What People Don't Know about Health Insurance Exchange

by Peter Lee


and John Grgurina






Much of the heat so far in the debate over how health care reform will expand coverage to uninsured Americans has been about whether or not there should be a public plan option. That has overshadowed one of the most important issues – how to design effective health insurance exchanges to meet the needs of small employers and individuals.

Both houses of Congress have now proposed frameworks for expanding coverage that rely on exchanges. A health insurance exchange is simply a structured marketplace where people can choose among health plan options. The exchange offers information to help people make informed choices, and it provides administrative services such as simplified processing of enrollment, subsidies and premium payment. This can be of great value to small employers and individuals who don’t have access to employer-sponsored group plans.

Plenty of academic experts have written about the ideal design of an exchange, but we bring a unique, real-world perspective. We know why exchanges have and haven’t worked based on our experience running one of the largest voluntary health insurance exchanges in the country, PacAdvantage, which served over 10,000 small employers in California from 1993 to 2006, at its peak providing insurance for 150,000 enrollees.

Health insurance exchanges can provide huge value, but they are bound to fail if not structured correctly. PacAdvantage, even though it grew to a large size, failed because of what economists call “adverse risk selection” – the same reason similar programs have failed across the country in the past fifteen years. People with higher medical costs enrolled in PacAdvantage, while lower-risk people obtained coverage outside the exchange where they could find less expensive insurance. This drove up premiums inside the exchange, causing healthier people to drop out. This is known in the insurance business as a classic “death spiral.”

We must learn from these lessons in order to avoid the problems that have doomed exchanges in the past. We must design exchanges to be sustainable and prevent them from being relegated to the dustbin of well-intentioned but flawed health reform proposals not anchored in the real world.

What has caused the adverse selection “death spiral” in past health insurance exchanges? In the health insurance market for small employers, insurers usually insist on being the “sole source” for an employer group; insurers feel threatened if employees are free to choose among competing health plans. As a result, insurers often steer lower-risk people to their products outside of the exchange. The exchange is left with higher cost enrollees, which drives up the premiums and creates a death spiral.