This is the story of how one state, New Jersey, destroyed its private individual health insurance market in the name of “health care reform.” It is a cautionary lesson to elected officials and policy analysts around the country.
New Jersey “Reform”
In the early 1990s, New Jersey embarked on an extensive health insurance “reform.” The three principal elements were:
1. Pure Community Rating: Neither age, gender, geography, nor health makes any difference in how much you pay.
2. Year-round Open Enrollment: No one can ever be denied coverage, regardless of current health.
3. Five Standardized Indemnity Plans and One Standardized HMO Plan: No other plans may be bought or sold in this market.
In short, New Jersey politicians and bureaucrats designed a one-size-fits-all solution for their individual health insurance market. Freedom of choice went away. Incentives to buy insurance while healthy went away. Recent high school graduates earning the minimum wage pay as much for health insurance as rich investment bankers living in Ridgewood, New Jersey, mansions.
Since 1995, these “reforms” have caused the number of people with private, individual health insurance to drop from 220,000 to 104,000. This is all the more alarming because the situation in New Jersey was already terrible. Based on national averages, a state the size of New Jersey should have roughly 750,000 people covered by private, individual health insurance plans.
Why Reform Failed
The New Jersey politicos overlooked one detail: They kept the decision to purchase health insurance optional. Had they made it mandatory, they would have at least forced cross-subsidization. Instead, they doomed the New Jersey individual health insurance market to a classic death spiral.
In a normal, competitive insurance marketplace, people will pay premiums even though they believe it is unlikely they will generate high claims, because they do not want to be without coverage in case they do. The insurer, on the other hand, must collect premiums equitably from everybody in the pool to finance the claims cost of the unlucky few whose claims are far in excess of the premiums they pay. The vast majority of insureds pay more premiums than they have claims, but a few unlucky ones have much higher claims than premiums.
The crucial thing is that the amount the many pay in excess of their claims cost, what we can call “excess premiums,” must roughly equal the claims generated by the few with high health care costs, what we can call “excess claims.” Figure 1 below shows how these two amounts are roughly equal in a competitive insurance market.
When guarantee issue and other insurance regulations enter the picture, the rules of the game suddenly change. Uncertainty is eliminated from the insureds’ side of the equation. If they are healthy, they do not need to pay premium dollars to the insurance company. Why should they? They can buy insurance when they need it!
As more people choose to go without insurance, the amount of excess premiums paid starts to shrink, but the excess claims do not. Figure 2 shows how heavy-handed regulation of insurance pricing leads to insufficient premiums paid by the many to subsidize the excess claims of the few.
Can you guess what’s next? Insurance premiums must be raised for those left in the pool to pay the excess claims. This leads still more people who cannot afford the higher premiums to drop their insurance, resulting in the situation shown by Figure 3. Note that people with excess claims have to keep their insurance no matter how expensive it gets.
Not Just a Story
So let’s say you’re 30, have a wife and two kids, and live in New Jersey. Your employer does not offer a group health plan, so you shop the market for private, individual health insurance. Get ready for sticker shock!
A boilerplate $500 deductible, major medical plan (Plan “D”) in New Jersey will set you back anywhere from $2,433 to $9,828 per month. That’s $29,196 to $117,936 per year. And don’t forget that if you’re buying private, individual health insurance, you buy it with after-tax dollars. If you’re in the 28 percent tax bracket, you have to earn over $41,000 to buy a $30,000 policy.
Is it any wonder so few people in New Jersey have private, individual health insurance? Could you afford to buy insurance at these prices?
What is remarkable is that liberal academics find ways to rationalize away these stultifying statistics. For example, in the July/August 1999 edition of Health Affairs (Vol. 18, No. 4), Katherine Swartz (Harvard School of Public Health) and Deborah Garnick (Brandeis University) defended this program as the “most sweeping set of state reforms to promote broadly based competition in the market for individual health insurance.” They actually had the audacity to state the plan “is a model for other states wishing to increase access to health insurance via market-oriented solutions that do not involve increased government financial obligation.”
Pure nonsense, and bad advice for elected officials who want to do the right thing . . . or at least get reelected!
A Better Reform Plan
Health insurance, like all insurance, is founded upon risk. Both the insurer and the insured must be at risk. Coverage must be based upon risk factors. Rates must be based upon risk factors. When risk is not properly assessed and evenly shared, the end result ceases being insurance.
The best system for private, individual health insurance contains these elements:
- Carriers are permitted to underwrite and reject applicants who do not meet their underwriting guidelines.
- The state establishes a comprehensive health insurance plan so that people rejected in the private market can buy quality, heavily subsidized health insurance. More than half the states have such pools and they work well.
- Carriers are permitted to rate risks according to generally acceptable actuarial principles.
- Carriers are prohibited from singling out insured people who get sick for larger rate increases than people who remain healthy.
- Regulators are concerned primarily with the solvency of carriers. Guaranteeing that carriers can meet their obligations should be the principal guide to regulators in their behavior.
- Politicians are chiefly concerned with fostering availability of products and competition among carriers.
One would have thought New Jersey policymakers would have awakened by now to the calamity in the state’s private, individual health insurance market. Perhaps they will wake up when nobody can afford to buy private, individual health insurance coverage any longer.
Lee Tooman is vice president of government relations for Lawrenceville, Illinois-based Golden Rule Insurance Company.
