What Flexibility? Debunking the Myth of the Free-Market Health Exchange

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A vast number of new federal healthcare regulations are introduced in  the Patient Protection and Affordable Care Act (ACA), most of which  will be enforced through state or federally run health exchanges. The  harmless public face of these health exchanges is a web-based  “marketplace,” in which the uninsured and small businesses can shop for  health insurance plans selected for sale by the government. Behind  agency doors, however, these exchanges will act as the primary regulator  of the insurance industry within states, approving or rejecting health  plans, overseeing new rate and coverage requirements, doling out health  insurance subsidies, and enrolling consumers in whichever government  program they are eligible for.

As originally introduced by the US  House of Representatives, ACA would have established a national health  exchange, in which federally approved plans would be offered to  consumers nationwide. The law was altered to allow states to establish  their own exchanges in the US Senate, in light of concerns about the  capacity of the federal government to regulate the insurance market in  each state without local knowledge. As the law reads now, each state  must either establish its own exchange by 2014 or allow the federal  government to do so in its place.

While this looks like a  compromise for federalism, states shouldn’t be fooled: very little  flexibility in structure – and almost no flexibility in regulatory  policy – is available within “state” exchanges under the requirements of  ACA. For the dubious pleasure of administrating and funding their own  exchange, states can enjoy such “flexibilities” as website design, call  center hours, board membership eligibility guidelines, and the choice of  whether to incorporate with an existing state agency or fund and  empower a nonprofit with the same service requirements.

States can  also choose whether to make their exchanges a “clearinghouse,” in which  every health plan that meets ACA’s stringent regulatory requirements  for insurance plans will be offered, or they may interfere even more in the market by adding further participation requirements of their  own. In the latter case, the state exchange will operate as an “active  purchaser” that “negotiates” directly with insurers by offering deals to  insurance companies to enter the market in their states.

Suffice  it to say, no room for free market experimentation exists between those  two equally intervention-heavy options. Whichever type of exchange they  choose, states will have no flexibility to accept or reject specific ACA  market “reforms” like guaranteed issue, community rating, and minimum  coverage requirements, the pervasive effects of which are outlined  below.

In plain terms, since the federal government doesn’t have  the resources to regulate the health care market directly in each state,  they’ve chosen to compel states to regulate their markets the way the  federal government has decided they ought to. The “flexibility” that  states have been told they will enjoy if they choose to set up an  exchange is a carrot hiding a stick.

While states are not  technically required to set up a health exchange of their own, they are  encouraged to do so by generous federal establishment grants and the  knowledge that, if they decline to establish one, the federal government  will set up an exchange for them.

Certain policymakers seem  convinced that so long as the health exchange is technically “run” by  the state, they’ll be able to convince South Carolinians that it isn’t  an Affordable Care Act exchange, or design the state exchange to have  minimal effects on the market. This claim is patently false. There is no  true flexibility within the federal law for states to run or operate  exchanges “their own way.” While policymakers may hope that they’ll  retain some control over the health insurance market in their states by  setting up state exchanges, in point of fact, they’ll only take on all  of the regulatory and administrative burdens imposed by ACA, while tying  their political fortunes to the most deeply unpopular piece of  legislation in recent memory.

The best thing South Carolina can do  now is shift our energy and focus to genuine health reform, by pursuing  better health outcomes and cost controls, and not the bureaucratic  shuffle of epic proportions proposed in the Affordable Care Act. Little  energy has been focused on this goal so far, however, because a myth has  been perpetuated among policymakers that genuine health reform can be  accomplished with the “right” kind of exchange.


The  unfortunate truth is that there is no “right” kind of exchange. The  model’s first test run in Massachusetts (“Romneycare”) has been an unmitigated disaster,  with a rapid, unexpected rise in premiums across the state, failure to  provide much-promised universal coverage, and reported 30-45 day wait  times for appointments with primary care physicians. The Beacon Hill  Institute reports that the state of Massachusetts created over 18,000 fewer jobs in 2010  than it would have had the law not been enacted, in addition to  suffering investment losses of twenty to thirty million dollars. Even  Governor Romney himself has stated publicly that he would order the US  Director of Health and Human Services to issue a waiver exempting all  fifty states from ACA’s requirements, should he be elected President.

Even  the arguably more free-market friendly health exchange in Utah has  suffered since its inception, with participants enrolling far below  expected totals. As of this June,  only 2,793 individuals participated in Utah’s health exchange,  including 112 small businesses – lackluster numbers, considering that  the exchange was established in 2009. Despite some initial enthusiasm,  enrollment had dwindled to 13 businesses at the end of that year.  Contrary to the expectations of the health exchange planners, insurance  plans offered inside of Utah’s exchange ended up being more expensive  than those offered outside of it. Instead of admitting failure, the  state simply mandated that plans inside the exchange be offered at the  same price as those outside of it, essentially transferring the premium  increase of the exchange-specific policies onto the entire private  health insurance market of Utah. And that’s the “free-market” version.

