This is the second part of a two-part post discussing the current state of health reform and where we should go from here. Part I examined the effects of the ACA and progressive reform initiatives. Part II below outlines a market-driven path forward.

In part I of this post, we described post-Affordable Care Act (ACA) consumer challenges and changes in health plan market dynamics, along with progressive policy responses. In part II below, we explore flexible, market-driven alternatives. The renewed national health care debate represents a conflict of visions of how to create better value: government central planning versus patient-centered, consumer-driven competition. With centralized payment and coverage decision making now in vogue, policy makers cannot ignore the limitations of central planning experienced in other national systems, such as Britain and Canada.

During the 2018 flu season, for example, the British National Health Service (NHS) cancelled 50,000 elective operations and asked families to take their elderly relatives home from the hospital, increasing wait times for patients and family caregiving burdens. Centralized systems also struggle with administrative operations: After the rollout of the NHS pay-for-performance program for primary care practitioners, it was later revealed that almost 3.6 million fake or deceased patients were registered, costing the British government more than half a billion pounds annually.

The COVID-19 pandemic has proved no exception, as British per capita mortality remains among the highest among economically advanced countries. Faced with COVID-19, the NHS declined to test symptomatic, exposed clinical staff; bungled a launch of centrally focused contact tracing application, and organized a pandemic response characterized as “offline” by the editor-in-chief of the Lancet.

America’s patients and physicians remain frustrated, creating an opening for practical alternatives. The time is ripe to transform the existing third-party payment arrangements that characterize both private and public insurance and to finally resolve the problem of the uninsured, while deploying the market forces of choice and competition to drive cost control. Market-driven approaches based upon defined-contribution financing (premium support), the states as insurance laboratories, and addressing the employer-sponsored insurance (ESI) tax exclusion would all serve to increase competition and engender insurance affordability and portability.

Premium Support: Flexible Support Across Markets

Under current law, total ACA spending is projected to amount to approximately $1.6 trillion over 10 years. It is composed of federal assistance for health insurance coverage (premium and cost-sharing subsidies), as well as the subsidies for Medicaid expansion for childless adults. Congress could transition direct subsidies of health plan products into state-managed funding pools for direct financial assistance to individuals and families. Funding could be designated as a risk-adjusted capitated plan, or appropriated per-beneficiary per-month, risk adjusted for a variety of factors including health status. Concurrently, Congress could ensure portability of funds from state-federal partnership programs, namely Medicaid and CHIP, allowing beneficiaries to choose to remain in these public programs or purchase a private plan product.  

Because of its distinct programmatic design and a commitment to the current level of funding for expanding coverage, such an approach would be distinct from the 2017 Graham-Cassidy bill. While retaining current law protecting persons from exclusion from coverage because of a preexisting medical condition, Congress could guarantee states funding to address adverse selection, risk mitigation, and otherwise generally structure their health insurance markets by whichever mechanisms each state feels works best for them. While both Congress and state legislators should aim to secure universal coverage, they should be able to do so within a model that provides greater flexibility for economic shocks, reflecting the severe challenges that face both citizens and officials responsible for managing state budgets.

State legislatures, with technical assistance from their state health and human services departments and local stakeholders, would determine the nature of risk transfer pools, reinsurance pools, specialized subsidies, and other technical details. States could draw on significant preexisting, local insurance expertise from the office of the state insurance commissioner. Commissioners and their staffs have decades of broad expertise regulating multiple lines of insurance, from property and casualty to life insurance, not to mention experience in health insurance markets prior to 2010.

In addition to restoring detailed decision making to state authorities and providing a designated appropriation to states as opposed to an entitlement, Congress could add automatic adjustments for times of economic distress. Alternatively, Congress could periodically revisit the funding—either increasing or decreasing the levels, critical in times of economic distress and pandemics. Congress could provide any necessary technical assistance to support efforts to expand coverage, while simultaneously monitoring quality improvement and patient satisfaction.

Given the current state of health insurance markets, Congress should set at least three major conditions on federal funding. First, states must use the funds to provide financial assistance to low-income persons who would not otherwise be able to afford health coverage. Second, states must deploy these funds to offset the costs of persons (including those with preexisting conditions) using the risk mitigation mechanisms that they think work best for their market—such as direct subsidy for the purchase of private health plan products, facilitating the creation of state-regulated and privately executed risk transfer pools, health reinsurance pools, and other mechanisms. Finally, states must deploy these funds to maintain and increase coverage for their citizens, with a goal of universal coverage, in conjunction with existing private and public insurance programs.

