By Sharon Silow-Carroll, Diana Rodin, Tom Dehner, and Jaimie Bern1
A central feature of the federal health reform legislation is its creation of "health insurance exchanges." The exchanges, to be operational in 2014, are envisioned as insurance marketplaces in which individuals and small businesses can compare and purchase health plans, and determine and receive premium subsidies for which they are eligible. States have the option to develop and host their own exchanges, or let the federal government establish and run exchanges for them. States that choose to implement exchanges will be able to tailor the exchanges to their states' particular strengths and circumstances. Yet, they will face a multitude of decisions regarding their governance, design, marketing, administration, technology, and other factors.
This States in Action focuses on two critical issues: the role of the exchanges in selecting plans for inclusion and in avoiding adverse selection. In the Ask the Expert column, Timothy Jost, J.D., a professor of law at Washington and Lee University School of Law and author of a Commonwealth Fund report and other analyses of insurance exchanges, answers questions about how states should assess their options in these key areas. The Snapshots describe three states that are ahead of the curve on implementing or legislating exchanges: Massachusetts and Utah, which are the only states to have implemented statewide insurance exchanges, and California, which was the first state to pass exchange legislation after the Affordable Care Act was enacted.2
What Is an Insurance Exchange?
According to the November 2010 Initial Guidance to States on Exchanges from the Department of Health and Human Services:
"An Exchange is a mechanism for organizing the health insurance marketplace to help consumers and small businesses shop for coverage in a way that permits easy comparison of available plan options based on price, benefits and services, and quality. By pooling people together, reducing transaction costs, and increasing transparency, Exchanges create more efficient and competitive markets for individuals and small employers."
In combination with insurance market reforms, exchanges are intended to make the markets for individual and small-group insurance easier to navigate by enabling side-by-side comparisons of health plan benefits and costs. They are also intended to encourage competition among health plans and thus make coverage more affordable. The exchange administrators will facilitate enrollment into health plans and determine, in cooperation with state Medicaid and Children's Health Insurance Program agencies, eligibility for public programs or federal tax subsidies. While exchanges will serve both individuals and small groups, they will be the exclusive market for individuals who are eligible for federal premium and cost-sharing subsidies based on their household income.
To promote transparency, competition, and efficiency, federal reform requires that the exchanges take on certain functions such as certifying whether health plans are qualified to participate and coordinating with appropriate state and federal agencies (Exhibit 1).
Exhibit 1. Required Functions of Insurance Exchanges
- Provide both an individual and small group insurance exchange portal, or combined portal
- Present plan options in a standardized way (i.e., Platinum, Gold, Silver, and Bronze)
- Provide electronic resources (e.g., cost calculators) and toll-free call center support to users of the exchanges' Web portals
- Administer exemption process for individual mandate requirement
- Determine eligibility for and enroll applicants in public programs
- Determine eligibility for new tax credits and cost-sharing reductions (if applicants' household income is 100-400% of the federal poverty level)
- Facilitate advance payments of premium tax credits by the Department of Treasury to insurers
- Determine whether employer-sponsored insurance is "affordable," i.e., less than 9.5% of household income
- Receive and process "free choice" vouchers for employees who have unaffordable employer-sponsored insurance
- Operate a consumer assistance program
- Report user and employer data to Department of Treasury
- Generate sufficient revenue to be self-sustaining by 2015
Source: Patient Protection and Affordable Care Act
Apart from these requirements, the legislation leaves considerable flexibility to states that choose to operate their own exchanges, including: determining their governance and organizational structure, financing them, and executing operational requirements to comply with federal standards.3 These decisions and how they are operationalized will largely determine whether an exchange is successful at providing affordable choices among health plans for individuals and small businesses. In addition, states have significant flexibility in two key policy areas—how selective an exchange will be in qualifying plans and how it will avoid adverse selection, or the disproportionate enrollment of high-risk, high-cost individuals, resulting in a rise in costs and premiums—that will shape how the exchange relates to and participates in a state's larger health care marketplace.
Selecting Health Plans: How Active Should Exchanges Be?