Of  course, neither the Massachusetts nor Utah exchange would fit into  ACA’s requirements, even if either of them worked as intended. As the  law is currently written, ACA does not empower states to decide which  policy reforms will best combat the problems in their insurance markets.  Instead of allowing them to choose which health care reform strategies  are appropriate for their unique circumstances, the law insists that  states adopt whatever “one size fits all” approach to market  intervention that the federal government has decided is best. Even if  this were constitutional, it would still be bad policy: state insurance  markets differ widely, and no single set of policies could have the same  kind of effect on all of them. Control of the “structure and  governance” of exchanges, as described by the US Department of Health  and Human Services, is totally insignificant in light of the regulatory  policies that state exchanges will be required to enforce on the federal  government’s behalf.

Below are brief descriptions of what market “reforms” ACA requires states to implement for plans within exchanges, regardless  of whether the state’s exchange is locally or federally run. With the  exception of minimum coverage mandates, even private health plans  offered outside of exchanges will be subject to these policies, an  unprecedented regulatory intervention in the private health insurance  market.

  • Community Rating: Community rating  is a standard for health insurance premium pricing that dictates that  every member of a plan – regardless of their health status or risk level  – pay the same premium. Future premiums will differ only according to  geography and whether the plan is for an individual or family. This  vastly increases the cost of health insurance for young and middle-aged  healthy individuals, leading many of them to drop out of the market altogether in a process called adverse selection: the young and healthy who enroll  in plans will be paying for far more heath coverage than they need in  order to subsidize the costs of providing care for higher-risk plan  enrollees. It’s worth questioning why we need yet another distribution  program from the young to the old, especially when the ones that  currently exist are headed for financial catastrophe.
  • Risk Adjustment: One of the most far-reaching interventions into the private market  under ACA, risk adjustment penalizes plans that have proportionately  low-risk enrollees (like the young and healthy) by transferring money  from them to plans that have high-risk enrollees. This “reform” acts in  concert with community rating to force every health insurance company to  operate off a single model: one that covers the expenses of high-risk  plan members with the premiums of low-risk plan members.
  • Medical Loss Ratio: This “reform” mandates that 80-85 percent of premium payments in health  plans be spent directly on health care costs. While well-intentioned, insurers point out that this kind of interference in their operational budgets could  divert spending from important services like fraud and abuse prevention  and consumer information systems. This type of command-and-control  intervention into the operation of private companies flies in the face  of any concept of free enterprise or administrative innovation, and sets  a very dangerous precedent for the future regulation of other  industries.
  • Guaranteed Issue: Guaranteed issue  mandates that insurers accept every employer and individual that applies  for coverage, regardless of their health status. While health insurance  should be accessible to all, guaranteed issue prevents health insurers  from targeting specific segments of the market by tailoring plans to the  needs of individual consumers. It also incentivizes consumers to wait to purchase health care until they become sick, since no insurer can deny coverage for pre-existing conditions.
  • Minimum Coverage Mandate: Though these regulations have yet to be released in full, the US  Secretary of Health and Human Services will decide what coverage  elements must be included in health insurance plans, and pass those  dictates down to the states. States can only escape this mandate by  applying for a waiver, which is granted at the Secretary’s discretion.

Community  rating and guaranteed issue gut the ability of insurers to manage risk  and remain solvent without government subsidies. Most experts, including  the Congressional Budget Office,  agree that the new group rating and risk adjustment requirements in ACA  will increase the overall cost of health care premiums. These policies  in conjunction with higher premiums will create a series of perverse  incentives for both consumers and insurers, in which insurance companies  chase after federal subsidy dollars instead of consumer satisfaction,  and consumers have to choose government plans to enjoy an affordable  premium rate.

The federal government will attempt to “shield”  consumers from these premium increases by providing direct subsidies to  those making up to 400 percent of the federal poverty level, which will  be passed out through exchanges. As we’ve previously written,  this range includes nearly 60 percent of South Carolina’s entire  population. Regardless of how high premiums rise, the amount of money a  consumer pays for health insurance will be limited to a certain  percentage of his or her income, with tax dollars covering the rest. In  order to be eligible to receive these subsidies, exchange participants  will have to select from among plans approved for sale by the  government.

These subsidy “incentives” will naturally cause many  employers to cease to offer coverage for those employees that are  eligible for them. Why would an employer spend its money providing  affordable health coverage when the government is required to do so by  law? Whatever fines those employers might face for not insuring their  employees will be dwarfed by the higher premium costs inherent in the  new market model, making it a perfectly rational (if unethical) decision  for them to cease to offer coverage plans for their employees. Other  employers will simply increase the employee share of premiums.

