How to Cover Preexisting Conditions

The health-care legislation enacted this spring followed more than a year of heated, rancorous debate. But rather than subdue the public's passions, the bill's passage has only stoked them. Opposition to the new law remains very high, and Republicans have made clear their intention to push for its repeal if they gain control of Congress and the White House in 2010 and 2012.

For their part, President Obama and other champions of the legislation insist that public attitudes will soon change. More Americans will come to appreciate the law, they argue, once people have a better grasp of its benefits. And foremost among these benefits is the law's prohibition of "pre-existing condition" exclusions in health insurance--which would prevent insurance companies from denying coverage to customers with serious medical problems.

Like most of the health-care bill's major provisions, this ban will not take full effect until 2014. But the mere prospect of finally addressing the "pre-existing condition problem" is held up as an enormous selling point of the law. At long last, the bill's advocates claim, America has a solution to a profound failing of our current system--a solution that will eliminate a source of worry for millions, and that opponents would not dare undo. Indeed, while describing the plight of a young woman in the audience at a rally he attended in April, Obama told the crowd: "If [opponents of the law] want to look at Lauren Gallagher in the eye and tell her they plan to take away her father's ability to get health insurance...they can run on that platform."

The president's dramatic talents notwithstanding, the choice he presents is a false one. We do not face an either-or showdown between cruelly denying sick people treatment and a massive new federal health-insurance entitlement. The problem of covering Americans with pre-existing conditions is certainly real, but the notion that the only way to solve it is through a massive transformation of America's health-care system--one that will increase costs, raise taxes, displace millions of the happily insured, create a new entitlement, and undermine our private insurance sector--is simply wrong.

The case for repealing the newly enacted law, then, is not that there are no problems to solve in American health care. Rather, it is that there are far better solutions available.

The Pre-existing Dilemma

The challenge of covering people with pre-existing conditions is a function of the way our health-insurance system has evolved over many years--and especially of the fact that it is largely employer-based, voluntary, and distorted by complex subsidies and regulations that favor some insurance purchasers over others.

Since most working Americans get health insurance as a benefit of employment, losing or changing jobs often means losing or changing insurance coverage. As a result, most people are not continuously covered by the same plan throughout their lives. If they move directly from one employer-sponsored health plan to another, the disruption is usually not a problem (for reasons laid out below). But whenever someone, by choice or necessity, leaves employer-sponsored insurance to purchase health insurance on his own, the switch in coverage can present several challenges.

In a voluntary individual insurance market, insurers must have some means of preventing large mismatches between the premiums they take in and the claims they will likely need to pay out. The classic form of such a mismatch is the case of a consumer who waits until he is sick to purchase or enroll in an individual insurance plan. If an insurer offers coverage to such a person without pricing the expected costs of the enrollee's illness into the premium, the expense of paying out medical claims will almost certainly exceed the premiums collected. The practice will also encourage other people not to buy insurance until they need to draw on it--a problem known as "adverse selection." Why pay for insurance when you're healthy if you can buy it for the same price when you get sick? It would be the equivalent of purchasing auto insurance only after you've totaled your car--and insurers would obviously go bankrupt if this were their business model.

In a voluntary individual insurance market, insurers must have some means of preventing large mismatches between the premiums they take in and the claims they will likely need to pay out.

Insurers selling directly to individual consumers use two practices to prevent widespread adverse selection. First, they try to take into account the health status of prospective customers when determining their premiums (a process called "underwriting," by which they consider an applicant's age and other demographic factors and, in certain cases, medical history). Second, in some instances, they deny coverage of pre-existing conditions for a set period of time after a customer enrolls, so that if he buys insurance (or changes insurers) only after he has already been diagnosed with a costly condition, he cannot immediately use the new coverage to pay for medical claims associated with his existing ailment. Taken together, these two practices have led to the pre-existing condition problem: People who are sick can find themselves without health-care coverage, and without the ability to secure coverage at an affordable price, sometimes through no fault of their own.

From the rhetoric of some politicians, one might think this dilemma lies at the very core of America's health-care crisis. But in fact, the problem is relatively contained. Senior citizens can get health-care coverage through Medicare; the poor have Medicaid; and most Americans who have employer-based coverage do not run across the "pre-existing condition problem." It primarily affects a subgroup of sick, working-age Americans--those who do not receive health coverage from their employers, do not qualify for Medicaid, and are not able to buy coverage in the individual market because their health conditions make their premiums too high (or cause insurers to reject them altogether).

Pre-existing conditions are not much of an issue in the (vastly larger) employer-based insurance market for several reasons. First, job-based plans are implicitly "community rated" products--meaning that everyone who is covered by the same plan is charged more or less the same price. Underwriting of individual patients is therefore minimal, as insurers sell group plans to firms based on the risk profile of the entire work force. (The high costs of caring for some workers with diabetes, for instance, are balanced by the relatively low costs associated with their more healthy co-workers.) Risk levels in employer plans are also somewhat contained by the plans' very nature, in that only relatively healthy people are likely to show up to work regularly, stay employed, and gain access to job-related insurance benefits.

