Rethinking Health Reform
The Need for a More Incremental Approach

As expected, President Obama put health reform on the back burner in his State of the Union speech. After a year of debate, Speaker Pelosi and Leader Reid have been unable to bridge the ideological divide within their own party over the scope of the legislation and the government's role in a reformed system. The lack of agreement on the legislation is not confined to Capitol Hill. As the President said, the ugly political process caused the public to ask what was in this for them--and more importantly, what was in this that would make matters worse.

Even the most casual observer could see that the legislation played favorites. Where was the fairness in giving Nebraska, and no other state, full federal payment for a Medicaid expansion? If there was to be a tax on high-cost health insurance, why should collectively-bargained plans be exempt? These vote-buying deals clearly caught the eye of the public, but the real problems in the legislation are structural.

We can all agree that people should have health insurance, health insurance should not cost so much, and health care should be effective. People should be able to keep their coverage and their doctor if they like what they have now. The promises are all attractive. We just cannot get there the way the legislation imagines.

The proposed solutions are as complex and interconnected as the problems they are trying to solve.

Faced with complex and overlapping problems, Congress devised massive bills that created a labyrinth of mandates, regulations, subsidies, and taxes. Legislative provisions piled up, one on top of the other, in the vain hope that every contingency could be anticipated and adverse consequences prevented. The proposed solutions are as complex and interconnected as the problems they are trying to solve.

This is the reason we are unlikely to see a slimmed-down bill this year. Taking either the Senate or House bill as a starting point will inevitably lead to arguments that a popular provision (such as guaranteed issue) will not work without other, less popular requirements (like a mandate on individuals to purchase insurance), which in turn will create the need for even more requirements. Those arguments will be political, with pressure from the left for more control over the system. But it is true that one cannot simply pluck a few provisions out of the bill and expect to have legislation that achieves ambitious goals.

The solution is to rethink both the goals and the methods of health reform. Rather than claiming that we can solve every problem in the health system, we should admit that we must set priorities. Rather than locking in policies that are rigidly interconnected, we should take more measured steps that allow us to make frequent mid-course corrections. Rather than imposing top-down solutions, we should recognize that real reform depends crucially on the way individuals, health providers, employers, and others respond to changes in incentives.

Four Principles for Practical Reform

If Democrats were no longer fighting with each other and this was not an election year, Republicans and Democrats could come together on a reasonable approach to health reform. Here are some ideas to jump start the conversation.

Put Our Fiscal House in Order. The country is in a deep recession and the federal government is facing record budget deficits. Health reform cannot be conducted in a vacuum, and it is reasonable to expect that spending in all major programs--including health--would be reduced as part of the effort to control the deficit. Under these circumstances it is unreasonable to insist on a new subsidy program for health insurance as expansive as that proposed by Congress.

According to the Congressional Budget Office, the Senate health bill reduces Medicare spending by $438 billion over the next decade to help pay for the $871 billion dollar cost of expanding coverage. Richard Foster, chief actuary for the Centers for Medicare and Medicaid Services, points out that the sustained reduction in payment updates proposed by the legislation would make it increasingly difficult for hospitals, skilled nursing facilities, and other providers to continue to service Medicare patients. Let's heed that warning and discuss a more modest program of assistance to the uninsured and more moderate reductions in Medicare outlays.

Save Medicare and Medicaid First. As important as it is to develop new programs for the uninsured, we cannot afford to ignore the very real problems of our existing health programs--Medicare and Medicaid.

Medicare is on a collision course with fiscal reality, with program spending continuing to grow faster than dedicated revenue. The program's $37 trillion unfunded liability represents a real threat to future generations of workers who will pay higher taxes unless the program is reformed. Simply cutting payments to providers has done little to slow the long-term growth of Medicare spending. Instead, we should change the way we pay providers so that the incentive is to provide better care, not just more of it.

Usually the policy conversation trails off at this point, with mumbling about the need for more research. That overlooks one obvious (but politically difficult) solution: fix the Medicare Advantage (MA) program without killing it. On average, MA plans are paid 14 percent more than the cost that would be paid under traditional fee-for-service, which is an artifact of a flawed bidding process. Let's correct the flaw and make the program fully competitive by having traditional Medicare bid and paying based on the lowest bid in each market. We can phase this in over time to avoid disruption and hold harmless anyone over age 50 or 55, for example.

Medicaid is a tougher problem. States are drowning in red ink, and expanding Medicaid could put them under. Let's remember that Medicaid is supposed to be a countercyclical program, so it should be spending more now. But don't forget that states have become adept at maximizing federal payments through provider taxes and other questionable financing schemes. Eventually we have to move to a better understanding of who should pay what. For now, a modest Medicaid expansion could be part of the reform with generous federal payments for all states, including those who already cover the expansion population. Let's also move away, a little, from the perverse incentives of an uncapped entitlement to federal funds. Instead of using a matching formula to cover any bill that is submitted, set the payments to cover, say, 95 percent of the cost of a typical new enrollee.

Reform Private Insurance Without Malice. Contrary to overheated political rhetoric, profit is not a dirty word in a market economy. We may want to put new requirements on insurers to help the uninsured and current policy holders, but hardly anyone wants to put insurers out of business.

