State officials can dramatically improve the func­tioning of their state health insurance markets, es­tablish portability and personal ownership in health insurance coverage, and make major im­provements in how they finance health care for the uninsured. Massachusetts, a state with a conserva­tive Republican governor and liberal Democratic legislature, has recently enacted comprehensive health care reform. Not surprisingly, many state of­ficials from around the country are carefully exam­ining the Massachusetts health plan, trying to dis­cern what is applicable to or appropriate for their own states.

The Massachusetts plan, signed into law by Gover­nor Mitt Romney, is a complex mixture of specific pol­icy initiatives aimed at providing residents with "access to affordable, quality, accountable health care."[1]  Most notably, the new law:

Several features of the Massachusetts health plan could revolutionize the traditional health care sys­tem by empowering individuals to buy and own their health insurance policies and keep these poli­cies with them regardless of job or job status. How­ever, officials in other states should shun the imposition of employer mandates and avoid public program expansions while making modifications and improvements to other significant components of the Massachusetts plan.

A Compromise

Given the partisan divide between the Romney Administration and the Democratic legislature, as well as the leftward political and regulatory climate in Massachusetts, the final language was not the ideal outcome for either the governor or the legis­lature. A key motivation for reaching an agreement was the expiration of an existing federal waiver. Massachusetts needed to restructure its waiver or risk losing federal funding for uncompensated care. Nonetheless, for the majority of the provi­sions, the final product was a genuine compromise on imperfect legislation.

The Achievements. There has been a great deal of media coverage of and commentary on the Mas­sachusetts law. Regrettably, some of it has been inaccurate.[2] Regardless of ideological or partisan disagreements on specific provisions of the final bill, legislators in other states can learn a great deal from the Massachusetts legislation. Two of the new law's key achievements are:

1. Creation of a new market for health insurance in which individuals and families can buy pri­vate coverage of their choice, own it, and take it from job to job without losing the existing favorable tax treatment for employer-spon­sored health insurance, and
   
   
2. Creation of a new system of premium assis­tance for lower-income individuals to purchase private coverage based on leveraging existing uncompensated care funds used to cover the cost of care for the uninsured.

These two components could revolutionize the traditional health care system by empowering individuals, including low-income persons, to buy and own their health care coverage, and they can be adapted to the unique conditions of other states.

The Shortfalls. At the same time, state legisla­tors should avoid a number of troublesome provi­sions in the new Massachusetts law. These include the counterproductive employer mandate for pro­viding health care coverage and the unnecessary Medicaid expansion. In reality, households, not employers, bear the burden of health care costs. Employer mandates constitute a regressive tax on workers and their families, usually in the form of reduced compensation or even job loss.

With regard to Medicaid, it is important to keep in mind that it is a welfare program. Ideally, the best Medicaid policy would "mainstream" individuals out of Medicaid and into the private health care coverage that is available to other Americans, just as the best welfare reform policy would mainstream welfare dependents into jobs in the private econ­omy. In effect, simple Medicaid expansions are an obstacle to the achievement of the broader goals of comprehensive welfare reform.

The Massachusetts law includes several impres­sive structural changes in the insurance market and health care financing, but states should improve other elements of the Massachusetts law. In adopt­ing an individual mandate for the purchase of health insurance, the legislature adopted final lan­guage that dropped a crucial provision that would have enabled individuals to demonstrate personal responsibility by allowing them to self-insure and demonstrate their willingness and ability to cover their own health care costs without enrolling in an insurance plan. This was a serious mistake.

The Massachusetts law also created a new health insurance market for small-business employees and individuals, but businesses of all sizes should be permitted to access the new consumer-driven market, and all consumers should have access to the broadest range of policies and carriers. The goal of state insurance reform should be to create a robust, wide, and open market. While the law pro­vided some regulatory relief from state rules gov­erning insurance plan designs and benefits, it should have pursued more aggressive deregulation of the health insurance market.

Key Components That States Should Adopt

The Massachusetts health plan is the product of a bipartisan compromise in a political and cultural environment that is peculiar to Massachusetts. It also reflects the peculiarities of that state's health care delivery system. Massachusetts is burdened with high health care costs, a high level of uncom­pensated care costs, and an overregulated health insurance market. Relative to other states, it also has a higher concentration of "branded" medical providers accustomed to leveraging their reputa­tions for quality to charge high prices and dictate reimbursement rates to insurers. Consequently, the legislation includes provisions to allow insurers more flexibility in contracting selectively with pro­viders and constructing "value-focused" networks. Massachusetts also has a high rate of employer-based coverage and a relatively low number of uninsured-a feature not found in all states.

