Government as Reinsurer: Potential Impacts on Public and Private Spending

Transcription

1 Linda J. Blumberg John Holahan Government as Reinsurer: Potential Impacts on Public and Private Spending This paper analyzes the potential effects of alternative government reinsurance mechanisms on public and private expenditures in group and nongroup health insurance markets. High reinsurance thresholds, with the government taking responsibility for costs over $50,000 per year, would absorb a small share of private costs. Lower thresholds would have greater effects, but would increase government costs significantly. We also find that reinsurance would reduce the variance in expenditures considerably and should reduce risk premiums charged by private insurers. We conclude that focusing on small employers and the nongroup market could target government spending where costs are highest and insurance markets most unstable. In voluntary health insurance markets, issues of risk selection and risk segmentation have important effects on the type and number of individuals or groups insured, and the costs associated with insuring them. Precisely because risk issues can be decisive in the outcome of health insurance reform proposals, greater attention is being paid to the idea of the government as reinsurer for the excess costs associated with people who have high medical expenses. In such a capacity, the government would fund some portion of the medical costs associated with high-cost individuals, and would finance that spending in as broad a way as possible (i.e., general revenues, income taxes). The key notion behind government reinsurance is that local risk pools (small group and nongroup insurance markets), in which a relatively low number of high-cost individuals can have significant effects on premiums, are inefficient mechanisms for spreading the costs associated with the high risk because they are too small. One component of the health care reform proposal suggested by Democratic presidential candidate Sen. John Kerry consists of a reinsurance plan for the group market (Kerry 2004). Proposals also have surfaced in academic circles: Swartz (2001a,b, 2002, 2003, 2004) proposed that government act as the reinsurer for the private nongroup insurance market, while Holahan, Nichols, and Blumberg (2001) suggested that government finance the excess costs of the high risk in both group and nongroup insurance settings. In addition, a public reinsurance mechanism is currently in place as a component of the Healthy New York program (Lewin Group 2003). This paper uses the Medical Expenditure Panel Survey-Household Component (MEPS-HC) for the years 1998 through 2000 to assess the impact of an array of government reinsurance mechanisms on average health expenses, and the variance of those expenses in different segments of the insurance market. We include analyses of Linda J. Blumberg, Ph.D., is a senior research associate, and John Holahan, Ph.D., is director of the Health Policy Center, both at the Urban Institute. Address correspondence to Dr. Blumberg at the Urban Institute, 2100 M St., N.W., Washington DC LBlumber@ui.urban.org Inquiry 41: (Summer 2004). Ó 2004 Excellus Health Plan, Inc /04/

2 Government as Reinsurer the effects of policies on the nongroup and group markets. The next section provides background on the distribution of risk and risk segmentation and outlines possible design options government might consider if it becomes a reinsurer. The third section describes the data used and defines the relevant variables. The fourth section outlines the types of reinsurance policies simulated here. The fifth section presents our empirical results, and a conclusion follows. Our major findings include: u Government reinsurance for the portion of expenses exceeding thresholds as high as $50,000 per year would have very modest expected effects on private costs. This is because: 1) very few people incur expenditures of this level; and 2) the majority of costs for those whose expenses do meet this threshold are attributable to their first $50,000 of spending. u While lower thresholds (e.g., $15,000 per year or the top 3% of spenders) increase government costs significantly, reinsurance focusing on the most vulnerable markets those covering small employers and individual purchasers are more feasible from a budgetary standpoint. u A reinsurance approach that lowers expenses by less than 10% still can lower the variance in expenditures to a dramatic extent on the order of 50% or more. Such a reduction in variance could lead to additional premium savings, given that risk aversion is a big factor in insurer pricing. Background As others have shown (Berk and Monheit 2001; Monheit 2003), the distribution of health expenditures is highly skewed. A small share of the population incurs a large share of health expenditures, while many individuals incur little or no health expenditures at all. Berk and Monheit used the 1996 Medical Expenditure Panel Survey and found that the top 1% of spenders in the U.S. population accounted for 27% of health care expenditures, while the bottom half of spenders accounted for only 3%. Because health insurance premiums are determined as a function of the average costs of those individuals enrolled in a particular insurance risk pool, this distribution of expenditures creates enormous incentives for insurers to segment enrollees into different premium rating pools based upon their expected costs and, when possible, to avoid enrolling the highest cost segments of the population. Identifying and selecting good risks are much more profitable than providing efficient care to bad risks (Newhouse 1994; Swartz and Garnick 2000; Blumberg and Nichols 2004). The financial risks associated with adverse selection are greatest for small groups and for individuals markets where the variances of costs are the largest. Addressing the issues of risk segmentation and adverse selection is fundamental to the development of strategies to expand coverage and to improve the performance of existing health insurance markets (Blumberg and Nichols 1996; Swartz 2003). Regulatory reforms of health insurance markets, many of which were implemented in the 1990s, were intended to address issues of risk segmentation and selection as well. Reforms such as community rating (both pure and modified), guaranteed issue, limits on pre-existing condition exclusions, portability, and guaranteed renewal increased the extent to which heterogeneous risks were pooled together for purposes of setting premiums, relative to what would have occurred in an unregulated market. Evidence from the implementation of these reforms suggest that their net effects on coverage were relatively small (Nichols 2000). Premiums tended to decline for high-risk individuals and increase for low-risk individuals. In certain markets, these changes led to a modest decline in the number of covered lives as low-risk individuals exited in response to the higher premiums. Generally speaking, however, the larger number of low-risk people compared to high-risk people means that the premium increases were not substantial enough to have tremendous impacts on the overall level of premiums. These regulatory reforms spread the costs of high-risk people somewhat more broadly within the particular subpopulations voluntarily choosing to obtain coverage within particular insurance markets. For example, 1993 reforms to nongroup insurance regulations in New York changed how risk was shared across the relatively small number of individuals who chose to purchase private nongroup coverage in New York (Buchmueller and DiNardo 2002). 1 The same is true for small group insurance reforms. Therefore, since the populations over which the risk can be spread 131

