Ghost of

By passing landmark legislation to create an online health-insurance exchange marketplace, California became the first state in the country to actively embrace the federal Affordable Care Act.

But now, with the legality of one of the plan’s key provisions appearing destined for the Supreme Court, health policy experts here are beginning to wonder whether the very problem that doomed a similar try at insurance overhaul in California – a heavily lopsided insurance pool of high-risk, high-cost patients – could undermine the federal reform plan.

That danger, known in the insurance industry as “adverse selection,” would likely result if the U.S. Supreme Court were to uphold a lower court ruling in Virginia last week that found the health reform law’s individual mandate provision unconstitutional.  

California’s original health-care insurance exchange, originally known as the Health Insurance Plan of California (HIPC),  lasted 13 years and was plagued by adverse selection issues. It ultimately folded in 2006.

The federal mandate requires all Americans – both the healthy and the sick – to acquire insurance or pay a fine. It is meant to create a large, balanced pool of high- and low-risk patients so that insurers can offer health coverage to all, regardless of preexisting conditions.

Without the mandate, analysts worry that healthy customers won’t have any incentive to buy coverage, leaving only the high-cost patients behind.

Others say even if the individual mandate withstands Supreme Court review, the specter of adverse selection and the resulting “death spiral” of rising premium costs – the very thing that killed California’s first insurance-exchange program – could still threaten the federal insurance-reform plan.

“You have to be very concerned about this,” said Alain Enthoven, a professor of public and private management at Stanford’s Graduate School of Business and one of the leading authorities on “managed competition.” “If there’s no mandate, there could be no viable guaranteed issue” – the provision that requires insurers to offer coverage to people regardless of their pre-existing conditions – “and the whole thing would collapse. Even with the individual mandate, there’s legitimate concern that the penalty for not buying insurance is too weak.”

Under the reform plan, failure to purchase health insurance would result in a $95 fine.

Insurance exchanges, as envisioned in the ACA legislation, are designed as a virtual marketplace where individuals and small businesses can shop for and purchase coverage from a pre-screened, regulated choice of private insurance plans. The state board that regulates the exchange can establish criteria for insurers wishing to do business on the exchange, thereby guaranteeing customers a level of care and controlling premium costs.

In California, that board will be appointed next month. The exchange will also help funnel people eligible for Medicaid and Medi-Cal toward plans that offer those subsidized government programs.

But California has, of course, already tried an insurance-exchange program – and seen it fail. And the 13-year history of the Health Insurance Plan of California, later known as PacAdvantage, is leading some in the state to caution that the “adverse selection” that sunk the nation’s first cooperative insurance exchange remains a glaring concern. Should the individual mandate be struck down, experts say, that problem will only grow.

That’s because the key to success for the exchange lies in attracting enough healthy, “low-risk” customers into the pool – something the first California exchange failed to do. Without a wide-enough pool of customers, the exchange can become a magnet for the unhealthy – which, in turn, leads insurers to raise premiums above open-market levels, or simply compels them to leave entirely. Without the individual mandate, there’s no incentive for people to buy insurance until they’re already sick. The low-risk portion of the pool, in short, vanishes – leaving only the most unhealthy, expensive customers behind.

“People have been able to get better products outside the exchange, if they’re healthy,” said Laura Tollen, an analyst with Kaiser Permanente’s Institute for Health Policy. “So the exchange makes itself attractive to people who are at a higher risk – that’s the premium death spiral. Once they raise the premiums, the next layer of people looks at that price differential (and walks away) – so premiums go up again.”

California’s first exchange, known initially as HIPC, was founded in 1993, and designed for small-business groups to pool their buying power and negotiate better premiums from insurance providers. At its peak, HIPC enrolled about 150,000 members. But the program failed to attract enough low-risk customers to flex any real buying power, and as a result, premium rates rose above open-market levels. In 2006, Blue Shield of California pulled out of the exchange, and HIPC folded. Later efforts to create a new state-run exchange, along with a state-wide individual mandate, pushed by Gov. Schwarzenegger, stalled out in 2007.

But the passage this year of the ACA reignited California’s plans to establish an insurance exchange.

The legislation, AB 1602 by Assembly Speaker John Perez, D-Los Angeles, and SB 900 by Sen. Elaine Alquist, D-San Jose, established a five-member exchange board, consisting of two members to be appointed by Gov. Schwarzenegger, plus single appointees from the Assembly speaker and the Senate Rules Committee. The secretary of the Health and Human Services Agency also is a member of the panel. The board will have control over exactly how the exchange is set up and functions.

Experts say the key to survival for California’s new exchange will be the tax relief that comes with buying through the exchange. Under the reform bill, people earning less than 400 percent of the poverty level who buy insurance through the exchange will qualify for tax credits – a point that some say could keep the exchange afloat even if the purchasing mandate dies.

“If (plans in the exchange) are subsidized by federal dollars, that’s what’s going to keep people in the exchange,” said Cliff Sarkin, policy director for California’s Insure the Uninsured Project.

But an exchange full of people whose health care costs are being subsidized by the federal government is problematic, other experts say, and expensive. According to Enthoven, the exchange needs to attract a majority of the unsubsidized individuals and businesses into the fold for the program to realistically compete with the outside market.

There are, however, measures that California’s exchange board could take to spread the risk out evenly. One way is to require that small businesses receiving government health subsidies offer coverage exclusively through the exchange – thereby guaranteeing a sizeable, moderately healthy pool of customers, Enthoven said.

Plus, California’s exchange board will be able to regulate the non-exchange market – which could go a long way toward giving insurers an incentive to participate in the exchange, said Sandra Shewry, the former executive director for the state board that oversaw HIPC.

“I think the No. 1 lesson and the No. 1 thing that congress did is realize the need to have the same insurance-market rules both inside and outside of the purchasing pool,” said Shewry, now an advisor on health reform implementation to state Health and Human Services Secretary Kim Belshé. &l
dquo;HIPC didn’t have that perfect alignment in and out, and that enabled HIPC to be selected against.”

And because California is getting started so early, the state is in a good position to work the kinks out of its exchange model, said Marian Mulkey, the director of health reform at the California HealthCare Foundation. Plus, she said, lots of people in California remember the problems that destroyed our first exchange program.

“We have the power of expertise,” Mulkey said. “We’ve been there. We know what didn’t work, and we’re determined this time to make it work.”

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