Health Insurance Exchanges: A Race To the Bottom

President Obama says that his health plan's popularity will grow once its provisions start being implemented. But peculiar rules tucked into the legislation are likely to make the entire scheme even more disliked as its implementation approaches.

At the heart of the Obama plan are 50 state-based exchanges where insurers will be able to sell health plans inside new marketplaces. The health plans that insurers market will have to comply with a strict set of government rules on the minimum benefits that they need to offer, and the amount of money that plans can spend on overhead and take for profits. These rules aren't out yet, but most observers expect them to be rigid. This ensures that health plans will operate on tiny profit margins.

The lure is that families of four earning less than about $90,000 annually will be able to get a federal subsidy to purchase insurance inside these exchanges. The size of the subsidy grows as peoples' income level declines -- not in a smooth fashion, but jumping up a few thousand dollars each time people pass through key income levels.

The problem is that the actual insurance that health plans offer may be fairly lousy -- perhaps just a little better than the typical managed care plan offered under Medicaid. That's because of the way these insurance products are going to be regulated, and the way they will be priced under the federal scheme.

The government is certain to mandate that the plans offer a fairly complete package of primary care benefits. But history has shown that these sorts of mandates drive up coverage costs. Yet the actual money that the plans will be able to receive to cover their expenses will be tightly controlled, limited, and will shrink over time.

So to afford the mandated benefits, health plans will have to shave other costs. They'll do this the same way the Medicaid managed care plans deal with similar government rules - by offering very narrow networks of providers that patients can see. Or by cutting what health plans pay for services, even if it leaves beneficiaries with fewer providers willing to offer them access to medical care.

All of this is a consequence of the Obama plan's singular focus on making sure that health plans operate on tiny profits, becoming low-margin service providers to the federal government. To see how this plays out, compare one way that the Obama plan designs the new health plans with the way that the Medicare drug plans were established under the 2003 Medicare Modernization Act.

Under Medicare's Part D drug program, the actuarial value of the drug coverage is calculated off a blended average of how all of the plans in a market are priced. This figure is then used to determine how much the government subsidizes the cost of peoples' drug coverage.

The average cost of a plan is chosen to make sure that the subsidies Medicare will pay aren't too rich to enable plans to earn windfall profits, but not so small that Medicare forces plans to slash benefits or fold their businesses. No surprise, the profit margins of the nation's more than 1,000 Medicare drug plans have reverted to a narrow mean.

Under the Obama health plan, insurance coverage will be priced off the second cheapest plan in each market. It was designed this way to save money. But it means that over time, insurance products get successively priced each year off the cheapest, and likely the lousiest health plan in a particular market. As a result, the actuarial value of all of the plans in a market could gradually decline, along with their quality.

This isn't an insurance marketplace. It's a race to the bottom.

There are other peculiar provisions in the Obama health plan that could leave consumers smarting. Perhaps none is more ominous than the "claw back."

This is a provision that lets the government reclaim some of the subsidy a person receives if their income goes up more than they expected. The subsidies are paid at the beginning of a year. Income is tabulated at the end of a year. So if someone gets a subsidy priced off a lower estimated income than what they actually earned, they could find themselves owing back more than a little extra income tax at the end of the year.

These are just some of the oddball provisions in the Obama health plan that will lead to distorted markets and unkind experiences. Proponents of the healthcare plan argue that its popularity will grow as its provisions become manifest. In the end, they may simply be glad that they pushed off its implementation past the election.