The Durbin-Lincoln Small Employers Health Benefits Program (SEHBP)Jeff Lemieux
revised March 4, 2004 10am
to reflect the fact that the final legislative language does not include per-enrollee caps on the small business tax credits.
There are three key problems with health insurance markets: (1) unreasonable prices, (2) inadequate choices of health benefits and plans, and (3) lack of continuity of coverage. To rectify some of those problems, a bill introduced today by Senators Richard Durbin and Blanche Lincoln would create a new version of the popular Federal Employees Health Benefits Program (FEHBP) for small businesses. Small businesses with low-wage workers joining the "SEHBP" pool would be eligible for tax subsidies.
The SEHBP system would not be identical to the federal employees' program. For example, SEHBP premiums would be adjusted by age, and the Office of Personnel Management (OPM) would be authorized to enter into risk sharing arrangements with health plans. These are reasonable and important measures designed to help the SEHBP system get up and running without massive federal subsidies. The Durbin-Lincoln bill is a serious first step toward improvements in health coverage, and is worthy of bipartisan consideration.
Outline:
Fixing the Health Insurance Market on a Modest Budget
Kerry and Bush Proposals, Costly vs. Ineffective
The Durbin-Lincoln Proposal
Adverse Selection and Age-Rating
Background -- The Fundamental Problem in Health Insurance is Inadequate Risk Pooling
The Durbin-Lincoln "Middle Ground" Approach to Insurance Pooling
Considerations and Concerns
The Importance of Transitional Health Coverage for the Unemployed
Fixing the Health Insurance Market on a Modest Budget: There are three big problems with health insurance in the U.S. They are essentially market problems, which can be fixed even before we contemplate a large subsidy program to expand health coverage.
First, premiums can be unreasonable, especially for small businesses or people with pre-existing or chronic medical conditions who can't get coverage at work.
Second, workers often lack choices of health benefits and plans. Even at large firms, where premiums are affordable, there may only be one or two health plans available, often from the same insurance company. Workers at small businesses rarely get a choice -- if they get health benefits at all.
Third, people lack continuity in their coverage. If they change jobs or drop out of the workforce, they often have to change insurance plans. Switching insurance can disrupt health care. It also dissuades health plans from investing in preventive care. Why spend a lot of money preventing a future illness when some other health plan will reap the savings?
Kerry and Bush Proposals, Costly vs. Ineffective. Senator Kerry wants to use the federal employees' system as a model for a new health insurance program for tens of millions of Americans. The federal program offers a wide choice of health plans in most cities, and several choices in rural areas.
Meanwhile, President Bush and Republican leaders in Congress used the federal employees' system as a model for last year’s drug bill. That bill will give senior citizens in Medicare a broader choice of health plans.
The good news is that both parties seem to agree that people should have a choice of various types of health insurance, from as many health plans as possible, and that the federal employees' system is a good model.
Ideally, it shouldn't matter where people work, or whether they are in the labor force. The choice of which health insurance they have should be theirs, not their employer's, and not the government's.
However, President Bush has not pushed for a federal employees-style system for the non-Medicare (under 65) population. He has proposed tax credits to help people purchase individual health coverage. But individual health coverage is too expensive in some states, and in other states it doesn’t provide a fair choice for people who are sick. Besides, the President hasn't pushed his tax credit plan in Congress, and did not dedicate funds for that purpose in this year's budget.
The President’s other health proposals -- Association Health Plans (AHPs) and Health Savings Accounts (HSAs) -- do not amount to a comprehensive solution either. HSAs are simply a promising new type of health coverage. But they do not solve the fundamental problems of the health insurance market.
AHPs could make insurance more affordable for some people, but more expensive for others. Moreover, people purchasing health insurance through an AHP could face the same limited choices as people with employer-based coverage. Most AHPs would not offer broad choices of coverage.
The big hurdle for Senator Kerry’s comprehensive proposal is the cost. It would require expensive federal subsidies -- hundreds of billions of dollars over the next decade -- to make a program exactly like the federal employees program available to most Americans. With the budget already in deep deficit, and with the Republican Congress unlikely to repeal some of the Bush tax cuts to pay for health coverage, that level of funding could be impossible to obtain.
Fortunately, there are ways to give more Americans the full choice of health insurance plans without massive subsidies, regardless of where or how they work.
The Durbin-Lincoln SEHBP Proposal: The new bill proposed by Senators Richard Durbin and Blanche Lincoln is a start.
Here is how the Durbin-Lincoln proposal would work.