The combination of guaranteed issue, rating restrictions, minimum loss ratios, and other dictates in the health legislation can be deadly, even with a mandate requiring everyone to buy the industry's product. The proposed regulations drive up the cost of coverage, particularly to young healthy people. The cost-saving decision for them is "just-in-time" coverage--insurance purchased to pay for a major medical expense and then dropped, saving thousands in premium payments. Heavier fines are not the answer; smarter regulation is.

Americans should be guaranteed access to insurance with premiums that do not unduly penalize them for developing health conditions that raise their risk profiles. But that guarantee should be granted only to those who maintain life-long coverage and do not attempt to exploit the system. Everyone could be given one opportunity to enroll freely in insurance. Failure to purchase initially or breaks in coverage would expose the person to the risk of new medical underwriting, which could bump him into a higher premium class. The initial guarantee of coverage, coupled with the risk of higher premium payments for failing to act responsibly, would be a strong incentive for individuals to maintain coverage--without having to resort to a government mandate that is unenforceable in practical terms.

Before a system to guarantee access to insurance is developed, we should provide a more secure safety net for medically uninsurable individuals who cannot buy coverage that covers their specific health problem, or may be unable to buy insurance at all. State high risk pools could fill that role, but additional federal support and better operating rules are needed to be effective.

Insurance should also protect families if they are faced with potentially catastrophic medical costs. Part of the solution is to eliminate annual and lifetime benefit caps. Such a requirement increases the cost of insurance, particularly in the individual and small group market, but mechanisms could be developed to spread those costs across a wider population. To further protect families against high unexpected costs, Congress could require better information available before the patient undergoes treatment. That information should include the price of care and the patient's financial responsibility once insurance has paid its share.


Make Consumerism More Than a Slogan. If "profit" is the least favored word in Washington, "choice" and "competition" are probably the most favored. The problem is that choice and competition are often used to describe proposals that offer little of both.

Giving consumers more choices among competing plans helps ensure a better match between what consumers want and what insurers offer. Without choices, dissatisfied consumers have no effective voice. Without competition, insurers have little reason to sharpen their pencils and find more efficient ways of operating their business.

Health insurance exchanges could expand consumer access to a variety of health plans and one-stop shopping. Exchanges could also become a vehicle for excessive regulation that drives up costs and limits choices unnecessarily. The Massachusetts Connector takes a regulatory approach, specifically defining the types of plans that may be offered. A better model is offered by Utah, which created an internet-based exchange to act as an information clearinghouse and one-stop shopping for consumers. Rather than requiring a single national exchange, states should be allowed to set up their own exchanges to permit greater experimentation with this developing idea.

The proposal to allow insurers to sell across state lines would promote competition but is frequently misunderstood. The idea seems simple. Insurers would be allowed to offer coverage in any state, as long as they satisfy the regulatory requirements in their home state. Adding a few more insurers to a market would increase competition. However, the real benefit derives from competition among state regulators to attract insurers willing to move their operations into the state. States would have an incentive to encourage insurers to relocate by lowering regulatory barriers (such as benefit mandates that increase costs but add little value for consumers).

For most people, choice of insurance is merely an academic concept. Nearly 90 percent of people with private health insurance receive coverage through an employer rather than buying the insurance themselves. According to the Kaiser/HRET survey of employer health benefits, 86 percent of firms offer only one plan type to their employees. The dominance of employer-sponsored coverage is explained by the generous tax break for workers worth more than $250 billion a year, and by the fact that accepting the employer's offer is the path of least resistance.

Reforming the "tax exclusion" would create new incentives for efficiency and correct an injustice. The exclusion provides greater tax savings for higher income people who purchase more expensive coverage (and whose employers contribute to the cost of the premium). Over time, employer plans have become more generous, with lower out-of-pocket costs for employees but higher premiums. That has reduced cost consciousness on the part of consumers and promotes greater use of services that may not be worth their cost. Moreover, people who do not have employer coverage get no benefit from this provision of the tax code.

The Senate health bill superficially addresses these problems by imposing an excise tax on so-called Cadillac plans whose annual premiums are greater than $8,500 for individuals and $23,000 for couples. The tax would be passed on to consumers as higher premiums, and everyone in the firm having high-cost insurance would pay the same additional premium--from the lowest paid employee to the CEO. A better approach, but one unlikely to receive serious consideration, is to cap the exclusion. Low-wage workers in low income tax brackets or who do not earn enough to pay income taxes would be largely unaffected, and high-wage workers would bear higher costs. Eventually, everyone could be given a risk-adjusted tax credit that would more fairly provide help to those who need help the most.

Reform This Year?

Let's get realistic. Democrats continue to talk about passing the Senate bill and using reconciliation to jam a "corrections" bill filled with expensive goodies for political backers. This strategy is unlikely to succeed given the continued failure of Democrats to resolve their differences and the formidable procedural barriers that could tie up the Senate for months. It also virtually guarantees that a serious bipartisan health bill is not possible this year.

The real problems in the health system are not going away and, by necessity, we will soon be back to this issue. Twice, we've tried and failed to enact over-reaching legislation that the public did not trust. Next time, it will be different--but only if we take a more incremental approach to health reform.

Joseph Antos is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at AEI.

Photo Credit: iStockphoto/Kameleon007.

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