The  fundamental problem with ACA and the health insurance market can be  described in a simple analogy. While the reforms outlined above may  “control” prices, they do absolutely nothing to control spiraling costs,  which is the single biggest issue in the health care market. Let’s  imagine that the government “subsidized” and “regulated” consumer  products this way:

The government sets the price of corn at $1 an  ear, then refuses to allow any farmer to charge more than $1.10 for a  head of corn without investing additional money in each ear. However,  the fertilizer, farm equipment, and farm labor companies can continue to  raise the prices they charge to farmers with impunity. Normally, this  would increase the price of each ear of corn, since the farmer would  have to spend more money to produce it. If corn became too expensive and  people stopped purchasing it, both the equipment manufacturers and the  farmer would have every reason to lower their respective  prices. Under the new “reformed” system, the price of corn will stay  absolutely fixed at $1, and the additional costs incurred by farmers  when producing it will be “covered” by federal subsidies. If the price  of each ear of corn is $2, the government will pay $1 for each ear  purchased; if the price of corn is $3, the government will pay $2 for  each ear, and so on. In this case, the government has controlled the  “price” of corn, but done nothing about its cost – and that cost will ultimately be borne entirely by taxpayers.


Let’s  move on to the fallacy of creating a state health care exchange that  operates “our way.” A number of policymakers (including those who claim  to favor small government) appear to be under the impression that it’s  possible for states to create a “minimalistic” exchange, which adheres  to federal guidelines without interfering too much in the market.

While  state exchanges will enjoy some latitude in defining how their agencies  relate to one another and work with existing health care institutions  (like hospitals and insurance companies), the state does not have the  authority to define the minimum requirements for a Qualified Health  Plan, the cornerstone of ACA’s intervention in the market. In essence,  state exchanges will act as enforcers for the federal reform regulations  described above, and their “flexibilities” will only be positive.  States can add more regulations that Qualified Health Plans offered must  meet to participate in the exchange, but they can’t take any of the  federal requirements away.

So that rules out the minimally  regulatory option. But there isn’t an option to provide minimal services  within an exchange available to state lawmakers, either. Below are the minimal federal requirements that a state health exchange must perform to comply with ACA:

  • Design and maintain a web portal that compares all Qualified Health Plans
  • Staff and establish a call-in support center
  • Certify and approve or deny Qualified Health Plans for participation
  • Oversee the financial solvency of insurance companies
  • Make “health quality assessments” of each Qualified Health Plan
  • Determine eligibility for government programs and subsidies
  • Enroll applicants in Qualified Health Plans or government programs

Contrary  to common references to the “minimalistic” or “Utah model,” any  exchange that meets the above requirements could hardly be considered  free-market, autonomous, or minimalistic.

Despite how close the  2014 deadline looms, the DHHS has not yet released all of its  regulations regarding state exchanges, and more flexibility could  certainly be added as states push back against these requirements. For  now, however, it seems impossible to imagine how states could genuinely  “experiment” within exchanges that are so heavily regulated by the  federal government.


The most important  thing to understand about health exchanges is that the very concept of a  “free-market” exchange is a contradiction. A free market is a market in  which businesses tailor their products to the desires and budgets of  their consumers: health insurance products offered within government-run  health exchanges are built to the government’s specifications alone.

Newly-released  federal regulations encourage state exchanges to “maximize enrollment  of eligible individuals into [Qualified Health Plans] to increase QHP  participation and competition, which in turn increases consumer choice  and purchasing.” Quite to the contrary, actively recruiting consumers to  enroll in government-run, heavily subsidized exchanges that only offer  the products of favored insurers will hardly “increase competition.”  When the state picks winners and losers in the health insurance market,  while offering generous subsidizes to consumers who enroll in their  chosen health plans, the competitive deck is stacked so heavily in favor  of government-favored health insurers that others may as well not enter  the game.

Most private health insurance markets within states are  already dominated by a single insurer in control of over 50 percent of  market share. South Carolina’s biggest insurer already controls over 65  percent of the entire market. If small insurance companies are prevented  from offering flexible, competitively priced, consumer-oriented plans,  the private market is highly unlikely to become more competitive.  Community rating and guaranteed issue in particular make it impossible  for insurers to target particular segments of the market, making the  only solvent and profitable health insurer an insurer that can afford to  insure all applicants. This insurer will almost always be the biggest  insurer around, with the largest pool of consumers to distribute risk  between. It doesn’t take an economics degree to predict that, when the  law is implemented, whatever insurer currently occupies that position  within states will enjoy an even less competitive market to dominate.

Any  hope of a truly competitive health insurance market rests on the  ability of insurers to offer plans that are priced differently, offering  different coverage, appealing to different segments of the market.  “Minimum” coverage mandates, rate review, and community rating policies  make that quite impossible, and any hope that insurance companies could  offer more competitive policies outside of the state exchanges is  thwarted by the requirement that within-exchange plans be offered at the  same premium rate as those outside of it.

Under the Affordable  Care Act’s requirements and policy mandates, the federal government will  interfere heavily in the operation and structure of health insurance  companies, and provide subsidies that cause health insurance companies  to compete for the government’s business instead of yours. This is an  unavoidable consequence of either a state or federally run exchange.  Does that sound like a free market option to you?

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