As different states have different political histories, cultures, populations, and lifestyle trends, state flexibility would allow a wide array of legislators to design programs that best fit the need of their diverse states. In short, this ample federal funding could help states maintain and expand health insurance coverage while simultaneously experimenting with innovative care delivery and insurance design, all while guaranteeing financial assistance for the poor and the sick. Transitioning an open-ended entitlement to a capitated, risk-adjusted budget would help ensure federal fiscal responsibility, while empowering states to decide how to manage and distribute funds.

States would have the full freedom to redesign their own individual and small group health insurance markets, including their pooling arrangements. They could decide whether or not to create, or continue to run, state health insurance exchanges, and additionally would have a choice to alternatively use—or not use—a federal insurance exchange.

States: Local Insurance Laboratories

States differ radically in

• the strength and vitality of their general economies;
• their mix of urban and rural populations;
• the age distribution of their population;
• the health status of their citizens and the accompanying burden of disease;
• the penetration of ESI;
• the vitality of their individual health insurance markets;
• their level of regulation and control over the health care sector;
• their patterns of prevailing medical practice, including the use of advanced medical technologies;
• the per capita availability of their physicians; and
• the competitiveness of their hospital markets.

Traditionally, states have used their constitutionally ordained police powers to respond to state and local market conditions, as determined by these variables. While Washington has legitimate health policy concerns in terms of ensuring equity for all US citizens, Congress should no longer pre-empt state experimentation and innovation, nor require states to request federal permission to innovate to improve the functioning of their own health insurance markets. The regulation of the state and local individual and small group health insurance markets is the legitimate responsibility of the states, and it should be restored—to the maximum extent—to the states.

There is strong empirical evidence that the states can indeed reverse the past pattern of accelerating health insurance costs within their own markets. The Centers for Medicare and Medicaid Services has approved waivers from federal health insurance rules for a set of diverse states under current law (Section 1332 of the ACA). The result has been a significant reduction in health insurance premiums within their individual markets and generous financial assistance to high-risk residents. For 2019, the seven states that secured waivers for various “risk stabilization programs” experienced a 7.5 percent reduction in ACA benchmark premium costs. Under the leadership of Governor Larry Hogan (R), Maryland, for example, secured a waiver for its reinsurance program and experienced a premium rate reduction of 13.4 percent in 2019, and it is projecting yet another 10.3 percent reduction in 2020.

In summary, Congress should retain the current protection of persons from exclusion from health coverage because of preexisting medical conditions. Furthermore, Congress should allow the states to reset the general rules governing their individual and small group health insurance markets, including but not limited to insurance rules governing age rating, risk pooling, insurers’ fiscal solvency, and consumer protections, particularly in the marketing of health insurance.

Fixing The Federal Tax Treatment Of Health Insurance

Recent efforts in federal health policy have focused on regulatory and administrative reform. While regulatory reform is necessary, it is not sufficient. Congress has the power to raise revenue, and thus make tax policy. As the late Nobel Laureate Milton Friedman and other leading economists have emphasized, tax policy plays a decisive role in shaping and driving the dynamics of America’s health insurance markets.

Acknowledged as flawed and regressive by both progressive and conservative economists, the ESI tax exclusion was an outgrowth of World War II wage and price controls, with the Internal Revenue Service initially implementing, and Congress later codifying, the unlimited exemption of employer-sponsored insurance from taxation. This was primarily a product of employer competition for workers and thus a matter of compensation policy, rather than health policy. Prior to the Second World War, fewer than 1 percent of Americans had hospital insurance. According to Schumpeter’s Employment and Health Benefits: A Connection at Risk, by 1958 more than 100 million Americans had coverage, a laudable development; however, 92 million (more than 75 percent) had obtained such coverage through their employers because of the tax benefit, rather than any cost or quality advantage for ESI over other coverage channels.

