February 23, 2017

The Key Questions Any Obamacare Replacement Must Answer

Republicans do not yet have a full replacement for the Affordable Care Act (ACA or “Obamacare”), but the outlines of one are emerging. The Policy Brief on Repeal and Replace issued by House Republicans on February 16 points the way toward a three-tier system. It promises to provide  “coverage protections and peace of mind for all Americans—regardless of age, income, medical conditions, or circumstances,” while ensuring “more choices, lower costs, and greater control over your health care.”

Those are lofty aspirations, but reformers will have to address many difficult questions before they can be met. To find realistic answers, they will have to overcome divisions within the party, ideological constraints, outside pressures, and some hard realities of healthcare economics.

Conceptual framework

The new policy brief, and similar plans put forward by Rand Paul, Mark Sanford, Paul Ryan, and others, include many common elements. Together, they point to a three-tier system that, in broad outline, would look like this:

Central tier, for individuals and households with incomes well above the poverty line in which no member suffers from a serious chronic health condition. Such people account for roughly 70 percent of the population and roughly 25 percent of personal healthcare spending. Members of this tier would be served by conventional commercial health insurance. The cost of premiums would be covered by a combination of individual payments, advanceable healthcare tax credits (HCTCs), and employer contributions. Premiums and HCTCs could rise with age, but insurers would not be allowed to charge differential premiums based on pre-existing conditions or to refuse coverage. High-deductible policies would be encouraged by using health savings accounts (HSAs) for covering out-of-pocket costs.

Low-income tier, for individuals and households with incomes close to or below the official poverty line in which no individual suffers from a serious chronic health condition. Such people account for roughly 20 percent of the population and roughly 10 percent of all personal healthcare spending. Their coverage would be funded entirely, or almost entirely, from government sources. Some proposals use Medicaid block grants as the model for this tier.

High-risk tier, for individuals in the 10 percent of the population with chronic health conditions who account for roughly 65 percent of all personal healthcare spending. Average healthcare costs for this group exceed median household income. Their conditions are uninsurable due to the high cost of care and the chronic nature of their conditions.  They would receive coverage from Medicare or some kind of high-risk pool, funded entirely, or at least in large part, from government sources.

In principle, such a system could ensure that 100 percent of the population had access to quality healthcare at an affordable cost—the aspirational goal set, but not fully achieved, by the ACA. However, the devil is in the details. Unless each element of the three-tier system is well thought out and adequately funded, and unless the parts fit together seamlessly, a Republican replacement could easily end up costing families more than the ACA and leaving a greater number of people without coverage.

Here are some questions that need answers before it will be possible to assess the workability of a Republican replacement for the ACA.

Questions for the central tier

How to control adverse selection? Conventional health insurance is affordable only if healthy people participate in the insurance pool. If people can easily buy into coverage after they become sick and drop out at will when they recover, the average cost of claims rises and premiums become unaffordable. This is the notorious “death spiral,” known to economists as the problem of adverse selection.

One way to control adverse selection is to make coverage mandatory. The ACA included a step in the direction of mandatory coverage in the form of tax penalties for healthy people who did not obtain coverage. However, that proved to be one of the least politically popular aspects of the ACA, especially among Republicans.

Another way to control adverse selection would be to refuse care to people who do not have insurance. However, absolute refusal would defeat the goal of making healthcare universally accessible. No one wants to see people who have been turned away by doctors and hospitals dying on the streets.

A possible compromise would be to require that providers serve people without insurance coverage, but to make aggressive retroactive efforts to collect full payment from them for services rendered. Those efforts would include mechanisms such as asset forfeiture, garnishing wages, and personal bankruptcy. A sufficiently severe financial threat would probably be enough to induce most healthy members of the middle-class to purchase insurance—catastrophic coverage, at least—thereby avoiding the worst effects of adverse selection. If expenses from a serious illness drove an uninsured person or household into bankruptcy, they would become eligible for coverage either under the low-income or the high-risk tiers.