The plan enacted by the Massachusetts legisla­ture and signed by the governor is not a program that can simply be replicated in other states. The political, economic, and social conditions of the states vary greatly, as do their patterns of health care delivery, including the number of uninsured, the pattern of health care costs, the ratio of public- private health care coverage, and the level of regu­lation and government control over the system. The true genius of the Constitution's federal system of government is its capacity for adaptation to local circumstances and the promotion of competitive policy innovation, enabling Americans to learn the best practices and avoid the most common mis­takes of their fellow citizens.

However, officials in other states should note that several features of the Massachusetts health plan could be adapted to the unique conditions of their states. Two features of conceptual importance merit close attention.

Component #1: Creation of a New Statewide Health Insurance Exchange

The Massachusetts plan creates a new consumer-driven marketplace (the Connector) where individ­uals and employees of small businesses can pur­chase health care coverage from a variety of competing health insurance plans. This is, in effect, a health insurance "exchange."[3] Conceptually, the Connector is like a stock exchange for health insur­ance-an administratively easy way for individuals to buy various health insurance products through an organized market, just as they would buy differ­ent stocks, bonds, and mutual funds through an organized financial market.

In this specific case, the Massachusetts Connec­tor is designed on The Heritage Foundation's ver­sion of a voluntary "health insurance exchange."[4] In this design, the health insurance exchange is not a regulatory agency. It does not supplant the authority of the state insurance department, nor does it impose a comprehensive standardized ben­efit package on health plan participation, such as Maine's Dirigo health care program.[5] It is not a pur­chasing entity like an association health plan or existing state-sponsored small-business purchasing groups. Moreover, this type of health insurance exchange is not intended to negotiate rates or ben­efits with health insurance carriers on behalf of its member employers, employees, or individuals. In this crucial respect, the health insurance exchange is not like the popular Federal Employees Health Benefits Program, which provides a broad range of health plan choice to federal workers and retirees.

Like a stock exchange for financial investments, a health exchange's primary role is to facilitate transactions among the government, employers, individuals, and health insurers, such as coordinat­ing contributions and government assistance for premium payments to insurers and other related paperwork. In principle, of course, such operations do not have to be run exclusively through a govern­ment entity like the Massachusetts Connector. States could charter a nongovernmental agency to carry out such functions or contract with existing private-sector entities to administer the essential functions of a statewide health insurance exchange.

Correcting Market Deficiencies. The rationale for the Connector is rooted in the deficiencies and complexities of the current individual and small group health insurance markets and the layers of state insurance rules that govern them. These defi­ciencies are common in all states. They are evident from the difficulties that small businesses and indi­viduals have in getting affordable health insurance and staying covered over time.

The Massachusetts Connector is a mechanism to overcome these deficiencies by combining the small group and individual markets.[6] It expands choice for employees of small businesses who typ­ically have few, if any, choices of health plans or car­riers. Moreover, the Connector expands access by facilitating coverage for individuals and families who currently do not have coverage through an employer by creating a new way of easing access to coverage for these persons and extending favorable tax treatment.

Establishing Portability. The empirical data on America's uninsured are voluminous. Nationally, more than 80 percent of the uninsured are in work­ing families. While they are an economically diverse group, the largest portion of this population is composed of lower-income working families. Moreover, they are heavily concentrated in small businesses that commonly do not offer health insurance, and they are often found among part-time and contract employees that typically do not qualify for employer-based coverage.

The data also show that the uninsured popula­tion is constantly churning, with individuals and families going in and out of health insurance cover­age, often because of changes in employment or employment status. In a detailed analysis of the empirical evidence over an extended period of time, Pamela Farley Short and Deborah R. Graefe of Pennsylvania State University found that the num­ber of those who were "always uninsured" over the long term (defined as 48 months for the purposes of the study) amounted to no more than 12 percent of the uninsured population. The vast majority experienced gaps or frequent changes in coverage or were making the transition into and out of health insurance coverage.[7] Similarly, in a Com­monwealth Fund study, Short, Graefe, and Cathy Schoen of the Commonwealth Fund observed: "To the extent that job turnover undermines coverage stability, designing ways for employers to contrib­ute to the cost of coverage, without directly admin­istering health insurance, could enhance continuity."[8]

The Massachusetts Connector makes coverage easier to purchase and to maintain. In other words, the Connector is intended to lessen the churning effect of the uninsured and general instability in coverage by providing an organized structure through which individuals and families can choose and purchase plans from competing insurers and maintain coverage regardless of job changes or employment status.