Of course, these techniques for spreading risk do not always work perfectly. Some smaller firms may have fewer workers across whom an occasional high-cost risk might be spread; in some industries--like automobile manufacturing or coal mining--the balance between new "healthy" workers and older "unhealthy" ones may be unfavorably tipped by demographic and economic factors. Even within larger firms, there is evidence that employers sometimes reduce cash wages to adjust for the cost of insuring some workers (particularly older and more obese ones) whose actual health-care expenses are likely to be much higher than average. Still, on the whole, the sick and the healthy pay roughly the same premiums in job-based plans. And insurers see it as a sustainable business practice, because selling to a group allows for the balancing of high and low risks.

Moreover, in 1996, Congress provided an important protection to workers by making it unlawful for employer-sponsored plans to impose exclusions on pre-existing conditions for workers in continuous group insurance coverage. This means that if a person stays covered by job-based plans long enough (usually six months), he can move from one job to another without fear of losing insurance protection, or of having to wait longer than other new hires before gaining coverage for ailments he may have developed. If a new hire maintained insurance in his old job, his new employer's plan must cover him--even if the worker has developed an expensive medical condition.

Job-based plans are implicitly "community rated" products--meaning that everyone who is covered by the same plan is charged more or less the same price.

In theory, this law--called the Health Insurance Portability and Accountability Act (or HIPAA)--also provided "portability" rights to people moving from job-based plans to individually owned coverage. The law gave state governments a few options for meeting this mandate: They could establish high-risk pools (which, as discussed below, is the approach most states have followed); they could require that all individual-market health insurers within their states offer insurance to all eligible individuals, without any limits on coverage of pre-existing medical conditions; or they could use their regulatory powers to create a mix of rules that would have similar results. But unfortunately, none of these approaches has worked well enough, and today many people still end up falling through the cracks.

The problem starts with HIPAA's requirement that a worker first exhaust his right to temporary continuous coverage under his former employer's plan (through a federal program called COBRA, which lets workers keep buying into their employers' insurance plans, generally for up to 18 months after leaving their jobs) before he can enter the individual insurance market without a pre-existing condition exclusion. Many workers are not aware of this requirement (though employers must advise them of it in a written notice); even if they are, the premiums required to stay in an employer's plan through COBRA are often too high for them to pay. This is because COBRA premiums must cover both the employer and employee share of costs, and generally provide more expensive comprehensive benefits than individual-market alternatives. And unlike premiums paid in employer-based plans, these COBRA premiums do not receive any tax advantage--making them more expensive still. As a result, many workers facing this fully loaded "sticker shock" price choose not to pay the premiums, simply hoping for the best until they can find new jobs (and new coverage). In so doing, they inadvertently waive their HIPAA rights--leaving themselves vulnerable to exclusions and high costs for pre-existing conditions when they try to buy insurance on their own.

But even if a sick person abides by HIPAA's requirements and remains continuously insured--thereby protecting himself from pre-existing condition exclusions in the individual market--nothing in current federal law prevents insurers from charging him more than they charge healthy people. Insurers are prohibited only from denying coverage for a pre-existing condition altogether; it is quite permissible, however, for insurance providers to charge unaffordable premiums (unless an individual state's laws happen to prevent or restrict the practice), thus achieving essentially the same outcome.

Likewise, current law and regulations provide no premium protections for persons moving between individual insurance policies. A healthy worker who leaves an employer plan for the individual market might find an affordable plan at first--but if he ever wanted to switch insurers (or was forced to by, say, moving to a new state), he would face the risk of having his premium recalculated based on a new assessment of his health.

Of course, the fact that the problem of pre-existing condition coverage is limited almost entirely to the individual market does not mean that it pervades that market. In 2008, at the request of the U.S. Department of Health and Human Services, health economists Mark Pauly and Bradley Herring examined how people with chronic health conditions, and thus high anticipated health-care expenses, actually fared when seeking insurance in the individual market. Pauly and Herring found little, if any, evidence that enrollees in poor health generally paid higher premiums for individual insurance. Nor did they find that the onset of chronic conditions is necessarily associated with increased premiums in subsequent years. Existing "guaranteed renewability" requirements in federal and state law already prevent insurers from continuously reclassifying people (and the premiums they pay) based on health risks. And most private insurers already provided such protection as standard business practice before they were legally required to do so.

But even if the exclusions and prohibitive premiums caused by pre-existing conditions are not a universal problem in the individual insurance market, they clearly affect many Americans. Estimates range from 2 to 4 million, out of a total population of about 260 million people under the age of 65. More important than the sheer number, however, is the fact that many Americans know someone who has faced this situation directly, and fear that they could find themselves in the same boat--which explains the strong public support for changing the way insurance companies treat pre-existing conditions.

Most people find it unacceptable that responsible fellow citizens who have tried to stay insured throughout their lives can suddenly find themselves sick and unable to get adequate coverage. On the other hand, insurers clearly need some way of aligning premiums and risks in order to stay financially solvent. And because the smaller individual market now often operates as a last resort for those lacking better insurance options through employers, insurers must plan for the risk that people seeking individual coverage are doing so because they believe they will need substantial medical attention.

