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Under Trump, insurance exchanges likely will survive, though economists got them wrong

Ed Lotterman: Real World Economics
Ed Lotterman: Real World Economics

Just before the election, re-enrollment of people insured on state health exchanges established under Obamacare made news. Premiums rose sharply and fewer insurers chose to participate.

Now, with Donald Trump soon in the White House and having GOP congressional majorities, repealing and replacing Obamacare could happen quickly. Trump announced sketchy proposals during his campaign. House Speaker Paul Ryan has had more detailed proposals for some time. Neither would maintain the state exchanges.

However, there are only so many ways to skin the health-care cat. What most Democrats wanted in 2009 was “single-payer” insurance like Medicare. The Affordable Care Act attempted to gain GOP support by adopting the core of the “Health Equity and Access Reform Today Act” that Republicans offered in 1993. There are differences between the 1993 GOP bill and Obamacare, but essential features, including an “individual mandate” and insurance exchanges, were all there in the Republican plan. It did not include the expansion of Medicaid or compelling plans to include contraceptives.

The idea of exchanges thus is not going to go away. Ryan, courageous in tackling Medicare, would convert it to a voucher system. That leads right back to some insurance exchange, probably national. So the issue is going to be around, regardless of how fast the new administration and Congress act on Obamacare.

Supreme Court Justice Louis Brandeis once described states as “laboratories of democracy.” We can glean lessons for national problems from initiatives tried at the state level. Studying the history of the exchanges under the ACA may be useful going forward.

One lesson: Avoid overly fragmented markets. My home state of Minnesota’s health exchange accounts for a tiny share of total health insurance coverage among the state’s residents. Nearly 65 percent of residents from birth through age 64 are covered by employer-sponsored plans. About 900,000 are on Medicare and 213,000 on Medicaid. About 67,000 families get coverage through a state-subsidized program for low-income people who do not qualify for Medicaid. This incorporates the federally funded children’s health program most states have.

That leaves the rest to seek insurance in the individual market. About 74,000 policies were bought on this Obamacare exchange as of March 1, 2016, out of 250,000 individual policies sold. The rest were procured through traditional channels. So fewer than 200,000 people actually got their coverage on the exchange, about 4 percent of the population.

Such exchanges have been in health reform proposals for at least 30 years. They found favor with politically liberal and conservative economists. They were in a 1980s proposal by the conservative Heritage Foundation that influenced the Senate GOP plan and Romneycare in Massachusetts.

Moreover, the basic model of private insurers selling policies directly to households in a government-organized market is the core of some European systems, notably Switzerland’s. It was a mainstream idea.

Despite the general appeal of exchanges to many economists, including me, they certainly have been problematic. For economists, the sharp price increases should force examination of why we were wrong.

Exchanges attracted economists and some politicians because these would use private market forces to implement a public good.

Introductory econ students learn what must be true for markets to have optimal outcomes: There must be many sellers and many buyers, and no barriers to new sellers entering the market. The product must be uniform. All participants must have good information. There must be equal bargaining power on both sides. There cannot be any externalities, either positive or negative.

There are few goods for which all of these conditions hold. Yet private markets remain the best alternative in many cases. The fact that a private market does not work perfectly does not mean that any alternative implemented by government automatically is better.

But there are few products for which conditions fail as completely as for medical services and insurance. There are few suppliers. There are barriers to entry. Information is very scarce and is asymmetric. The products are not “homogeneous” or uniform. Bargaining power is extremely skewed.

Such problems were the primary reason why insurance exchanges did not arise naturally, the way markets for carrots did. And the fact that government established exchanges did not make these deficiencies disappear.

Any given state has a thin, illiquid market with a handful of sellers. There is competition, but in a situation of “oligopoly,” in which the actions of one supplier have great influence on the price and quantity decisions of all other suppliers.

There is poor information for both sellers and buyers. A primary reason for high premium increases now is that sellers did not really know beforehand what sort of costs they would have. This depended very much on how many sick people would buy policies and also on how many healthy people would choose to go without coverage, paying a penalty instead. Sellers underestimated what their costs would be or overestimated the average health of buyers.

They lost large amounts when things actually got underway, and they are either throwing in the towel or raising prices to make up for that now — or both.

So is this a market failure? That is yet to be determined. Still, those who will “repeal and replace” Obamacare may well find themselves coming back to using some sort of exchanges. They will just have to take care to call it something else.

St. Paul economist and writer Edward Lotterman can be reached at boise@edlotterman.com.

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