In 2020, more than one in two Americans receives unlimited tax relief for health insurance coverage merely because their coverage is purchased through their employer. Today, millions of middle-class individuals and families not offered ESI are ineligible for ACA subsidies because their income exceeds the allowable thresholds; thus, they are forced to buy increasingly expensive ACA-regulated health insurance with after-tax dollars, making it even more expensive or simply unaffordable.

Valued at more than $283 billion annually, the current ESI tax break encourages excessive health care spending and suppresses wage growth, while shielding health care consumers from the direct impact of rising health care costs. This health insurance tax break is one of the largest federal tax exemptions and the largest source of federal support for health care after the annual expenditures for Medicare and Medicaid.

The current federal tax exclusion of ESI undercuts consumer ownership and portability of health insurance, distorts health insurance markets, and frustrates consumer choice and market competition while increasing health insurance costs for individuals and families. A worthy policy goal is the provision of individual tax relief for the purchase of private health insurance. There are a variety of ways this could be accomplished, ranging from a tax deduction to a system of individual tax credits. In any case, such individual tax relief would enable individuals and families to choose the kind of personal coverage they want, from whichever source they prefer, including their employer, while allowing them to take it from job to job or through different stages of life without regulatory or financial penalties.  

To accomplish this goal, Congress could replace the recently repealed excise tax on these expensive plans with a simple cap on the existing tax exclusion—set at the ACA’s “high value” plan threshold—and give employees the option of either taking advantage of the ESI tax break beneath the cap or opting to take individual tax relief for the purchase of their own health insurance.

In 2018, the threshold for the ACA’s 40 percent excise tax on high-value or “Cadillac” health plans was set at $10,200 for single coverage and $27,500 for family coverage, indexed to annual inflation plus 1 percent. Using these initial dollar thresholds and the same formula for indexing, Congress could cap the exclusion while simultaneously providing individual tax relief for persons who do not have job-based coverage.

No person would be forced to change their coverage, while the tax break for coverage in either case—consumer-purchased or employer-derived–would no longer be unlimited. Workers would be free to choose the tax treatment, as well as the health plan, that was most advantageous to them, either through the current tax exclusion for ESI products or with the new individual tax relief. If Congress wanted to ensure that the provision of new individual tax relief was budget neutral, it could simply authorize the Treasury to adjust the cap on the exclusion, annually and automatically, to ensure that the federal tax expenditures for health insurance were stable and fiscally responsible. Any lost revenue from the provision of new individual tax relief would be offset by increased revenues from reducing the cap on the exclusion.

Such a new tax policy would help to rectify the profound inequity and the economic inefficiency of the status quo; it would also facilitate greater consumer, as opposed to employer, control of health policies, creating true coverage portability. Such a change would encourage the widest possible range of consumer choice, intensify health plan competition, and expand access to a broader range of coverage options for millions of Americans, regardless of where they live or work.

Summing Up

Previous legislative attempts at solving cost and access challenges in health policy have viewed health insurance and care delivery markets through a national lens, focusing on standardizing benefits and care delivery. As any patient or clinician will volunteer, health care markets are intensely local, and policy solutions must navigate the complex interplay of local, state, and federal stakeholders.

Recent progressive health policy efforts remain firmly anchored in a political philosophy that champions national regulation and central control, sitting in direct conflict with consumers who strive for mass-customized health care. Currently, consumers and clinicians are persistently frustrated, as both strive for choice, flexibility, and modernity in an otherwise dysfunctional system. In selecting health benefits, consumers face an impossible task: to predict their trajectory as patients, a challenge when the healthy office worker one day can become a terminal cancer patient the next. In this setting, a single benefits package is at its core unfair—a person’s needs change over time, and they should be able to change and customize their coverage as they progress through different stages of life.

Congress has multiple options to enhance choice and competition in health care markets, helping consumers achieve a more flexible, cost-effective system. Congress can transform the hundreds of billions of dollars in ACA subsidies to a “premium support” system of health care financing; impose a cap on the tax exclusion for ESI and gradually transition the current tax regime into a system of individual tax relief for health insurance; and facilitate, through ample federal funding and technical assistance, the role of the several states as laboratories for experimentation in insurance regulation, risk mitigation, and benefit design.

Both Congress and consumers have choices regarding how to implement health policy in a large, economically dynamic, and increasingly diverse country. Let’s make smart ones.