Of course, insurers have incentives to avoid excessive underwriting. For one thing, screening is expensive. For another, if insurers screen too aggressively, they will lose customers whose care would not in fact have been very costly. Insurance companies balance the benefits of screening against these costs in the individual market no less than in others: Indeed, the most extensive research in this area, by Pauly and Herring, has demonstrated that there is already a great deal of pooling of health risks in the individual market. But some people clearly still cannot get covered.

The question is what should be done for them. The most effective solution would be not heavy-handed regulation, but rather a new insurance marketplace built around truly portable, individually owned insurance. If households, not firms, chose and controlled their own insurance plans, people would no longer face the risks that come with changing coverage based on new employment arrangements. By carrying the same insurance plan from one job to the next (or even through periods with no job at all), individuals would keep their coverage even as their health status changed. Moreover, insurers would have strong incentives to do what they could to keep their enrollees healthy, knowing full well that some of them could be enrolled for many years. That is how health insurance is supposed to work.

The most effective solution would be not heavy-handed regulation, but rather a new insurance marketplace built around truly portable, individually owned insurance.

But moving to true insurance portability will not be easy. It will require fundamental reform of the tax treatment of health insurance in order to level the playing field between plans owned by employers and those owned by individuals, as well as a reworking of some current insurance regulations. For now, both reforms face long political odds. And even if these changes were to happen, we would still need some way of covering people who already suffer from costly health conditions (and so could not easily buy their own portable insurance, even once a new system got up and running).

Short of such a transformation, then, what can be done to help people shut out by the current system? Some states have attempted to address the problem by imposing price controls on health-insurance premiums--requiring insurers to sell to all comers, regardless of their health status (a rule called "guaranteed issue") and at standard rates ("community rating"). But this has only caused insurers to increase the premiums they charge everyone else--even young, healthy customers--in order to make up for the losses associated with the enrollment of these more expensive cases at below-cost premiums. And when premiums rise for younger and healthier customers in a voluntary marketplace, a significant number of these people--weighing the low risk of an expensive illness against the high cost of buying health insurance--will drop out of coverage altogether. The pool of enrollees thus becomes older and less healthy, further driving up premium costs for the enrollees who remain. The resulting vicious cycle triggered by excessive regulation can cause so many consumers and insurers to flee that the entire market can collapse. This is what happened in Washington state and Kentucky when such reforms were tried in the 1990s, before they had to be "repealed and replaced."

The new federal health-care legislation, meanwhile, aims to solve the "pre-existing" problem by dramatically transforming our entire health-care system--even though most insured Americans are quite happy with the coverage they have--and by creating an enormous and expensive system of regulations and entitlements. Obamacare thus creates an even greater risk of system collapse--in this case, with taxpayers picking up the pieces.

As so often happens, though, the model for a promising national solution has begun to emerge from the states. Across the country, state policymakers have turned to an approach that does not require a fundamental transformation of the insurance marketplace: the creation of high-risk pools. Unfortunately, these state-level efforts have not been sufficiently ambitious or adequately funded; they would also be badly undermined by the new federal health-care law. But if that law is in fact repealed, reformers concerned about the problem of pre-existing conditions should champion a system of robust, well-funded high-risk pools as a smart and effective solution. . . .

The full text of this article is available from National Affairs.

James C. Capretta is a fellow at the Ethics and Public Policy Center. Thomas P. Miller is a resident fellow at AEI.

Photo Credit: iStockphoto/DNY59

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

Thomas P.
Miller

 

James C.
Capretta

What's new on AEI

Defeating ISIS: AEI experts weigh-in before the president’s address on Wednesday
image Degrading, defeating, and destroying the Islamic State
image Wealth Building Home Loan: Building wealth through homeownership and retirement savings
image The $3 iPhone
AEI on Facebook
Events Calendar
  • 15
    MON
  • 16
    TUE
  • 17
    WED
  • 18
    THU
  • 19
    FRI
Tuesday, September 16, 2014 | 5:00 p.m. – 6:00 p.m.
The Constitution as political theory

Please join us for the third-annual Walter Berns Constitution Day Lecture as James Ceasar, Harry F. Byrd Professor of Politics at the University of Virginia, explores some of the Constitution’s most significant contributions to political theory, focusing on themes that have been largely unexamined in current scholarship.

Wednesday, September 17, 2014 | 8:10 a.m. – Thursday, September 18, 2014 | 1:30 p.m.
Third international conference on housing risk: New risk measures and their applications

We invite you to join us for this year’s international conference on housing risk — cosponsored by the Collateral Risk Network and AEI International Center on Housing Risk — which will focus on new mortgage and collateral risk measures and their applications.

Thursday, September 18, 2014 | 2:15 p.m. – 3:00 p.m.
Speaker of the House John Boehner on resetting America’s economic foundation

Please join us as Speaker John Boehner (R-OH) delivers his five-point policy vision to reset America’s economy.

Friday, September 19, 2014 | 9:15 a.m. – 11:00 a.m.
Reforming Medicare: What does the public think?

Please join us as a panel of distinguished experts explore the implications of the report and the consumer role in shaping the future of Medicare.

No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.