How to deal with temporary, cyclical, and unexpected loss of coverage? In addition to dealing with people who voluntarily accept the financial risks of foregoing insurance, any plan should have some provision for dealing with people who lose coverage through no fault of their own. Examples include cyclical job loss, plant closings, death of a covered parent or spouse, and divorce. Measures to deal with such contingencies might include emergency premium support for affected individuals. They might also require temporary federal help to state-administered programs in cases of economic downturns that affect regions unevenly—say, a Florida real-estate collapse or an Oklahoma energy bust.

What role for employer-provided insurance? Historically, a large portion of people eligible for the central tier of the three-tier system have received coverage through their employers. However, employer-provided coverage has a number of disadvantages. Among others, it is a burden on the employers themselves—one that, according to economists, is passed through at least in part to workers in the form of lower wages. It works less well for small and medium businesses than for large corporations. Also, it tends to decrease labor mobility through “job lock,” since moving to a new job will  most likely mean loss of coverage.

One option would be to follow the lead of the ACA and leave the current employer-provided system in place. Doing so would perhaps have the political advantage of reducing the apparent budgetary cost of subsidies to individual insurance companies within the central tier. However, those savings are largely illusory, since existing tax preferences for employer-provided insurance are a drain on the budget, too.

Another option would be to let employer-provided insurance gradually die. It is, in fact, already gradually dying. Some GOP proposals would accelerate the demise of employer-provided insurance by repealing the employer mandates of the ACA. It would also be possible to speed the phase-out of employer-provided insurance by withdrawing tax preferences, as some Congressional Republicans are reportedly considering.

What conditions should be set for transition into the high-risk tier? Premiums would remain affordable for people in the central tier only if the sickest patients—the 10 percent of the population who account for two-thirds of all personal healthcare spending—were covered by the high-risk tier. To make that work, there would have to be an orderly transition mechanism to move people who develop costly chronic conditions from one tier to the next.

One way to do that would be to allow insurers in the central tier to place annual or lifetime caps on claims. The ACA does not allow such caps, although they were previously common. If access to the high-risk tier were automatic for all people whose expenses exceeded the caps, it would be possible to maintain the goals of universal coverage and affordable premiums for the central tier.

Questions for the low-income tier

How to ensure full funding? There is much discussion within the GOP about providing coverage for the lowest tier through Medicare block grants to individual states. What mechanisms would ensure that states actually provided universal coverage and quality care to people in this tier? At present, states vary enormously in the degree to which they achieve these goals and in their political willingness even to try to do so.

A further question concerns the growth of funding over time. There has been some discussion of pegging the size of block grants to increases in the consumer price index, but the rate of growth of healthcare costs, in the past, has regularly exceeded the growth of the CPI. Pegging grants to the CPI, then, would mean progressively tightening healthcare budgets of the states.

How to maintain work incentives during transition into the central tier? In order to achieve universal coverage, participation in the low-income tier would have to be a universal entitlement for all people meeting the income criteria. Furthermore, the upper bound of eligibility would have to be set high enough so that people would not leave the low-income tier until they were financially able to participate in the central tier. The terms of transition from the low tier to the central one will require careful thought.

In particular, it is important to make sure that healthcare subsidies to not degrade work incentives for low-income individuals. For example, a simple income cutoff, say 150 percent of the poverty line, would create a “healthcare cliff,” beyond which earning a few dollars of extra income would cost a household thousands of dollars in medical benefits. One way to avoid a cliff would be to gradually taper low-income healthcare benefits as income rose. However, the healthcare benefit reduction rate for people in the transition range would add to the effective marginal tax rate faced by affected workers. Its disincentive effects would be compounded by that of other social programs, such as the earned income tax credit.  The problem of high effective marginal tax rates for households close to and just above the poverty line is already severe. (See here for a more detailed discussion.) Ideally, healthcare reform should alleviate the problem, not intensify it.