Preserving Tax Breaks. The federal tax code is a significant obstacle to achieving personal owner­ship and portability of health insurance. On one level, it is generous. It provides unlimited tax relief for the purchase of health insurance, but it largely confines that generosity to those who obtain health coverage through their places of work. Under cur­rent federal tax law, the total value of the employer-purchased health benefit is excluded from an employee's taxable income. On another level, it is stingy. Such lucrative tax preferences are not extended to workers who lack employer-based coverage. They must purchase coverage on their own with after-tax dollars.

This presents a dilemma: Buying a health plan in the individual market with after-tax dollars imposes a financial hardship, especially on individ­uals with lower incomes. The alternative-going without coverage-runs the risk of incurring high medical costs from serious or catastrophic illness. Without federal action to level the playing field, the policy challenge is to establish individual access to coverage in an inflexible federal tax system that almost exclusively privileges employer-based health insurance coverage.[9]

Through the Connector, the Massachusetts law resolves this dilemma and maintains the generous federal and state tax breaks for health insurance that are confined almost exclusively to coverage purchased by employers. In short, the new law establishes a defined contribution option for employers that they did not previously have. Spe­cifically, an employer can designate the Connector as its employer-sponsored health insurance plan, allowing the employee to receive tax-free premium contributions from their employer. Thus, the Con­nector protects the current, favorable treatment of health insurance for employees and provides choice, ownership, and portability for them.

The Massachusetts reform also creates a new opportunity for employees to gain other tax advan­tages. The new law requires employers with 11 or more employees to set up a Section 125 plan so that their employees can pay their share of health insurance premiums with pre-tax dollars. This requirement will help all employees, but especially part-time and contract employees who may not receive any pre-tax contributions from their employers.

While critical of elements of the Massachusetts law, the editors of National Review nonetheless remarked:

[T]he connector in the plan is genuinely innovative. The federal tax code encourages employers to provide health insurance rather than just giving people higher wages with which to buy their own insurance. The connector is a way of working around that problem. Employers would give workers a set amount of money, and they could use the connector to buy from one of several participating companies and the federal tax break would still apply.[10]

Component #2: Direct Assistance for Lower-Income Persons to Buy Private Coverage

The central issue in America's health care debate, aside from the rising cost of health care, revolves around the uninsured and helping them to get cov­erage. The correlative issue is how to finance addi­tional assistance to help those who are without health insurance.

John C. Goodman, president of the National Center for Policy Analysis, notes that federal and state governments already spend tens of billions of dollars annually on a variety of programs for the uninsured, including Medicare and Medicaid funds for hospitals that serve a disproportionately large number of patients without health insurance cover­age. Goodman has long argued that current gov­ernment subsidies and tax incentives for the uninsured should be realigned and redirected to help the uninsured get coverage, primarily through health care tax credits.[11] The Massachusetts law puts this concept into practice by using existing government funding to help lower-income individ­uals purchase individually owned private coverage.

Governor Romney builds on Goodman's central insight. In Massachusetts, the costs of uncompen­sated care totaled $1.3 billion in 2005. In the tradi­tional arrangement, hundreds of millions of government dollars, including federal funds,[12] were going to a few Massachusetts hospital systems to reimburse them for providing services to the uninsured-an arrangement that has often lacked accountability. With its uncompensated care waiver from the U.S. Department of Health and Human Services expiring, the Romney Administration pro­posed turning the massive uncompensated care subsidy structure upside down by using those funds to provide direct assistance to individuals and families rather than paying health care provid­ers to provide services to the uninsured.

The direct subsidy will become a new premium assistance program, administered by the Connector and designed to help lower-income individuals and families buy private health insurance. Much like federal proposals for refundable health care tax credits or vouchers, the premium assistance pro­gram is designed as a sliding-scale system of finan­cial help, based on the ability to pay, up to 300 percent of the federal poverty level ($30,480 for a single person and $60,432 for a family of four in 2005 dollars).

At the federal level, President George W. Bush has included a refundable tax credit for lower-income individuals and families in past budget proposals. While there are technical differences, the Romney income-based premium assistance program broadly covers the same uninsured populations that have been targeted by the Bush Administration's health care tax credit proposals.[13] The Bush Administration has consistently targeted its refundable health care tax credits on a sliding-scale basis to individuals earning up to $30,000 and families earning up to $60,000 per year.[14] Members of Congress have introduced similar proposals, but Congress has cho­sen not to enact these credits.

The adoption of this provision of the Massachu­setts law amounts to a revolutionary change in health policy. It mainstreams low-income individu­als and families into private health care coverage, and does this without new health care expendi­tures, by redirecting state health care spending from meeting the needs of providers to meeting the needs of patients and consumers. In sum, it con­verts the current de facto provider safety net into a consumer safety net.