3 Inquiry/Volume 41, Summer 2004 are limited, the burden of the high cost on any particular individual can be significant. In addition, because of the voluntary nature of insurance coverage in the United States, any individual or group can completely opt out of a particular market, thus avoiding sharing the burden of others risks completely. Public reinsurance is a strategy for addressing the costs of higher-risk people while keeping them in the existing markets in which they obtain coverage (Claxton 2002). Having the government finance the costs of people at highest risk can spread those costs very broadly if desired. In fact, the financing of such a program can encompass the full tax-paying population, regardless of insurance status. This approach not only differs from existing market regulations, but also contrasts with other programs and proposals that would have higher-risk people receive their insurance through distinct sources state high-risk pools, for example. Government reinsurance has some obvious advantages in addition to the capacity to spread costs much more broadly. First, public reinsurance would allow higher-risk individuals to have more choice of insurance plans, consistent with their low-risk counterparts. This expanded choice would occur because insurers incentives to exclude individuals whom they expect to be very high cost would be diminished with the government covering at least a portion of these high costs. In addition, the incentive to significantly rate up premiums charged to those with high expected costs would be reduced as well, making premiums for these individuals more affordable and providing them with increased access to an array of plans. Second, public reinsurance would provide consistency in coverage and source of coverage as individuals moved from being low cost to high cost, and then back again to low cost over time. Third, it would decrease the incentive for insurers to screen applicants for potential high costs, thereby reducing administrative costs for all insured people. While private reinsurance does exist in some markets, such products do not address the critical issues that are the focus of a public reinsurance approach. Voluntary private reinsurance policies are subject to the same selection concerns as are the insurers that they are designed to cover. Those insurers that historically have attracted high-cost individuals and high-cost groups find the private reinsurance products either very expensive or inaccessible to them. In addition, the costs of the reinsurance products must be passed back to the individuals and groups purchasing the original insurance, again creating incentives for low-risk individuals and groups to avoid the burden of risk sharing by opting out of the insurance completely. If we accept the notion that at least a portion of the expenses associated with higher-cost individuals is a broad social responsibility, there are a variety of ways in which a public reinsurance program can be structured. Programs can be designed for the private nongroup market alone, the group market, or both. Programs also can focus on segments of a particular market, for example, small group insurance. Similar to options available today through private reinsurance policies, reimbursable expenses may be designated as the costs associated with individuals with expenditures exceeding a particular threshold, or reimbursement may occur once an insurer has incurred a specified aggregate level of expenses for a particular group of enrollees. Claxton (2002) notes two additional targeting strategies one based upon health screening at the time of enrollment and another based upon the presence of particular medical conditions. While these targeting approaches are not considered true reinsurance in the technical sense of the term, they are options that can be used to target financing to certain high-cost cases. Targeting individuals at the top of the health expenditure distribution, for example the 3% or 10% of individuals with the highest expenses, would be an approach more consistent with the usual definition of reinsurance. Percentile thresholds could be determined using nationally representative data on health expenditures (such as the MEPS-HC) and then implemented in the same way as an absolute dollar threshold. Once a threshold level of expenditures is chosen, the design also has to specify the particular health expenditures that can be applied to that threshold. For example, are only those expenses that are reimbursable by the insurer counted toward the chosen threshold level, or are out-ofpocket expenses paid by the individual counted as well? This design option highlights the complexity of existing markets where insurers offer and individuals/groups purchase insurance with very different benefit packages. For example, if only insurer-covered expenses can apply to reach 132

