A Regulatory Bypass Operation

Published November 1, 2001

Even after the 1994 demise of then-President Bill Clinton’s national health care proposal, we’ve witnessed increasing federal regulation of health insurance.

The 1996 Health Insurance Portability and Accountability Act (HIPAA) applied yet another regulatory band-aid to problems caused by previous public policy errors. The system of federal and state regulation set in motion by HIPAA will inevitably drift toward increasing federal government involvement, and will also encourage a state race to the bureaucratic top.

More recently, this year’s Senate version of the Patients’ Bill of Rights suggested a new role for federal solvency regulation of health insurers. Federal regulators want to make certain the insurers’ pockets won’t be completely empty . . . at least not until after they’ve paid off the attorneys’ fees and judgments that will result from the lawsuits the bill will authorize and encourage.

New Arteries for Reform

Our health insurance system is increasingly burdened by thickening globs of regulatory sclerosis. It’s time to open up some new arteries for consumer-driven health care reform.

Step one in the regulatory bypass operation is diagnosis of the underlying condition: Consumers are not in control of their health care decisions. Public policy discourages them from retaining control of their health care dollars and hinders the availability of empowering options in the marketplace.

Step two requires that we move out of the box of conventional palliative therapy and address fundamentals. First and foremost, policymakers must neutralize the distorting effects of the income tax exclusion that favors employer-financed group insurance.

Any tax subsidy for health care spending should be available to all consumers, and it should flow directly to them–regardless of where they work or how they choose to purchase health care. Tax benefits for health coverage must be made portable at the individual level.

Current tax subsidies often operate as tax penalties on consumers seeking other types of coverage, whether it’s individual insurance, high-deductible policies coupled with personal saving vehicles, or simply different coverage than what one’s employer offers.

Tax equity would provide consumers with real choices in their health care arrangements and would decentralize decision-making. Consumers would be less likely to turn over to third parties key decisions regarding the scope and terms of their health insurance coverage. Preventive care? Dental or vision coverage? Low monthly premiums? The right to see any doctor, at any time? Those are the kinds of decisions consumers—not third parties—should be making for themselves and their families.

The Operation Continues

Step three is to develop better vehicles to pool health risks outside of the workplace, and to provide longer-term protection against the redefinition of health risks over time.

The best way to address the risk definition concerns of buyers in the individual and small-group markets is not through politically mandated pooling, with all risks—male and female, young and old, healthy and unhealthy—forced to pay the same premium. Instead, non-government purchasing pools could offer experience-rated, multi-period contracts to willing buyers, if pool sponsors can establish necessary ground rules.

Those rules would allow competing health plans to set their own premiums; experience-rate new entrants to the pool at the outset, if necessary; facilitate entry of new insurers to compete for pool business; and provide annual open enrollment periods.

Such purchasing pools would differ from the early versions of association health plan and health mart proposals. They should not be limited just to employers making collective decisions for all their employees. Individuals should be permitted to join the pools as well.

Pre-specified contractual restrictions would provide incentives for people to remain in the purchasing pool once enrolled. Exit disincentives would provide long-term protections and minimize adverse selection. Actuarially fair prices would be required at the outset.

Step four—and it’s a crucial step in the process—is to recognize the diverse preferences, characteristics, and needs of individual consumers. Respect the decisions they make. Enforce private contracts as they are written. Don’t prohibit risk-based pricing. Rely instead on targeted and transparent subsidies if market-set prices and coverage options don’t address the needs of low-income, medically high-risk, or other specific groups of people.

Of course, the Patients’ Bill of Rights legislation is poised to outlaw or override what remains of the already paltry and unimaginative contractual options available in today’s private health insurance market. Regulatory mandates, along with “judge-made insurance,” already discourage most efforts by insurers to stray very far from the medical community’s consensus view of what insurers should finance (“medical necessity”). Insurers these days are responding to the demands of judges and the medical profession, instead of offering consumers a range of coverage options that vary in quality, access, and pricing.

Accurate risk assessment often conflicts with the politicians’ desire to control the distribution of risk. But the problems of inadequate income to purchase insurance, or health conditions making someone medically uninsurable, can and should be addressed as social problems. Safety net subsidies, private charity, community-based clinics, and high-risk pools—not insurance—are the right mechanisms for addressing social problems.

Heading Off Regulatory Attack

The band-aid of increased federal regulation cannot cure what ails our health care system: an unstable structure of already over-regulated and over-subsidized employer-based health insurance.

Still further reliance on the federal government will burden the health care industry with a “one size fits all” regulatory framework resistant to competitive pressure. It would be prone to deliver just one “cure,” of comprehensive scope, likely to be the wrong one but difficult to reverse.

Which brings us to step five in the regulatory bypass operation. We need revitalized state regulatory competition that can reach across geographic boundaries.

Such competitive federalism could facilitate diversity and experimentation in regulatory approaches. It would slow down the second-guessing of market decisions, discipline the tendency of regulation to promote inefficient wealth transfers, and promote individual choice over collective decisions driven by interest group politics.

Insurers facing market competition across state lines would have strong incentives to disclose and adhere to policies that encouraged consumers to deal with them. Firms would migrate to state regulatory regimes that didn’t impose unwanted mandates but instead fit the needs of their customers. State lawmakers would become more sensitive to the possibility that over-regulated insurers would take their business elsewhere.

Competing Regulatory Regimes

State competition in health insurance regulation could be achieved through choice-of-forum clauses, and perhaps choice-of-law clauses, in insurance contracts.

Insurers would specify in each policy the state whose laws would govern that policy. Consumers, by purchasing a specific policy, consent to that choice of governing law. Policies purchased in Wisconsin, for example, wouldn’t necessarily be governed by that state’s laws. The insurer might offer a more expensive policy governed by the laws of regulation-heavy Illinois, and a less-expensive one governed by the laws of regulation-light New Jersey. Consumers who believe there are advantages in new and different regulatory approaches would be allowed to try them.

Critics of such competitive federalism will warn that a “race to the bottom” will take place, that states will offer the most lax, least expensive regulatory regime possible, leaving customers at the mercy of evil insurers.

Those critics fail to acknowledge we’ve already run a race to the bottom with over-regulation. The losers end up uninsured—because they can’t afford coverage, or because they refuse to overpay for it.

The race to the market top needs a full field of healthy state regulators running in each other’s markets. The five-step bypass operation prescribed here would get consumers, insurers, and state regulators in shape for that race—and everyone wins.

Tom Miller is director of health policy studies at the Cato Institute and contributing editor to Health Care News.