Key Components for States to Avoid

To expand personal freedom and harness the power of competition through a more robust pri­vate market, states should resist certain features of the Massachusetts plan that obstruct this goal.

Imposing an Employer Mandate. The final lan­guage of the Massachusetts health law imposes new penalties on employers who do not provide health insurance to their workers, who do not make a "reasonable" contribution, or whose employees accumulate free care services.[15] However, employ­ers in Massachusetts who provide coverage to their workers already pay a state health insurance pre­mium tax. The existing premium tax is counterpro­ductive, as are the new penalties. Governor Romney vetoed the new employer mandate provi­sions, but the Massachusetts legislature overrode his vetoes.

The underlying assumption behind an employer mandate-that employers pay for health insurance for their employees-is errone­ous. In fact, households, not employers, pay 100 percent of health care costs. Health benefits, like wages, are part of the employees' compensation, and every increase in the payment for health ben­efits is routinely offset by decreases in workers' wages and other compensation.

Policymakers in other states should vigorously oppose employer mandates, regardless of how nar­rowly targeted or defined they may be.[16] Not only does an employer mandate provide an additional platform for further regulatory control over private health insurance contracts, but the additional costs of a mandate make it even more difficult for entrepreneurs to start and maintain a small busi­ness, and these higher costs are passed onto work­ers and their families through lower wages and even job loss.

Expanding Medicaid. The Massachusetts law expands Medicaid eligibility to children of working families up to 300 percent of the federal poverty level. As a general rule, expanding Medicaid or other public health programs, such as the State Children's Health Insurance Program (SCHIP), is not the best option for families or state policymak­ers. In surveys, the overwhelming majority of unin­sured families expressed a preference for enrolling in private coverage, not public programs.[17] For state officials, Medicaid is consuming ever-greater portions of state budgets, crowding out other important services (e.g., education, transportation, and homeland security), and jeopardizing the qual­ity of care for those whom the programs were intended to serve.

Instead of expanding eligibility for these strug­gling government-run public programs, states should pursue innovative alternatives for working families and protect the public program for the truly indigent. Building on new market mecha­nisms such as a health insurance exchange like the Massachusetts Connector and providing direct assistance to lower-income families so that they can afford private health coverage are far better alterna­tives than simply enrolling them in Medicaid or other public health programs. Moreover, states would do well to begin mainstreaming many of their working individuals and families out of public coverage and into affordable private health insur­ance options.

Key Components for States to Improve

As noted, the Massachusetts plan is the product of a bipartisan compromise in a political, cultural, and health system environment that is peculiar to Massa­chusetts. A number of provisions in the law need improvement, and states looking at the Massachu­setts model should consider these modifications.

Removing the Legal Restriction on a Person's Right to Self-Insure. The Massachusetts health plan imposes a simple "pay or play" mandate on the individual by requiring an individual to purchase coverage or pay a state fine.[18] This simple mandate is not the ideal option for dealing with the "free rider" issue-the very real problem of individuals seeking and getting health care at hospital emer­gency rooms or other health care facilities and then leaving the taxpayer to pay the bill. These costs are incurred either directly through taxation or through higher private insurance premiums. In Maryland, for example, caring for the uninsured cost an estimated $713 million in 2005, raising family premiums by $948.[19] In Massachusetts, as noted, uncompensated health care costs reached a stunning $1.3 billion in 2005.

A far better option would be to adopt Governor Romney's original proposal, which would have pro­tected an individual's right not to purchase health insurance coverage. His "personal responsibility" proposal would simply have required everyone who could afford health insurance either to purchase cov­erage or to self-insure by posting a $10,000 bond or equivalent of a bond, which would demonstrate a willingness and ability to pay for any future hospital care. The $10,000 figure was taken from the Massa­chusetts auto insurance law, which also requires the posting of funds if one does not wish to purchase auto insurance. This is simply a tangible demonstra­tion of a person's willingness to pay his own way and eliminates the option of obtaining expensive health care services and then skipping out, leaving the tax­payers to pay the medical bills.

The current debate over the individual mandate to purchase health insurance in Massachusetts must be understood against the backdrop of a simple fact: Federal law prohibits hospitals from turning away patients because of their financial inability to pay for care. In effect, the status quo imposes a mandate on taxpayers, and the burdens of that mandate are steadily increasing. These burdens are not relieved by resorting to new funding for public hospitals for the poor and the indigent, shifting bad debt else­where, or fruitlessly chasing down the unpaid bills of high-cost patients who are simply incapable of paying high health care bills. Governor Romney's original approach would protect individual taxpay­ers from paying the uncompensated care costs for free riders while preserving the individual's freedom to decide how best to pay for care.