4 Government as Reinsurer a specified threshold, an individual with a lower deductible will be more likely to hit the threshold than will the same person with a high deductible policy. Consequently, chosen thresholds can vary with the generosity of benefit packages, out-ofpocket expenses can be counted toward the threshold, or some combination of approaches can be used. Once the target population, thresholds, and relevant expenditures were established, a public reinsurance policy also would have to identify the extent to which those targeted expenses would be reimbursed. Options range from full reimbursement of insured expenses for those identified as high cost to partial reimbursement for those whose expenses exceed the threshold. The latter is more consistent with the technical definition of reinsurance, however. Examples from existing proposals are helpful for illustrative purposes. John Kerry has proposed a public reinsurance mechanism for the private group market that would reimburse employee health plans for 75% of the costs they incur above a catastrophic threshold (Kerry 2004). 2 Swartz (2003) provides an example where government reinsurance would cover private nongroup insurance expenses at variable rates, beginning when expenses exceed $40,000 per year. Reinsurance would be responsible for: 90% of costs between $40,000 and $75,000; 85% of costs between $75,000 and $125,000; 90% between $125,000 and $200,000; and 100% above $200,000. Others (e.g., Holahan, Nichols, and Blumberg 2001) have suggested approaches that would provide broader opportunities for spreading risk, with government subsidies available to cover the costs of those exceeding median levels of expenditure. The Healthy New York program has tried a number of different reinsurance options, including assumption of 90% of costs for claims between $30,000 and $100,000 and, alternatively, 90% of costs for individual claims between $5,000 and $75,000 (Lewin Group 2003). Data and Methodological Approach Data The analyses presented in this paper are based upon 1998, 1999, and 2000 data from the Medical Expenditure Panel Survey Household Component. The MEPS-HC is nationally representative of the noninstitutionalized population and collects data on: demographic characteristics, health conditions, health status, use of medical services, charges and payments, health insurance coverage, income and assets, and employment (AHRQ 2004). The MEPS-HC employs an overlapping panel design. Data are collected from each household in several rounds covering two full calendar years. A new sample of households is introduced into the survey process each year, providing the overlapping panels of data. The sample size is roughly 25,000 individuals per year of data. Because of small samples in some of the subpopulations of interest (e.g., those covered by private nongroup health insurance), we merged data from three years of the MEPS. Expenditures in each year were inflated to 2004 dollars (as described later). Weights were adjusted downward so that the combined sample would reflect the population size represented in the 2000 survey. Each person weight was multiplied by a single factor equal to the sum of the weights in the 2000 survey divided by the sum of the weights in the three surveys combined. This adjustment factor was computed based upon the full populations in the surveys. Approach Our analysis simulates the potential implications of implementing a public reinsurance program in existing private health insurance markets. We assume that the full costs of the reinsurance programs are absorbed by the federal government. In other words, we assume for the purposes of exposition that no premiums are charged to insurers for the reinsurance program. The simulations do not adjust for possible behavioral responses to the programs (by individuals or insurers) because there is no sound basis for making such adjustments. For example, to the extent that reinsurance is successful in lowering premiums and/or out-of-pocket requirements, individuals may have less incentive to choose the most efficient providers and may consume more health care services. Additionally, insurers may put less emphasis on managing high-cost cases efficiently, thereby leading to higher total levels of spending than would occur in the absence of public reinsurance. On the other hand, management disincentives can be tempered if the insurers are required to continue to bear some of the risk for high-cost cases, as true reinsurance would 133

5 Inquiry/Volume 41, Summer 2004 require. Alternatively, government could offset behavioral responses by imposing its own management of high-cost cases. People also may switch coverage in response to public reinsurance. To the extent that reinsurance schemes lower premiums, some individuals who are currently uninsured or who are insured through other markets may purchase coverage in the reinsured markets. These new entrants may increase the government costs associated with the policy, depending upon the particular design of the program and on the health cost profile of the new entrants. Again, in the absence of any evidence on such behavior, such a response to the policies is not taken into account here. Given these possible but uncertain behavioral responses, the estimates presented here should be treated as reasonable first approximations of the magnitude of the impacts of such programs on private markets. We confine our simulations to reinsurance programs that would reimburse the expenses associated with high-cost individuals, as opposed to reimbursing for high aggregate expenses in an insured group. We limit ourselves in this way due to data constraints there are no publicly accessible data that would provide expenditure data by group. The MEPS-HC is ideal, however, for examining the distribution of individual expenditures and identifying high-cost cases. 3 The particular contours of the policies simulated are described in the next section. We define relevant expenditures as those paid by private insurance or by individuals out of pocket. This definition is consistent with the approach described previously that allows us to avoid the complexity of variations in existing benefit packages for analytic purposes. Federal costs presented in the paper also are computed based upon the total costs paid by private insurers and by individuals out of pocket. While reimbursement of out-of-pocket costs generally are not included in public reinsurance proposals, the data do not allow us to identify the portions of out-of-pocket or insurer-reimbursed costs that were incurred above or below a particular threshold level of spending; consequently, it is more straightforward to treat them equivalently here. While this approach tends to overstate the government costs of a reinsurance program, it also serves to counteract somewhat the understatement of costs due to potentially cost-increasing behavioral responses of individuals and insurers. As already noted, such behaviors are not estimated in our simulations. Finally, people 65 and older are excluded from the analysis. 4 We inflate expenditures from the MEPS-HC in two ways: 1) to take into account a recognized undercount in aggregated individual expenditures in the MEPS relative to the National Health Accounts (Selden et al. 2001), and 2) to take into account the growth in per capita health expenditures between the survey years and 2004 (CMS 2004). Analytic work by researchers at the Agency for Healthcare Research and Quality (AHRQ) and the Centers for Medicare and Medicaid Services (CMS) has demonstrated that when the individual health expenditures in the MEPS are aggregated, the expenditures are low compared to National Health Accounts spending data. To compensate for this undercount, we increase privately insured health expenditures in our MEPS-HC analytic file by 27%. This adjustment is consistent with the undercount of privately insured expenditures identified by Selden et al. (2001). We use growth in per capita out-of-pocket health care spending and per capita private health insurance payments from the National Health Accounts data to inflate MEPS expenditures from Time period Privately insured expenditures Out-of-pocket expenditures 1998 to % 31.2% 1999 to % 25.9% 2000 to % 21.7% 1998, 1999, and 2000 to 2004 dollars. The growth rates used are as follows: As detailed in the next section, this analysis assesses the effects of reinsurance policies on a number of insurance markets separately. Individuals are included in computations for the private nongroup health insurance market if the individual has been covered by private nongroup insurance for at least part of the calendar year. 5 Likewise, expenditures for all those covered by employer-group insurance for at least part of the year are included in the group market analyses. Because MEPS provides annual expenditure values only, spending cannot be attributed to the particular periods in which an individual had insurance coverage of the relevant type. Again, this 134