How to ensure interstate mobility? For a variety of reasons, interstate mobility in the U.S. labor market has significantly decreased in recent years. Decreased mobility makes it harder for the economy to adjust to trade shocks, technological change, and occupational shifts. If low-income healthcare coverage is to be provided on a state-by-state basis, as many Republican plans propose, what assurances will there be that coverage will remain portable from state to state, without waiting periods or major changes in coverage? The question is especially important since workers who lose their jobs due to trade or technology shocks are likely to drop into the low-income tier temporarily while seeking new employment. Their chances of finding new jobs would be greatly reduced if they had to remain within their home state to receive continuous health coverage.

Questions for the high-risk tier

Who provides coverage? The healthcare needs of people in the high-risk tier are uninsurable by traditional standards because of high costs and a high probability that claims will continue year after year. Except, perhaps, for the very wealthy, the healthcare needs of people with expensive chronic conditions will require heavy subsidies.

The existing Medicare program would be one way to finance care for the chronically ill. Forty percent of people in the top 5 percent by health care spending are over 65. They could remain on Medicare, reducing the number of people who would need another financing mechanism. Simpler still would be to extend Medicare to everyone in the high-risk tier, regardless of age.

Alternatively, the nonelderly chronically ill could be covered by high-risk pools, as was done in some states before the advent of the ACA. The pools could be run either at the federal level, or at the state level with federal subsidies. If they were run at the state level, they would raise the same questions of interstate mobility as would state-by-state coverage for the low-income tier. Even though many seniors are no longer in the labor market, interstate moves to be closer to relatives, or necessitated by relatives’ job changes, would create problems if high-risk coverage were not fully portable.

How to ensure full funding? The past record of state high-risk pools is decidedly mixed. Inadequate funding often led to waiting periods, denials of eligibility, or other limits on coverage. There is no getting around the fact that the high-risk tier, although small in terms of the number of people it includes, represents by far the largest single slice of healthcare spending.

If the top 5 percent of spending units ended up in the high-risk tier, they would absorb approximately half of all spending. If it were 10 percent, they would account for two-thirds of all spending. Reducing the funding needs of the high-risk tier by reducing the number of people covered would mean leaving more people with costly chronic conditions in the central tier. That would push up premiums in that tier, increasing its subsidy needs.

The funding requirement of a high-risk pool that maintained open access and quality care would vastly exceed the costs of subsidies for the low-income tier. Imposing them entirely on state budgets would be unrealistic, especially given the large income disparities among states. Most of the money would have to come from the federal government in one way or another, and the amount would have to increase with actual healthcare costs, not just the CPI, in order to avoid the re-emergence of waiting periods or other coverage limits. Also, it would need to be protected from periodic waves of austerity and sequestration arising from business cycles and generally imprudent fiscal policy.

Questions for all tiers

Some questions cut across all tiers of coverage, from low to high incomes and from the completely healthy to the chronically ill. GOP healthcare policy reformers will have to address these questions, too.

How to ensure that “accessible” means “affordable”? The GOP policy brief uses the words “accessible” and “affordable” almost interchangeably, but they are not necessarily the same thing. Suppose you take the “Members  Only” sign off the door of an exclusive country club, and replace it with one that says, “Open to the Public. Greens Fees $250.” That makes the club accessible but it is still not affordable.

One of the chief criticisms of the ACA is that in some cases, premiums and out-of-pocket costs for insurance purchased on exchanges are so high that the covered parties cannot actually afford to use the services. Without adequate funding for all three tiers, at both the federal and state level, the GOP plan would be no better. If budget hawks gain control of Congress or statehouses, it could turn out worse. But adequate funding is only half the story of making “accessible” and “affordable” truly synonymous. Our next item, cost control, is equally important.