The Office of Personnel Management -- which runs the federal employees' health system -- would administer a nationwide health insurance system for small businesses. The proposal would create a side-by-side version of the Federal Employees Health Benefit Program, which any small business could join. Enrollment would be limited to firms with 100 employees or fewer, although OPM could make exceptions for larger businesses.
Employers would have to bring their whole group of employees into the SEHBP program -- no employees could be left out, and none could be offered alternative health coverage.
Businesses with low-wage workers would be eligible for refundable tax credits, provided the firm paid at least 60 percent of the workers' premiums. ("Refundable" means that the firms would receive the credits even if they paid no tax that year, perhaps because they operated at a loss.)
The tax credits would equal 25 percent of the premium for single workers, 30 percent for couples with no children, and 35 percent for family coverage, and would apply only for workers earning less than $25,000 a year. Employers paying more than 60 percent of the premium would be eligible for “bonus” tax credits.
To encourage health plans to offer coverage within the program, OPM would be authorized to enter into "risk-corridor" arrangements with plans during the first five years of SEHBP implementation.
In addition, OPM would receive a budget of $18 billion over the next 5 years to fund a "reinsurance" program for SEHBP plans with enrollees whose health costs exceeded $50,000 in a year. OPM would set the reinsurance payment amounts based on what the $18 billion budget permitted, but it could not exceed an 80 percent payment rate. (The $18 billion fund would also be used as a reserve for the risk corridor arrangements.)
Adverse Selection and Age-Rating. In general, voluntary insurance pools like SEHBP are susceptible to what actuaries call "adverse selection," which can drive premiums up to very high levels.
In this case, adverse selection could result if small businesses with large numbers of sick workers or dependents joined SEHBP to take advantage of its guaranteed rates, while small businesses with disproportionately healthy workers did not enroll in SEHBP (presumably because they could get a better deal on insurance outside the SEHBP system).
SEHBP includes several measures designed to prevent adverse selection problems.
The risk corridor and reinsurance provisions -- which are not used in federal employees' program -- would help make SEHBP an attractive test market for health plans. Those provisions would reduce plans' fears of unexpected losses while they were gauging potential SEHBP enrollment and the health costs of workers who signed up.
The tax credits for firms with low-wage workers will help attract small businesses with younger and healthier workers into the SEHBP system. That is because workers earning less than $25,000 a year are likely to be younger and less experienced or productive. Requiring employers to pay at least 60 percent of the premium to get the tax credit will induce young and healthy employees to enroll in an SEHBP plan when it is offered.
However, some small firms cannot afford to pay 60 percent of their workers' premiums and thereby receive the tax credits. But they might want to join SEHBP anyway.
One way to be sure young and healthy enrollees join a voluntary pool is to subsidize them heavily. This is the approach suggested by Senator Kerry, several of the other early Democratic presidential contenders, the center-left Progressive Policy Institute, the Commonwealth Fund (which advocates universal coverage), and other scholars and commentators (including the author). However, these sorts of subsidies could easily cost hundreds of billions of dollars within the 10-year Congressional budgeting period.
The SEHBP proposal presumes that such large subsidies will not be available, at least for the next several years.
In the absence of large government subsidies, SEHBP would take a different approach: age-adjusted premiums.
Age-adjusted or "age-rated" premiums are a fundamental departure from Democratic orthodoxy on health insurance. But they are necessary when the budget doesn't permit large subsidies to entice younger and healthier workers into insurance pools.
Age-rating is not common in group health insurance, at least from an employee's perspective. Even if insurance plans use the ages of workers to help determine a group's overall premium, it is rare for older workers to actually pay more than their younger colleagues.
In the case of SEHBP, age-rated premiums -- in combination with risk corridors, reinsurance, and a 60 percent employer-paid premium requirement to be eligible for tax credits -- would probably prevent adverse selection problems. (SEHBP would also allow health plans to give premium discounts or rebates to long-time enrollees. This would also help encourage younger enrollees to sign up early and maintain their coverage for long periods of time.)
Within bounds, it is not unfair to charge older enrollees more for health coverage. They generally value health insurance more highly than younger, healthier people, and the price they face for health insurance can reasonably reflect that. Moreover, SEHBP would provide older workers with some very real advantages: the ability to keep a particular coverage for long periods of time, transparent and predictable prices, no big premium increases related to their specific medical condition or claims experience, and so on.
Background -- The Fundamental Problem with Health Insurance is Inadequate Risk Pooling: Health insurance is pretty simple: everybody pays premiums, but only a few have expensive claims.
The fundamental problem with health insurance is inadequate risk pooling. Health insurance works when relatively healthy people -- who are usually younger and have few expensive health claims -- subsidize the claims of a smaller number of older or sicker people.