6 Government as Reinsurer approach tends to overstate the costs associated with a particular reinsurance scheme. In the case of analyses focused on small group insurance coverage, expenditures are included for policyholders and their dependents receiving coverage through a small employer. Expenditures associated with any employer-sponsored insurance (ESI) policyholders in the family who receive their coverage through a large employer are excluded from the estimates of effects on the small employer market. The steps of our simulation methodology are as follows: u Identify cases that satisfy the definition of high cost; u Tabulate total expenses eligible for reinsurance; u Apply assumption about the percentage of eligible expenses reinsured; u Calculate variance of private expenses in the risk pool with and without public reinsurance. Reinsurance Designs Studied We use six alternative rules for designating highcost individuals: u Expenditures at or above $50,000 in the year; u Expenditures at or above $30,000 in the year; u Expenditures at or above $15,000 in the year; u Expenditures in the top 3% of the expenditure distribution for their private insurance market; u Expenditures in the top 10% of the expenditure distribution for their private insurance market; u Expenditures in the top 25% of the expenditure distribution for their private insurance market. These thresholds provide a broad range of generosity of reimbursement, and encompass the levels of prominent proposals in this area. To place these thresholds in perspective, average private expenditures are $2,656 per year in the employer group market and $2,516 per year in the private nongroup market, defined as in the previous section. The dollar amounts associated with the top 3% of the expenditure distribution are $15,172 per year for those with employer-sponsored insurance, and $14,041 for those with nongroup coverage. The thresholds associated with the top 10% of the distribution are $6,103 in the group market and $4,919 in the nongroup market. The top 25% threshold amounts are $2,197 and $1,748, respectively. We also simulate three variations in the level of reimbursement provided for high-cost cases: u Full reimbursement of expenses for high-cost cases; u Reimbursement of 75% of expenses exceeding the threshold; u Reimbursement of 90% of expenses exceeding the threshold. Our analyses focus on the potential implications of the reinsurance policies on four private health insurance markets: 1) the full employer group market, including all employer sizes; 2) the small group employer market defined as establishments with fewer than 25 workers; 3) the small group market defined as establishments with fewer than 100 workers; and 4) the full, private nongroup insurance market. Empirical Results The distribution of health spending in the United States is highly skewed. Table 1 shows that the top 1% of the population with the highest expenditures accounts for about one-quarter of all spending, the top 2% accounts for about onethird, and the top 5% about half. 6 The data also show that this general pattern holds true for nonelderly individuals with different insurance arrangements. For those with nongroup coverage, the very highest spenders account for a somewhat larger percentage of all spending compared with the population as a whole. In Table 2, we show the effect on private expenditures under the alternative reinsurance arrangements detailed in the previous section. The results show that if the government provides reimbursement for only the costs (or a portion of the costs) exceeding a particular threshold amount, the threshold has to be relatively low for this arrangement to have a significant effect on private costs. If, however, the full costs (both above and below the threshold) are reimbursed for those whose spending exceeds a given amount, higher thresholds can have substantial impacts on private costs as well. For example, if the government paid 75% of the cost above a $50,000 threshold, private costs associated with the population covered by ESI would fall by 5.9% (column 1, row 1). The same policy imple- 135

