A few cautions about exchanges

The health benefit exchanges outlined in the Patient Protection and Affordable Care Act (ACA) are a necessary foundation for market-based reform of the health care financing and delivery system.

At least in theory, exchanges embody the type of market structure that I termed “managed competition” in 1986.  In such a market, individual, informed, cost-conscious consumers drive the system to produce ever-increasing value for money.  Individual choice, as opposed to employment group choice, is necessary because many efficient delivery system models limit choice of providers to those on their teams.  Because consumers understandably want to choose their own doctors, they must be allowed to choose their own health plan, which includes the doctors they like.

The dominant method of provider payment for most of today’s health plans is open-ended fee-for-service (FFS) – “open-ended” because it leaves patients and providers with the sense that there is no limit on health care resources, no budget, no reason to use less costly methods of care.  This type of payment rewards providers for volume of services, whether needed or not, but not for quality and superior outcomes.

The transition to exchanges and managed competition is needed to give consumers an opportunity to switch – if they choose – from health plans that use traditional, inflationary, fee-for-service payments to those that work with “accountable care organizations.”  As the name implies, these delivery system organizations can be held accountable for the total cost and quality of care for their patients and, in a competitive market, have incentives to improve both.  However, the great majority of employed, insured Americans do not have a choice between fee-for-service providers and accountable providers that allows them to keep the savings if they choose a higher-value provider.  (Some employers—the federal government, a few states and universities, Wells Fargo, and Hewlett Packard, to mention a few—do offer such a choice.  Their experience is that most people migrate to value for money when given a cost-conscious choice.)

The opportunity for delivery system reform through cost-conscious consumer choice is particularly promising in California where we have Kaiser Permanente and more than 200 multispecialty group practices and IPAs, marketed by seven HMO plans under the “California Delegated Model.”  This model has not been as effective as needed to bend the cost growth curve because doctors’ incentives are not often fully aligned with the desires of patients for high quality, affordable care, and patients are often locked into FFS providers by their employers.

While I am a long-time proponent of exchanges as a tool to improve health plan and delivery system value, it is important that the concept be implemented correctly.  I note some areas of concern regarding the exchange provisions of ACA and in the recently enacted California law.