One of the most important questions in developing insurance exchanges is how aggressive to be in defining standards for and selecting plans that qualify for participation. States will need to carefully consider, and some will likely define in legislation, how much authority the exchange should have to set standards for qualifying plans.
As Tim Jost notes, the Affordable Care Act allows an exchange to certify a health plan only if it "determines that making available such health plan through such Exchange is in the interests of qualified individuals and qualified employers in the State or States in which such Exchange operates."4 Exchanges also must require plans to submit justifications for premium increases and take this information into account when determining whether to certify them. They will present standardized information on plans to enable consumers to compare their options and will publicly rate plans on such factors as the quality of care, cost, and customer service. However, the reform law also restricts exchanges' regulatory role in a number of ways, including prohibiting them from imposing price controls or excluding plans for using fee-for-service payment methodology.
Within these parameters, states must decide whether their exchanges will require insurance plans to compete and essentially "bid" for participation, with the exchange choosing some plans and excluding others, or whether every plan that meets a minimum set of specifications should be included.
In states that require or permit an exchange to be selective in terms of which plans it certifies, the exchange will need to determine the basis on which to make those selections. Some have referred to this approach as the exchange being an "active purchaser" on behalf of individuals and small employers—explicitly aiming to maximize value for consumers by selecting only the highest-performing plans. It is important to note, however, that states may not necessarily focus on health plans' overall performance in terms of costs and quality. Some may prioritize reducing premium costs and thus focus their bids on price. Other states may want to certify only those plans that achieve high scores on measures of health care quality, and still others may seek to advance strategic objectives such as instituting limited networks or advancing payment reform innovations. States may take a combined approach by placing relative values on price, quality, and other strategic priorities.
Leaving aside the values on which to base health plan selection, states must generally consider how selective, if at all, an exchange should be. In particularly, they must consider:
Size of the exchange. An exchange that attracts a limited number of enrollees, both in absolute terms and compared with the rest of the market, may have a harder time bargaining with insurers. The relative size of the exchange and the remaining market outside it may also influence its ability to be selective; an exchange with a larger share of the market will be more appealing to insurers.
Composition of the insurance market. Similarly, some markets are dominated by a small number of carriers, leaving few choices among insurers. In such cases, the exchange may want to accept all comers in order to provide an acceptable level of choice for customers.
Jost suggests that exchanges may want to start out as less selective and gradually move toward a more active purchasing model, building participation among both customers and insurers to create a sought-after marketplace. Decisions about an exchange's purchasing role dovetail with its responsibilities to provide consumers with user-friendly comparisons of plan benefits and costs, quality ratings, and other information. For example, states could use their rating systems to help define explicit cut-off points for allowing (or excluding) plans in the marketplace.
The two existing statewide exchanges, in Massachusetts and Utah, have taken different approaches to selecting plans for inclusion. Department of Health and Human Services Secretary Kathleen Sebelius reiterated recently in a letter to governors that "states have the option to allow all insurers to participate in the exchanges (the Utah model), or they can be more active purchasers in shaping available choices (the Massachusetts model)." Massachusetts' Connector, the state's insurance exchange, accepts competitive bids for participation in Commonwealth Choice, which offers non-subsidized commercial insurance. Selected plans are given the Connector "Seal of Approval" and offered on the exchange. A central component of the Seal of Approval process is to validate that plans meet minimum benefit standards and are standardized across benefit tiers. The Connector also accepts competitive bids for the separate subsidized program, Commonwealth Care.
Utah plays a much more limited role in its exchange. The state administrators view their exchange as first and foremost a technical platform, whereby the state contracts with private companies that own and run the software. The state's exchange budget is very modest; their role is to oversee, provide some basic requirements, and help scale up the exchange. While Utah is collecting and plans to monitor data on the quality and cost of care provided through participating health plans, it has not turned away any carriers and considers the private insurance market to be "working" for the people of Utah.