7 Inquiry/Volume 41, Summer 2004 Table 1. Distribution of health expenditures Entire population (%) Nonelderly individuals with some ESI (%) Nonelderly with some nongroup coverage (%) a Nonelderly with some ESI through establishments <25 (%) b Nonelderly with some ESI through establishments <100 (%) c Top 1% Top 2% Top 5% Top 10% Top 25% Top 50% Source: Urban Institute analysis of MEPS-HC. All dollar values inflated to Notes: Health expenditures include out-of-pocket spending and spending reimbursed by private health insurance. a Excludes those with full-year ESI. b Includes those policyholders working for establishments of fewer than 25 workers, and their dependents who report ESI coverage, c Includes those policyholders working for establishments of fewer than 100 workers, and their dependents who report ESI coverage, mented in the portion of the group market covering establishments with fewer than 100 workers would reduce private costs by 4.5% (column 1, row 3). However, there is a substantially greater reduction in private costs if the government assumes all costs associated with individuals who exceed the threshold (including dollars below the threshold). Such a policy implemented in the full employer market would reduce private costs by more than 15% (column 3, row 1). The same policy focusing exclusively on the market of employers with fewer than 100 workers would reduce private costs in that market by almost 13%. Estimates in the third column also can be thought of as the share of expenditures attributable to those with spending above a given threshold. The differences in the results of policies that provide reimbursement of expenditures above a particular threshold and reimbursement of all expenses for those spending at least as much as the threshold illustrate the importance of this design choice for the potential effects on private markets. At high threshold levels, a large share of even a high-cost individual s total expenditures fall below the threshold amount. For example, in the ESI market, for those whose spending exceeds the $50,000 threshold, an average of 63% of expenditures is attributable to their first $50,000 of expenditures (data not shown). The percentage savings in private costs increase if the threshold is lowered from $50,000 to $30,000, but the savings are still relatively small, with the exception of the policy in which the government pays for full expenses. Lowering the threshold to $15,000 begins to result in significant reductions in private expenditures, even when expenditures in excess of the threshold are the only ones reimbursed. For example, if the government paid 75% of the costs above a $15,000 threshold, the private costs of employer-sponsored insurance would fall by 16.1%; the private costs of ESI in establishments with fewer than 25 and fewer than 100 workers would fall by over 14%, and the private costs of nongroup policies would fall by 21.2%. If costs associated with the top 3% of spenders in each insurance market were reimbursed, the effect would be quite close to the $15,000 threshold. Private savings increase substantially if the government sets the threshold at the top 10% of spenders, and rise dramatically if the threshold moves to the top 25% of spenders. For example, a policy that reimbursed 75% of costs exceeding the top 10 th percentile s spending level would lead to a 30% savings for private payers in the ESI market, and a 37% savings in the private nongroup market. The same policy applied to the top 25 th percentile would lead to savings in the ESI market of 47% and savings in the nongroup market of over 50%. In summary, government reinsurance policies that have a high threshold and only reimburse for costs exceeding that threshold will have only modest effects on reducing expenditures in the private group and nongroup markets. The effect of these policies on reducing premiums could 136

8 Government as Reinsurer Table 2. Reduction in private costs resulting from different reinsurance approaches Threshold Government pays for 75% above threshold (%) Government pays for 90% above threshold (%) Government pays for full expenses (%) $50,000 Nonelderly individuals with some ESI Establishments, 25 a g g g Establishments, 100 b Nonelderly individuals with some nongroup c g g g $30,000 Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c g g g $15,000 Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 3% of spenders d Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 10% of spenders e Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 25% of spenders f Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Source: Urban Institute analysis of MEPS-HC. All dollar values inflated to Notes: Health expenditures include out-of-pocket spending and spending reimbursed by private health insurance. a Includes those policyholders working for establishments of fewer than 25 workers, and their dependents who report ESI coverage, b Includes those policyholders working for establishments of fewer than 100 workers, and their dependents who report ESI coverage, c Excludes those with full-year ESI. d The 3% threshold for those with ESI is $15,172; for those with nongroup it is $14,041; for those with ESI through an establishment with fewer than 25 workers it is $13,998; and for those with ESI through an establishment of fewer than 100 workers it is $13,531. e The 10% threshold for those with ESI is $6,103; for those with nongroup it is $4,919; for those with ESI through an establishment of fewer than 25 workers it is $5,312; and for those with ESI through an establishment of fewer than 100 workers it is $5,120. f The 25% threshold for those with ESI is $2,197; for those with nongroup it is $1,748; for those with ESI through an establishment of fewer than 25 workers it is $1,876; and for those with ESI through an establishment of fewer than 100 workers it is $1,821. g Results not shown due to small sample sizes. be greater than the effect on expenditures, however, to the extent that they reduce year-to-year uncertainty faced by insurers. The reductions in variance of expenditures resulting from these reinsurance policies are discussed subsequently. Table 3 examines the cost to government of different reinsurance approaches. The one-year government cost for a reinsurance policy in the employer market with a threshold of $50,000 and reimbursement of 75% of costs exceeding that threshold is $26.2 billion. If this reinsurance were limited to employers with fewer than 100 workers, the cost would be $5.2 billion. Government costs increase somewhat if the government 137