• Total Membership. For exchanges to reform the delivery system, a sufficiently large percentage of the population must be covered through an exchange, or through other employers that sponsor managed competition, forcing providers to organize and compete to serve them.  Nobody knows exactly what percentage that is.  In Dane County, Wisconsin (Madison), 25 percent of the non-Medicare, non-Medicaid market is covered through the state employees managed competition model, in which four non-profit delivery systems compete.  The growth rate of spending relative to the rest of the state has visibly slowed, although not by enough to approximate the growth rate of the GDP.  For that to happen, most of the health care system must be in a regime of cost-conscious choice of health plan/delivery system. The Congressional Budget Office estimates that by 2019, 24-30 million people will be covered through exchanges created by the ACA.  I believe a much larger number is needed to motivate most providers to form accountable care organizations and to compete on value – probably a majority of the population.  Once the ACA subsidies for low and middle income people are in place, many employers will be tempted to drop health insurance altogether and send their employees to the exchanges.  Others will be tempted to outsource the services of low paid people to firms that do not provide health insurance, letting those people buy through exchanges and be subsidized, too.  If this happened on a large scale, it would greatly increase the number of people buying through exchanges.  It would also greatly increase the cost to the federal budget, an eventuality not included in the CBO estimates of the cost of ACA.
• Employment-Group Size. The legislation provides that states can open exchanges to employment groups of up to 100 employees (and even larger later on) on a voluntary basis. The problem with such voluntarism is that it could open the exchanges to massive adverse selection, as the groups that join first will be those with the highest medical costs.  To spread the risks evenly, it would have been better if all groups of up to 100 employees had been included from the outset, with strong tax incentives to join (as proposed in the bipartisan Managed Competition Act of 1992); that is, mandatory participation for all small groups that want to continue to receive a federal tax subsidy.
• Permissible Choices. Americans, including myself, believe in individual choice. “Don’t fence me in” is a part of American culture.  However, in health care, the issue of “choice” is complex.  Take individual choice of benefit levels (the percentage of total costs an insurance policy is expected to pay). The ACA requires exchanges to offer individuals an array of plans, covering varying percentages of total costs.  At first blush, this requirement is attractive from the point of view of individual choice, but it will complicate the risk selection problem.  The scheme is reminiscent of the Federal Employees Health Benefit Plan in its early days, when it offered employees a choice of Blue Cross Blue Shield high- and low-option plans, differing in cost-sharing.  Predictably, the high option suffered severe adverse selection and had to be replaced by a “standard” option.  It may be feasible to manage individual choice of benefit levels with risk adjustment, but I have doubts.  People will switch plans opportunistically when they expect higher medical costs in the next year.  Further, some apparently healthy, low-income people are likely to choose the lowest benefit level to get the lowest premium, taking a great risk of being unable to afford their out-of-pocket costs.  A narrower range of benefit level choices would mitigate this problem. While it may be wise to limit choice of benefit levels, I believe exchanges must offer individual choice of health care financing and delivery plans.  (Here I am referring to the insuring and associated care delivery organizations, not to choice of different “plan designs” in the sense of PPO versus HMO.)  Choice among delivery systems is necessary to create competition to improve value, but experts disagree about whether the ACA actually requires exchanges to offer this type of choice.  I believe they must.  Elsewhere in the ACA, Congress has recognized that improvement in quality and affordability (i.e., “value”) must come from organized systems of care that take responsibility for managing quality and cost.  To succeed, such organizations must be based on teamwork, aligned incentives, coordinated care, complete and convenient sharing of patients’ medical information, evaluation of outcomes, and feedback of results into decision-making.  Such accountable care organizations, combined with their own affiliated insurance plans, should be offered in exchanges, and employees should have the opportunity to mitigate for themselves the consequences of medical inflation by choosing them.
• Weak Individual Mandate. Another potentially fatal flaw in the ACA which impacts exchange enrollment is that despite a mandate to buy insurance, the penalty for being uninsured is too small relative to premiums.  This mandate may not be strong enough to generate a sufficiently well-balanced risk pool in the exchanges (or in the non-exchange market for individuals, either).  This problem might be mitigated somewhat by limiting guaranteed issue to one standard annual open enrollment period, as is normal in choice-offering employment groups such as the federal government, and in Medicare Parts B and D.
• Poorly Structured Subsidies and Contribution Rules. To achieve the goal of delivery system transformation, it is important that consumers may keep all the savings associated with the choice of a less costly plan and delivery system.  This financial incentive is needed to overcome the costs of switching (including fear of the unknown) and a preference for preserving unlimited free choice of provider.  Thus, employer contributions and public subsidies need to be in the form of fixed-dollar amounts, not more subsidy for more costly plans.  The ACA does not provide any guidance regarding the structure of tax-excludable employer contributions.  The regulations, when issued, should make clear that the federal subsidies are structured as fixed-dollar amounts.
• Problematic Rate Regulation in California Law. The California law enacting the exchange provides that health plans seeking certification to participate must “submit a justification for any premium increase prior to implementation of the increase.”  The Exchange Board will be able to deny access to the exchange for any plan whose increases are considered excessive.  While superficially appealing, conflating the exchanges’ market-making roles and price regulation is not a good idea.  “Justification” suggests cost reimbursement.  Health plan premiums are driven mainly by the costs of providers and consumers’ use of services.  Regulators will have to allow insurers to cover costs with enough left over to maintain reserves.  Such regulation risks bringing in politics: politically disfavored plans won’t get the increases.  Regulators will be blamed for unavoidable increases, but no regulator will want to be blamed for driving an insurance company out of business. The aim of the exchange should be to maximize competition, not to restrict it.  The impersonal competitive market, if properly structured, is a far tougher disciplinarian of price increases than any regulator can be.  (That is why this country abandoned price regulation of airlines in favor of competition.)  What many think of as “the market in health insurance” has not worked because most consumers have not had cost-conscious, informed choice among competing plans.  Exchanges and fixed-dollar subsidies will help.  Beyond that, if the market is not working well, the Board should investigate, determine the causes, and take appropriate action.
• Attack Exchanges to Attack ACA? Many of the newly resurgent congressional Republicans campaigned to repeal the ACA. As long as a Democrat is in the White House, that is unlikely to succeed.  However, some Republicans in Congress may be tempted to attack or impair exchanges because they are part of ACA.  This would be a serious error.  Consumer choice and competition may not be the preferred strategy of most Democrats, but they ought to be the preferred strategy for Republicans who generally stand for decentralized private markets as the best way to allocate resources.

The status quo does not provide us with high-value care.  Lack of competition is a major contributor to the survival of the inflationary incentives of fee-for-service.  Exchanges are a necessary foundation to improve competition as part of a market-based strategy for health system reform.

Alain C. Enthoven is the Marriner S. Eccles Professor of Public and Private Management (Emeritus) at the Stanford University Graduate School of Business.

The opinions expressed in this column are those of Professor Enthoven, and not necessarily those of the Kaiser Permanente Institute for Health Policy, nor Kaiser Foundation Health Plan and Hospitals, nor Stanford University.