Under the Affordable Care Act, new federal standards will define minimum essential benefits that must be offered by all insurance plans (unless they are excluded or "grandfathered" plans) and will require plans to be associated with standardized benefit tiers that are defined by relative actuarial values. As a result, all exchanges will to some degree have to confirm compliance with these new federal rules. States have the option to mandate coverage of specific, additional benefits.
Avoiding Adverse Selection
"The greatest threat facing exchanges is adverse selection," according to Jost.5 Adverse selection refers to the disproportionate enrollment of high-risk, high-cost individuals, resulting in a rise in costs and premiums. This could result from lower-risk people and employers who have more affordable options elsewhere dropping out of the exchange, leading to further escalation of risk, costs, and premiums—creating essentially a high-risk pool or, at the extreme, a "death spiral" of rapidly escalating costs.
Adverse selection could occur at the health plan level within an exchange, if certain health plans attract more costly individuals than others. Or, it could occur against the exchange as a whole, if predominantly high-risk individuals and groups enroll in the exchange while younger, healthier people and groups purchase coverage in the individual or small-group markets outside of it. This type of market-level adverse selection would primarily stem from the existence of different rules for health plans inside and outside of the exchange. If non-exchange plans are permitted greater flexibility around benefit design and rate setting, those plans could offer lower prices to attract lower-risk individuals.
In order for exchanges to fulfill their intended purpose of providing choice and affordable, high-quality coverage options, protections are needed against both types of adverse selection. The Affordable Care Act contains many such protections; the law:
requires individuals to purchase minimum health coverage beginning in 2014, ensuring that large numbers of healthy people participate in insurance markets;
prohibits insurers both inside and outside of exchanges from rejecting or charging higher premiums based on health status or preexisting conditions (beginning 2014);
makes premium subsidies for individuals and tax credits for small businesses available only through exchanges;
requires health plans both inside and outside of the exchanges to cover the same defined "essential health benefits" and apply the same out-of-pocket limits;
requires insurers with health plans inside and outside of the exchanges to combine individuals into one risk pool and small groups into another risk pool (with exceptions for grandfathered plans);6
requires insurers of "qualified health plans" to charge the same premium for a plan inside and outside of the exchanges; and
creates risk-adjustment programs whereby health plans outside of the exchanges compensate plans inside them if the former enroll much healthier people.
Despite these substantial structural protections, some risk of adverse selection against the exchanges remains. For example, insurers may choose to sell plans outside of the exchanges only and offer less expensive options (e.g., plans with high-cost sharing or catastrophic plans), thereby attracting younger, healthier populations. Also, health plans existing at the time of the Affordable Care Act's passage (March 2010) are grandfathered and thereby exempt from some rules and from inclusion in combined risk pools. Low-risk people may disproportionately retain these non-exchange plans.7
States have the following options to supplement the above provisions to further level the playing field and minimize adverse selection against their exchanges:
States may eliminate insurance markets outside of the exchange. Banning the sale of health insurance outside of the exchange would remove adverse selection against the exchange. However, there are legal, practical, and political considerations that make this option difficult. For example, policymakers should consider whether the state's constitution would restrict the exchange's ability to selectively contract with certain health plans if an outside market is eliminated. Also, the state should consider the extent to which this would reduce undocumented residents' access to private health insurance (this population is prohibited from purchasing through an exchange).
States may apply the same rules to health plans inside and outside of the exchange. Through their regulatory authority, states could impose additional requirements on health plans outside of the exchange comparable to those for exchange plans, such as requiring accreditation, quality improvement and disparity-reduction strategies, inclusion of safety net providers, and other features that could increase costs. States could require the same marketing and benefit designs inside and outside of the exchange, including similar standardized benefits or cost-sharing arrangements. States should also consider commission rates and other incentives for insurance brokers and agents to steer enrollment toward or away from the exchange, and attempt to make them comparable. Applying the same rules inside and outside of the exchange—thereby creating a level playing field—requires coordination among regulators of each market.
California, the first state to enact legislation for an exchange after passage of the Affordable Care Act, experienced adverse selection in an earlier exchange-like purchasing pool. To avoid similar problems, its new legislation requires all plans offering coverage in the exchange to offer all five benefit levels stipulated by federal law (platinum, gold, silver, bronze, and catastrophic) and to sell the same products outside of the exchange.