Health insurance fails when there are insufficient numbers of healthy enrollees to balance the risk pool. It fails in one of two ways: (1) unaffordable premiums, or (2) exclusions of sick people from coverage.
Large Employer Coverage -- Good Pools, Inadequate Choices. Group health insurance at large employers works because it is heavily subsidized. Employees get a substantial tax break when their companies pay a share of the premium. Furthermore, insurers demand that employers pay a large share of the premium, so that most workers at the firm sign up and cross-subsidize each other.
Between the tax and employer subsidies, even young and healthy employees are induced to sign up, because the effective price to them is greatly reduced.
Small Employer and Individual Coverage -- Inadequate Pools, Bad Choices. Small employers get the same tax subsidy as large firms, but they have too few employees to cross-subsidize each other in a stable way. If one employee gets terribly sick, the premium for the group can skyrocket, even if there are several other healthy employees in the pool.
In the market for individual coverage, which is largely unsubsidized, it is next to impossible to create fair pricing rules. This is because illness isn't random. People often know that they will need expensive claims in the future, as a result of past illness, family history, obesity or smoking, or genetic factors.
Therefore, individual coverage is generally "underwritten." That is, insurers essentially require potential enrollees to "prove" their insurability, which, of course, excludes unhealthy people, people with pre-existing conditions, and (in the future, possibly) those with genetic tendencies toward disease.
Community Rating Doesn't Work Without Large Subsidies. States regulate health insurance plans in the U.S. They make sure health insurers are solvent and actually pay the promised benefits and claims. They set the "rating rules" for how insurers must price health plans targeted to individuals and small groups.
Some states have chosen "community rating," which, at the most simplistic level, forces health plans to charge the same premium regardless of an enrollee's age or health status.
In theory, community rating is seems fair. In practice, however, community rating tends to drive up premiums to unaffordable levels for nearly everybody in the market.
What happens is this. At a guaranteed flat rate, older and sicker people sign up for coverage. This drives premiums up. Gradually, younger and healthier people are priced out of the market. (Sicker people -- who know they are likely to need the coverage -- will still purchase coverage even at very high rates.)
The problem with community rating is the lack of subsidies to entice young and healthy people to enroll. After all, community rating within a large firm usually works fine, when the employer pays a hefty share of the premium.
Absent large subsidies to keep the effective premiums down for young, healthy, and low-income people, community rated systems usually end up with very high premiums for everybody.
Experience or Individual Rating Doesn't Work For the Sick (Especially in an Era of Genetic Testing). At the other extreme, some states allow insurers in the small group and individual market to exclude sick people or high-cost groups. They can't explicitly deny them coverage in most cases, but they have the flexibility to charge sufficiently high premiums that coverage is unaffordable.
In these states, low-risk individuals or small groups may be able to purchase affordable coverage. The cost is raised by the high administrative expense of underwriting small groups or individuals, but if the underwriters succeed in weeding out high-risk enrollees, the premium will be reasonable.
But what about the sick? People with chronic illnesses often cannot purchase coverage at reasonable rates in these states. They are at the mercy of insurers of last resort, or high-risk pools set up specifically for those deemed medically uninsurable. Even in state-subsidized high-risk pools, premiums can be very high.
This problem will get worse. As genetic testing improves, and science links more disease tendencies to the genetic code, people will know further in advance that they will need expensive health care. And insurers may know too. Even if they don't, insurers will worry that prospective enrollees know about their potential for future illness, and will raise premiums accordingly.
In sum, community rating can be actuarially problematic, but experience or individual rating is morally unacceptable.
The Durbin-Lincoln "Middle Ground" Approach to Insurance Pooling: The SEHBP program would create a sensible middle ground, which would probably avoid the most worrisome pitfalls of both community and experience or individual rating for health insurance.
SEHBP would have several of the best features of community rating -- especially predictable, transparent pricing -- without the marketplace problems. Workers and small business owners could feel secure that they would not lose their health coverage or face extremely steep premium increases if someone in their group became seriously ill.
SEHBP would also have a wide choice of health plans. Its open format would spark innovation in the market for health insurance products based on consumer preferences, which might be different from those of employers.
Of course, SEHBP is not a panacea. Because the program only applies to participating small employers, portability from job to job is not guaranteed for workers leaving the system.
And because premiums would be adjusted by age, older workers would be asked to pay more. That is a difficult, but necessary step in the absence of large subsidies for health coverage.
However, the SEHBP proposal is expandable. It could accommodate individual coverage coupled with personal tax credits, if future budgets permit. Larger employers -- especially those with low-wage workers -- could be admitted. If future Congresses enacted large subsidies or generous tax credits, SEHBP's age-rating rules could be relaxed.