9 Inquiry/Volume 41, Summer 2004 Table 3. Government costs resulting from different reinsurance approaches Threshold Shares of expenditures attributable to those with spending above threshold (%) Government costs ($ billions) 75% above threshold 90% above threshold Full expenses $50,000 Nonelderly individuals with some ESI Establishments, 25 a g g g g Establishments, 100 b Nonelderly individuals with some nongroup c g g g g $30,000 Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c g g g g $15,000 Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 3% of spenders d Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 10% of spenders e Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 25% of spenders f Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Source: Urban Institute analysis of MEPS-HC. All dollar values inflated to Notes: Health expenditures include out-of-pocket spending and spending reimbursed by private health insurance. a Includes those policyholders working for establishments of fewer than 25 workers, and their dependents who report ESI coverage, b Includes those policyholders working for establishments of fewer than 100 workers, and their dependents who report ESI coverage, c Excludes those with full-year ESI. d The 3% threshold for those with ESI is $15,172; for those with nongroup it is $14,041; for those with ESI through an establishment with fewer than 25 workers it is $13,998; and for those with ESI through an establishment of fewer than 100 workers it is $13,531. e The 10% threshold for those with ESI is $6,103; for those with nongroup it is $4,919; for those with ESI through an establishment of fewer than 25 workers it is $5,312; and for those with ESI through an establishment of fewer than 100 workers it is $5,120. f The 25% threshold for those with ESI is $2,197; for those with nongroup it is $1,748; for those with ESI through an establishment of fewer than 25 workers it is $1,876; and for those with ESI through an establishment of fewer than 100 workers it is $1,821. g Results not shown due to small sample sizes. were to cover 90% of the costs above the threshold. Paying the entire cost for those individuals who exceed the threshold (i.e., a full buy-out of high-cost cases), increases government costs substantially. For example, if the government paid the full expenses for those in the ESI market whose spending exceeded a $50,000 threshold, the costs would be approximately $70 billion per year 2.7 times the cost of reimbursing 75% of the costs exceeding that threshold. Government costs increase as the threshold is lowered, and the $30,000 threshold is signifi- 138

10 Government as Reinsurer cantly more expensive than the $50,000 one. If the government covered 75% of the costs above the $30,000 mark, the price tag for the reinsurance would be $40.9 billion for the entire employer insurance market, $6.7 billion for the market of establishments with fewer than 25 workers, and $8.6 billion for the market of establishments with fewer than 100 workers. Not surprisingly, costs are substantially higher if the threshold is set at $15,000. If the government covered 75% of the ESI costs exceeding a $15,000 threshold, reinsurance would cost $71.5 billion per year. Limiting the provision of reinsurance with a $15,000 threshold to the market covering establishments with fewer than 25 workers, or alternatively to 100 workers, would lower the cost to the government substantially to $12.6 billion and $16.6 billion, respectively. If this policy were applied to the nongroup market alone, the one-year cost would be only $4.2 billion, owing to the much smaller size of this market. If the government were to cover expenditures for the top 3% of spenders in the ESI market, the program costs would be very similar to those for a $15,000 threshold. Increasing the threshold to cover expenses for the top 10% and top 25% of spenders raises government costs enormously. However, reinsurance at even these generous levels in the nongroup market, as small as it is, would not exceed about $10 billion per year. The variability of expenditures for those in the private nongroup market is much larger than that in the group market under current law. This greater degree of variability is precisely what causes insurers to add risk premiums onto the premiums they charge to individual purchasers, thereby reducing the insurers financial exposure to the possibility of attracting a relatively high-cost selection of enrollees. The baseline coefficient of variation of expenditures in the group market is.02 compared to.17 in the nongroup market (data not shown). 7 Table 4 shows that providing reinsurance would reduce substantially the variance of private health expenditures in all markets. Without reinsurance, insurers face the highly skewed distribution shown in Table 1. By providing reinsurance, with the government paying a substantial share of the cost above the threshold, insurer liability for the high end of the expenditure distribution is reduced substantially. With a $50,000 threshold and reimbursement of 75% of the excess costs, the variance in spending in the entire employer market is reduced by about 50%. Lowering the threshold to $30,000 or to $15,000 reduces the variance in private expenditures considerably more. For example, with a reinsurance threshold of $15,000, the variance is reduced by at least 70% whether the government pays 75% or 90% of the costs above the threshold. Given a reinsurance design, the reduction in variance in the nongroup market would be greater than in the group market. This occurs because the baseline variance (absent reinsurance) in the nongroup market is so much greater than that in the group market. Consequently, a 98% reduction in variance in the nongroup market does not imply that virtually all of the variation in that market has been eliminated. In essence, in the nongroup market, reinsurance of full expenses for those in the top 3% of the expenditure distribution would leave the nongroup market with a variance comparable to that found in the baseline group market. Putting the nongroup market and the group market on similar footing in this respect would be a desirable outcome. Conclusions We have examined the fiscal implications of the government acting as a reinsurer in private health insurance markets. The results show that if the government restricted its reimbursements to a share of the expenditures exceeding a certain threshold, the government would need to provide reinsurance above relatively low thresholds (e.g., $15,000) to have a significant effect on private expenditures. However, the lower the threshold, the higher would be the government costs associated with financing the program. Private insurance premiums likely would fall by more than the reductions in private expenditures suggest because the reinsurance mechanism would reduce the variance in private expenditures, and thus the risk to insurers of the impact of a high-cost individual. As a result, insurers could be expected to become less aggressive in underwriting and marketing, and other administrative expenses likely would fall. In other words, there would be efficiency gains resulting from the transfer of risk to the government. These additional savings are very difficult to predict, however. 139