In the Utah Health Exchange's 2010 pilot, the state and participating health plans quickly realized that they needed parity to avoid adverse selection, and adjusted prices to be the same inside and outside of the exchange. Legislation standardized rating practices and required health plans to establish a single risk pool for their products both inside and outside of the exchange, which is also a requirement of the federal health reform legislation. The Utah exchange also has both prospective and retrospective risk adjustment for health plans within the exchange, whereby plans enrolling sicker people get a larger share of total premiums to offset their higher costs.
The Massachusetts Health Connector has many requirements to reduce adverse selection, most of which are included in the Affordable Care Act. For example, the state legislation mandates individuals to purchase coverage, limits subsidized coverage to the exchange market, requires the same products inside and outside of the exchange, and pools health plan risk for enrollees across the exchange and the outside market.
Protection against adverse selection within the new state exchanges also will be addressed by the Affordable Care Act's risk adjustment and reinsurance policies. In early years (2014–16), an assessment on insurers will help pay for reinsured, high-risk individuals. In later years, a risk adjustment mechanism developed by the federal government and implemented by the states should shift funds from health plans with lower-risk enrollees to plans with higher-risk, more costly enrollees. It will be critical for states and exchanges to monitor the markets to identify signs of adverse selection and make adjustments in their risk-adjustment mechanisms and/or rules and requirements on health plans inside and outside of the exchanges.
Timeline and Resources
Exchanges are required to be operational by January 1, 2014, so most states are actively planning and pursuing federal funding for their development and implementation. The Department of Health and Human Services (HHS) made two announcements offering grants to states to support their planning and implementation work, in September 2010 and January 2011. In February 2011, HHS announced the award of "early innovator" grants to seven states or consortia that are showing leadership in developing the information technology capabilities that state exchanges will need. Most states are taking advantage of federal planning funding, and there will likely be further opportunities as implementation proceeds.
By January 2013, the HHS secretary will verify whether each state will be ready to open its exchange on time. If a state chooses not to run its own exchange, or is deemed to be unprepared to do so, the secretary will take responsibility for its exchange functions, though it is not yet clear how this will work.
So far, HHS has released initial guidance on exchanges and the National Association of Insurance Commissioners has developed model legislation on which states can base the exchange laws that many of them are likely to develop this year. Since the start of many state legislative sessions in early 2011, activity to develop exchange legislation has accelerated and become more widespread. States are anticipating further policy guidance from HHS on a number of key issues. The essential health benefits package that plans will need to cover is a critical factor in state planning efforts and will likely be defined in the later part of 2011. Also this year, HHS will develop a methodology for state exchanges to use to assess the relative value of health plans, taking into account their cost, quality, enrollee risk, efficiency, and actuarial value. Exhibit 2 provides links to resources designed to assist states in developing health insurance exchanges.
The authors would like to thank Timothy Jost, J.D., professor at Washington and Lee University School of Law, and Elliot Wicks, Ph.D., health economist at Health Management Associates, for their assistance and input on this publication.
Other state legislatures, including in Texas and Washington, are developing or considering legislation to establish exchanges.
Regarding exchange governance, Jost outlines three options: states can establish a non-profit entity to run an exchange, house it in an existing governmental agency, or establish it as an independent public entity. For a fuller discussion of governance issues, please see "Health Insurance Exchanges and the Affordable Care Act: Eight Difficult Issues," Timothy Stoltzfus Jost, The Commonwealth Fund, September 2010, pp. 2-7.
T. S. Jost, "Health Insurance Exchanges and the Affordable Care Act: Eight Difficult Issues," The Commonwealth Fund, September 2010, p. 8.
6 States may require that individual and small-group populations be combined into one risk pool.
So-called "mini-med" plans will be phased out by the launch of exchanges in 2014, though some insurers and employers have recently received year-long waivers to help maintain some form of coverage for employees until exchange options become available and annual limits are completely prohibited in 2014.