Considerations and Concerns: In general, the Durbin-Lincoln bill authorizes and instructs OPM to operate SEHBP so that it is as similar as possible to the federal employees' system. Current FEHBP health plans are not required to offer coverage within the SEHBP system, although it is clear that the bill’s sponsors wish they would.
However, there are some features of the federal employees' program that may not be suitable for a voluntary small group system.
Moreover, the Durbin-Lincoln proposal also raises other important questions, some of which can be easily clarified, and others of which may require additional analysis.
Negotiation or Shadow Pricing? One question is whether OPM will come to agreement with health plans on the appropriate premiums via a straightforward negotiation or through a benchmarking process against premiums for coverage that plans offer to other purchasers.
For example, OPM requires health plans in the federal employees' system to base their premiums on what those plans charge to large employers in comparable regions of the country. That may be a decent starting place for negotiations with health plans, but more flexibility to adjust premiums would probably be necessary to entice carriers to offer coverage within SEHBP.
Subsidies to Employers, Not Employees. In general, advocates of market-based health reforms support tax credits to people, not employers. This is because we want people to have greater choices of coverage -- why subsidize employers who may only offer one or two plans?
The logic is simple. If you give people the money, they will demand the sort of insurance they want. Market-oriented health analysts favor individual choice, not a paternalistic system where employers or government agencies decide which sorts of health insurance people have. This, we believe, will spark greater innovation in health insurance products, and a greater feeling of "ownership" and price-sensitivity for health care consumers. In the long run, consumer choice should lead to greater cost savings than if employers or governments chose the insurance products.
However, the SEHBP is explicitly a consumer choice system. Subsidizing participating employers in this case supports consumer choice, not paternalism -- it is a practical way to expand people's choices. Tax credit advocates can embrace employer subsidies when they are used to provide workers with a much broader array of health plans.
Finally, the SEHBP system is amenable to adding individual tax credits at a later date, if the budget permits. The SEHBP subsidies for small employers are appropriate because their pools are too small to be stable, and small businesses need a modest financial incentive to migrate to a better system. However, in the longer run, any additional subsidies should be targeted to people with low incomes, regardless of where they work.
Disruption of Small Group Insurance Markets? Health insurance is a difficult proposition for small employers precisely because it is difficult for health insurers to profitably provide.
Health plans are low-margin operations. Their actuaries fear slight changes in the composition of insurance pools that could switch a small profit into a substantial loss. Unlike providing health coverage for large, stable businesses, the small business market is fragile, and potentially unstable.
Current small group insurers might worry that SEHBP would draw significant enrollment away from their health plans, roiling the market.
On the one hand, if SEHBP attracted a random mix of small employers -- with average health costs -- then the current small group market would not be disadvantaged. It would simply be smaller. Of course, current small group insurers could offer coverage through SEHBP to expand their business.
However, if SEHBP somehow attracted healthier-than-average enrollees, that would in fact disfavor the current small group market. With low premiums in SEHBP, however, most small groups -- healthy or sick -- would switch out of the current market and into SEHBP. This would normalize premiums.
But a full conversion to SEHBP wouldn't necessarily be a bad thing; in fact, it could be a very good thing. Most of the current problems of small group coverage -- unreasonable prices for "bad" groups, inadequate choices of coverage for workers, lack of continuity of coverage -- would be solved, and health plans currently serving the small group market could simply join SEHBP and serve most of the same people.
If SEHBP attracted sicker-than-average enrollees, then the whole SEHBP program might not work very well. But if "bad" groups were disproportionately attracted to SEHBP's guaranteed rates, the current small group market would actually become more profitable.
In general, the rating rules and other regulations used by SEHBP may have to be adjusted to match the rules used by states, so that the pricing system in SEHBP is similar to the system used in states' current small group markets. This would help minimize any disruption in the current small group markets.
Federal or State-Based Administration? One important question is: Is OPM the right agency to run SEHBP? The Durbin-Lincoln bill authorizes OPM to contract with local or regional administrators, and would dun all premiums in the system by a small percentage to pay for administrative and enrollment costs.
Since states are currently the main regulators of health insurance, it might make sense to allow states to run their own SEHBP programs, with subsidies similar to those available if OPM was running the program in the state.
In general, states are important laboratories for innovation and experimentation. Rather than starting with a purely federal approach, perhaps SEHBP could allow more of a federal-state partnership.
Geographic Adjustment? Federal employees are charged the same premium for nationwide plans no matter where they live. This gives federal workers living in high-cost geographic areas an incentive to choose national plans, rather than local HMOs (whose premiums reflect the higher local health costs).