11 Inquiry/Volume 41, Summer 2004 Table 4. Reduction in variance of private health expenditures resulting from different reinsurance approaches Threshold Share of expenditures attributable to those with spending above threshold (%) Percentage reduction variance Government pays for 75% above threshold Government pays for 90% above threshold Government pays for full expenses $50,000 Nonelderly individuals with some ESI Establishments, 25 a g g g g Establishments, 100 b Nonelderly individuals with some nongroup c g g g g $30,000 Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c g g g g $15,000 Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 3% of spenders d Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 10% of spenders e Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Top 25% of spenders f Nonelderly individuals with some ESI Establishments, 25 a Establishments, 100 b Nonelderly individuals with some nongroup c Source: Urban Institute analysis of MEPS-HC. All dollar values inflated to Notes: Health expenditures include out-of-pocket spending and spending reimbursed by private health insurance. a Includes those policyholders working for establishments of fewer than 25 workers, and their dependents who report ESI coverage, b Includes those policyholders working for establishments of fewer than 100 workers, and their dependents who report ESI coverage, c Excludes those with full-year ESI. d The 3% threshold for those with ESI is $15,172; for those with nongroup it is $14,041; for those with ESI through an establishment with fewer than 25 workers it is $13,998; and for those with ESI through an establishment of fewer than 100 workers it is $13,531. e The 10% threshold for those with ESI is $6,103; for those with nongroup it is $4,919; for those with ESI through an establishment of fewer than 25 workers it is $5,312; and for those with ESI through an establishment of fewer than 100 workers it is $5,120. f The 25% threshold for those with ESI is $2,197; for those with nongroup it is $1,748; for those with ESI through an establishment of fewer than 25 workers it is $1,876; and for those with ESI through an establishment of fewer than 100 workers it is $1,821. g Results not shown due to small sample sizes. Government reinsurance also would have the effect of spreading the risk of high-cost cases across a broader base of payers. Such a policy would spread the costs associated with high spenders beyond the particular markets in which they were insured; all individuals in the country would share in the financing of these costs through general revenues. Such a policy would 140

12 Government as Reinsurer Table 5. Simulated effects of a targeted reinsurance policy (reinsurance of 75% of expenditures for those in the top 3% of the spending distribution) Market Share of market s expenditures reinsured (%) Government cost (in billions $) Relative reduction in variance (%) Small group (,100 workers) a Nonelderly individuals with some nongroup b Total c 79.0 Source: Urban Institute analysis of MEPS-HC. All dollar values inflated to Notes: Health expenditures include out-of-pocket spending and spending reimbursed by private health insurance. The 3% threshold for those with ESI is $15,172; for those with nongroup it is $14,041; for those with ESI through an establishment with fewer than 25 workers it is $13,998; and for those with ESI through an establishment of fewer than 100 workers it is $13,531. a Includes those policyholders working for establishments of fewer than 100 workers, and their dependents who report ESI coverage, but who are not themselves policyholders through a larger establishment. b Excludes those with full-year ESI. c The total is not equal to the sum of the small group and nongroup costs because some individuals had part-year coverage in both markets. Expenses associated with those individuals are not double counted in the total. reduce the current disincentive to purchase coverage for low-risk individuals, while at the same time it would increase the affordability of coverage for high-cost people. The results do show that it is possible to design a targeted reinsurance policy that could have many desirable effects. Insurance in the small group market and the nongroup market is expensive. Providing reinsurance in these smaller markets could significantly lower private costs and, in turn, premiums, without dramatically increasing government expenditures. Since these markets are accessible to those with high rates of uninsurance, a reinsurance policy could spread their risks more broadly, reducing premiums enough to have a positive effect on the number of people with coverage. Unless thresholds were set relatively low, however, the coverage effect would unlikely be very large. These results suggest that a policy providing government reinsurance for cases in the top 3% of the expenditure distributions in the nongroup market and in the employer market for establishments with fewer than 100 workers (roughly the same as $14,000 thresholds in those markets) would cost the government about $23 billion a year, assuming the government paid 75% of the costs incurred above the threshold (Table 5). Such a program would reduce private expenditures in the small group market by almost 16%, and in the nongroup market by 22%. Premiums would be likely to fall by more than these estimates because of the large reduction in the variance in expenditures faced by insurers. While the effect of the variance reduction on premiums is unknown, it could be quite large. 8 A reinsurance policy could both stabilize these insurance markets and result in an increase in coverage. The magnitude of the effect on coverage depends on the size of the reduction on premiums. Obviously a reinsurance policy could adopt far more generous thresholds at a much higher government cost, and have greater effects on private spending and coverage. However, the intent of reinsurance is not to be a mechanism for eliminating uninsurance. Subsidizing high-cost cases through reinsurance is meant to provide more stable private health insurance markets, thus making those markets more attractive and accessible to individuals of all risk classes. Such reforms, however, will have to be coupled with expansions of public programs and/or direct subsidization of the purchase of private coverage for low-income populations in order to comprehensively address the problem of uninsurance in the United States. Notes The views expressed are those of the authors and do not necessarily reflect the views of the Urban Institute or its sponsors. The authors are grateful for research assistance provided by Fred Blavin and for comments from Katherine Swartz, Joel Cantor, Jack Hadley and Steve Zuckerman. 141