Accelerating the Deregulation of the State Health Insurance Market. Massachusetts has a highly regulated health insurance market, espe­cially for small businesses. Much of the recent crit­icism of the Massachusetts plan from conservatives is that the plan did not deregulate enough, and especially that it did not eliminate the guaranteed issue requirements for health insurance.[20]

In fairness, the Massachusetts law does make some important changes in health insurance regu­lation, including a two-year moratorium on new mandated benefits. It also introduces new flexibil­ity for products in the Massachusetts health insur­ance market, such as tiered networks, expanded health savings account options, the factoring of tobacco use into health insurance ratings, and more affordable mandate "lite" health plans for younger populations between 19 and 26 years of age.

Projecting future health care costs or savings is extremely difficult. Nonetheless, the governor's staff estimates, based on the available insurance data, that these regulatory changes in the health insurance market will reduce average individual premium costs by 20 percent to 50 percent.[21] The governor's staff has also calculated that the new provisions giving consumers greater information, including transparency in pricing, will stimulate greater market competition in cost and quality among hospitals and other medical professionals, which will result in larger statewide health system savings.

Nonetheless, the critics' basic point is well-taken. The Massachusetts health insurance market is overregulated, as are the health care markets in many other states. Much of today's state health insurance regulation is counterproductive and out­dated. With respect to benefit mandates, while many legislators believe that they are necessary and socially beneficial, it is also true that enactment of these mandates (which now exceed 1,800 nation­wide[22]) is too often driven by anecdotes and "hard cases," narrow political considerations, or the spe­cial financial interests of providers who want legally required coverage and reimbursement for their specialties.

State legislators should rigorously review exist­ing rules and repeal those that impose unnecessary costs on individuals and families. Specifically, states should provide greater flexibility as well as man­date and rating relief for carriers offering health insurance in the small group and individual mar­kets. Better still, they should simply abolish the existing rules that govern these dysfunctional mar­kets and start over with a clean slate: a single mar­ket and a common set of understandable rules focused on consumer information and protection.

Expanding Access to and Choice of a State­wide Health Insurance Exchange. The Massachu­setts plan focuses primarily on providing relief to small businesses and their employees. Specifically, it creates an avenue for these individuals and families to take advantage of the generous federal tax breaks that accrue to employer-based health insurance while enabling them to own their own health insur­ance policies and keep them regardless of job change or status. The Massachusetts plan, however, restricts participation in the Connector to employees in busi­nesses with 50 or fewer employees and individuals purchasing coverage on their own. Moreover, lower-income individuals receiving the new premium assis­tance subsidy are restricted in the types of products that are available to them through the Connector.[23]

Officials in other states who are interested in establishing statewide markets should consider expanding participation in a health insurance exchange to employers of all sizes, including state and local government employees. States should also fold public programs, such as certain enrollees in Medicaid and SCHIP, into the health exchange. In many instances, families involved with public health programs do not share the same coverage. Folding the public programs into an exchange would allow these families to maintain private cov­erage together under a single policy.

In establishing a health insurance exchange, state officials should also ensure that it does not and can­not become a barrier to entry for new and innovative insurance products or options. Therefore, consistent with consumer protection, it is equally important, that states should allow any willing insurer to partici­pate in the health exchange arrangement and not restrict populations from choosing the product that best fits their needs, regardless of their income or level of financial help from the government. In the end, larger and more open participation in the state­wide market will result in a more successful, com­petitive, and robust consumer-driven marketplace.

Conclusion

Massachusetts officials have made significant strides in reforming their health insurance market, and other states can learn from the Massachusetts experience. States should build on the solid features of the Connector: the establishment of a statewide health insurance exchange to allow individuals to buy and own health insurance without losing favor­able tax treatment and direct assistance to low-income individuals and families for the purchase of private coverage using existing government funds. Likewise, states should reject certain problematic features of the final plan, such as the employer man­date and public program expansions, and improve other aspects of the plan.

Every state wrestles with the impact that rising health care costs and numbers of uninsured have on the economy and budget. Nonetheless, every state has its own health care delivery system that operates in a unique political, cultural, and legal, and regulatory climate. While the Massachusetts plan is clearly not perfect, it does make some cru­cial conceptual breakthroughs in health policy. Furthermore, the process itself illustrates that states, regardless of their differing characteristics, can tackle the difficult health care issues that thus far have stymied federal policymakers.

Nina Owcharenko is Senior Policy Analyst for Health Care in and Robert E. Moffit, Ph.D., is Director of the Center for Health Policy Studies at The Heritage Foundation.