In effect, FEHBP's nationwide plans subsidize people in areas with high health costs at the expense of people living in low-cost areas.
Perhaps OPM should allow for differential premium rates in different localities or regional areas, to better "reward" residents in areas with low health costs and more accurately reflect the cost of coverage for workers living in high-cost areas.
Commissions for Brokers and Associations? The Durbin-Lincoln proposal does not specify whether insurance brokers or associations would receive a commission for steering their clients or members into SEHBP. That might be a good idea, both to reduce political opposition from brokers and associations, and to help build SEHBP's enrollment.
Government or Private Reinsurance and Risk-Adjustment? SEHBP has an intriguing risk adjustment scheme, based on federal subsidy for cases costing more than $50,000 a year.
However, it is safe to say that no risk adjustment or reinsurance scheme will be perfect, and that OPM might need a lot of help from its health plans to make the system truly fair.
For example, some participating health plans -- like staff model HMOs, which own their health facilities and pay salaries to their health providers -- may not have tracking systems that tell when a patient really started to cost more than $50,000 a year. HSA plans and other new "consumer-directed" health plans -- which often use individual savings accounts in conjunction with "catastrophic" or high-deductible insurance -- may need a slightly adjusted formula.
The SEHBP program should consider forming a partnership with participating health plans, where the plans themselves continually monitor or even control the reinsurance and risk adjustment process.
That is not to say that having OPM conduct the system would be inherently unfair or that OPM or its administrative contractors wouldn't listen to health plans' concerns.
But in the long run, a system controlled by participating health plans might be more adaptable to changes in the delivery of health services and changes in the way health benefits are delivered and health insurance is designed.
Why Not Individual Coverage Too? SEHBP is only for small businesses. The question is, why not offer individual coverage too?
Of course, allowing individuals into SEHBP on a voluntary basis could worsen adverse selection problems. SEHBP's guaranteed rates would be very attractive to sick people unable to find individual coverage at reasonable rates.
By contrast, SEHBP controls for adverse selection among small employer groups in various ways. For example, employers have a strong incentive to subsidize at least 60 percent of their workers' premiums. Thus, SEHBP can be sure that younger and healthier employees have extra reasons to enroll in a plan, which would help balance out SEHBP's insurance pool.
However, states and SEHBP might consider allowing individuals to join SEHBP if they qualified for a federal or state-based subsidy. Certainly, if a generous federal tax credit for health coverage was enacted, adverse selection by individuals entering SEHBP would be reduced.
Alternatively, states with particularly difficult problems in their individual health insurance market might consider "buying" individuals into SEHBP. It might save money for states to subsidize SEHBP to take over their problematic individual market. Over time, SEHBP's age-adjusted rates should attract a reasonably healthy pool of enrollees, and adverse selection problems would be reduced.
The Importance of Transitional Health Coverage for the Unemployed: One of the perils of the U.S. employment-based health insurance system is unemployment. Unemployed workers may lose their health coverage, or may not be able to afford continuing COBRA coverage from their ex-employer.
Moreover, people with gaps in their health coverage would not qualify for SEHBP, at least not without restrictions. Plans could adjust their premiums to reflect the gap, or could exclude pre-existing conditions from coverage.
The Durbin-Lincoln proposal would be a natural fit for an expansion of "transitional" health coverage.
Under current law, a handful of workers who lost their jobs due to foreign trade are eligible for a 65 percent tax credit to help them pay the cost of COBRA or other specified forms of transitional health coverage. This tax credit is commonly referred to as the "TAA" tax credit after the Trade Adjustment Assistance Act, under which it was enacted.
First, Congress should expand the list of people eligible for the TAA tax credit to all unemployed workers.
Second, SEHBP should be designated as a qualifying venue for transitional health coverage. This would assure workers without access to COBRA that a choice of health plans would be available while they were receiving the federal subsidy.
Links:
Durbin-Lincoln Small Employers Health Benefits Program Act of 2004 (Legislative text as introduced on March 4, 2004)
Senator Kerry's health proposal (announced May 16, 2003)
President Bush's health policy agenda and speech (January 28, 2004)
Centrist Policy Network Kerry's Health Populism -- How Deep? (February 26, 2004)
Progressive Policy Institute A Progressive Path Toward Universal Health Coverage (December 2000)
Karen Davis and Cathy Schoen Creating Consensus on Coverage Choices Health Affairs (April 23, 2003)
Centrists.Org From Transitional to Universal Health Coverage (September 24, 2003)
Centrist Policy Network Transitional Health Coverage Resource Page
Centrists.Org Issue Summary Health (Basics)
Centrists.Org Issue Summary Universal Health Coverage