13 Inquiry/Volume 41, Summer These reforms pre-dated the current Healthy New York program. 2 The Kerry health care reform plan includes an array of policy proposals, with reinsurance for employer groups being only one component. Other policies in the plan include: expanded eligibility for public programs, expanded access to the Federal Employees Health Benefit Plan, tax credits to small employers, malpractice reform, incentives for quality improvement, administrative simplification, and tax credits to assist the unemployed and near-elderly to purchase coverage. 3 The fact that the MEPS-HC excludes the institutionalized population limits our ability to identify a portion of high-cost individuals, however. 4 The analytic samples do include some nonelderly individuals who had public insurance coverage for at least part of the year in addition to private coverage for at least part of the year. However, any medical expenses paid by public programs on behalf of these individuals are not included in the analysis. 5 There are 1,756 observations which satisfy the criteria to be included in the private nongroup analysis. 6 As noted in the third section, expenditures here include those reimbursed by private insurers and out-of-pocket spending. 7 While the estimated variance in the nongroup market is extremely large compared to that in the group market, we do not believe this is the result of a sample size problem because the nongroup market sample used here is 1,756 observations. And, while the estimate of variability is quite sensitive to the inclusion of the top two observations (removing the two observations which exceeded $100,000 decreased the coefficient of variation from.17 to.07), we did not remove these high expenditures because they were well below the highest expenditures observed in the group market. 8 A simple descriptive comparison of Healthy New York premiums and HMO premiums in the individual market in a subset of counties showed that Healthy New York premiums (which are covered by a public reinsurance mechanism) were 30% to 50% lower (Swartz 2001b). Compared to HMO products available in the small group market, Healthy New York premiums were 15% to 30% lower. While these differences are not shown to be wholly attributable to the reinsurance mechanism, nor are they necessarily predictive of the effects of other reinsurance reforms implemented in other markets, they provide initial support for the hypothesis that variance reduction could lead to premium reductions well beyond the actual reduction in average claims. References Agency for Healthcare Research and Quality (AHRQ) Overview of the Medical Expenditure Panel Survey. Available at: Berk, M. L., and A. Monheit The Concentration of Health Care Expenditures, Revisited. Health Affairs 20: Blumberg, L.J., and L.M. Nichols First, Do No Harm: Developing Health Insurance Market Reform Packages. Health Affairs 15: Why Are So Many Americans Uninsured? In Health Policy and the Uninsured, C.G. McLaughlin, ed. Washington D.C.: The Urban Institute Press. Buchmueller, T., and J. DiNardo Did Community Rating Induce an Adverse Selection Death Spiral? Evidence from New York, Pennsylvania, and Connecticut. American Economic Review 92: Centers for Medicare and Medicaid Services (CMS) Table 3: National Health Expenditures; Aggregate and Per Capita Amounts, Percent Distribution and Average Annual Percent Change by Source of Funds: Selected Years Available at: nhe/projections-2003/t3.asp. Claxton, G Using Public Reinsurance Approaches to Expand Access to Coverage. Unpublished report. Falls Church, Va.: The Lewin Group. Holahan, J., L.M. Nichols, and L.J. Blumberg Expanding Health Insurance Coverage: A New Federal/State Approach. In Covering America: Real Remedies for the Uninsured, J. Meyer and E. Wicks, eds. Washington, D.C.: Economic and Social Research Institute. John Kerry for President, Inc Affordable Health Care for All. Available at: com/issues/health_care/ Lewin Group Report on the Healthy NY Program. Prepared for the New York State Insurance Department. Available at: Monheit, A.C Persistence in Health Expenditures in the Short Run: Prevalence and Consequences. Medical Care 4(7)Supplement:III-53-III-64. Newhouse, J.P Patients at Risk: Health Reform and Risk Adjustment. Health Affairs 13: Nichols, L.M State Regulation: What Have We Learned So Far? Journal of Health Politics, Policy and Law 25: Selden T.M., K.R. Levit, J.W. Cohen, et al Reconciling Medical Expenditure Estimates from the MEPS and the NHA, Health Care Financing Review 23: Swartz, K Covering the Uninsured: Efforts to Make Health Insurance More Affordable Need to Address Risk. Harvard Magazine 106:

14 Government as Reinsurer Reinsuring Risk to Increase Access to Health Insurance. AEA Papers and Proceedings 93: Government as Reinsurer for Very- High-Cost Persons in Nongroup Health Insurance Markets. Health Affairs web exclusive: W Available at: webexclusives/index.dtl?year¼ a. Justifying Government as the Backstop in Health Insurance Markets. Yale Journal of Health Policy, Law, and Ethics 2: b. Healthy New York: Making Insurance Affordable for Low-Income Workers. Briefing for the Commonwealth Fund. Swartz, K., and D.W. Garnick Lessons from New Jersey. Journal of Health Politics, Policy and Law 25: