sign up for a new insurance plan for, say, $8,000/yr when their predictable costs to the insurance will be >$8,000/yr isn't a market failure in the traditional sense of the term. Everyone knows when they sign up for insurance that if you get a pre-existing condition that you'll have to deal with that insurer. Sure, you can't switch directly and that might be annoying but you should anticipate actually needing the insurance for serious conditions in advance. It's not a market failure when mid-way through a fire you want to change your homeowner insurance carrier and no one is willing to get onboard.

Posted by: justin84 | June 22, 2010 10:49 AM | Report abuse

Health insurance is, at first, a complex thing, but it doesn't have to be. HealthCompare (the company I work with) has a YouTube channel with lots of videos, explaining the many details of health plans: the types of plan, the types of care, copays, deductibles, and so on. If you take some time to watch a few of these videos, you'll be able to understand what each plan covers. Then you will be in a position to go to, where you can get free quotes for the plans available to you. The "problem" with the market is in the perceived complexity - and the resources HealthCompare provide should make it much more simple.

Posted by: HealthCompare | June 23, 2010 3:02 AM | Report abuse

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