How to control underlying healthcare costs? Healthcare policy is not just a matter of how to distribute the burden of costs—it also has to deal with their magnitude. The United States currently spends far more per capita on healthcare than any other OECD country—16.9 percent of GDP compared to just 11.8 percent for the second highest spender, the Netherlands, and far above the OECD average of 9.3 percent. Although about half of all U.S. healthcare dollars now come from private sources (a far higher percentage than in any other OECD country), the government share of U.S. healthcare spending alone is higher than the average government share for the OECD. In fact, U.S. government healthcare spending is higher in relation to GDP than total public and private healthcare spending in Korea and Israel.

Clearly, cost control has to be a priority in any healthcare reform. The growth of healthcare spending has slowed somewhat under the ACA, but it has not been reversed and may accelerate again with full recovery from the Great Recession. GOP reformers offer a number of promising cost-control measures, including stronger bargaining over drug prices, greater vigilance against fraud and abuse, more interstate competition in the insurance market, and reform of medical malpractice. Many of these are good ideas, and there are more good ideas on the Democratic side of the aisle. However, the implementation of cost controls faces a major obstacle: every dollar of healthcare cost savings means a dollar less of revenue for some healthcare providers. Providers, whether pharmaceutical companies, doctors, hospitals, or insurance companies, have considerable influence in Congress. “Watch what they do, not what they say,” must be the rule in judging the seriousness of would-be healthcare cost cutters.

How to ensure participation by providers? Healthcare coverage for patients is worthless unless providers are willing to accept that coverage. There are already many providers who opt not to accept patients covered by Medicaid, Medicare, or narrow-network private plans. Encouraging participation by a broad spectrum of providers would be especially important for the low-income and high-risk tiers. Reform proposals to date have not always been clear on how they would maintain adequate levels of participation by doctors, hospitals, pharmaceutical companies, and other providers.

What services to cover? Another problem that reformers have not always adequately addressed is that of what services should be covered in any given tier. There seems to be a general preference among GOP reformers to minimize mandates and allow consumers free choice of plans with broader or narrower coverage, especially in the central tier. However, that could lead to problems. Women who opt for plans without coverage for pregnancy might accidentally become pregnant. People who opt out of coverage for mental health or addiction services, thinking “It can’t happen to me,” might nonetheless find themselves in need of those services. Problems could also arise if a person making the transition from a central-tier plan with broad coverage found themselves unable to use their regular doctor, hospital, or medications if circumstances forced them into the low-income or high risk tiers.

Will GOP reforms match international best practices? Contrary to what one often hears, the high level of U.S. healthcare spending does not buy the world’s best health care. A survey of the healthcare systems of eleven wealthy countries by the Commonwealth Foundation ranked the U.S. dead last in terms of overall efficiency and effectiveness. Despite the popular belief that the U.S. system provides timely care while the single-payer systems of other wealthy countries impose long waiting times, the U.S. ranked only fifth among the eleven in terms of timeliness. In practice, though, the U.S. healthcare system uses rationing by cost more than by waiting. In terms of cost-related problems of access, such as inability to afford insurance or to pay for needed services or medications, the U.S. ranked eleventh out of the eleven countries.

Creating a system that performs better than the ACA should not be hard. The various pieces of the ACA do not fit together smoothly. The system as a whole fails to adequately address many of the questions raised above regarding Republican alternatives—gaps in coverage, perverse disincentives, and difficulties in moving from one part of the system to another. Conceptually, if all of our earlier questions receive satisfactory answers, a three-tier system like the one that seems to be emerging from GOP reform efforts could more fully meet the goal of universal and affordable access to quality healthcare services than does the ACA.

But just beating the ACA is a low bar. The real question that Republican reformers should ask is whether their proposed multi-tier mechanism would outperform the best single-payer systems of countries like Switzerland, Sweden, Germany, and New Zealand. Achieving that level of performance within the limits of self-imposed ideological constraints and outside pressures from providers who profit from the status quo will be extremely challenging.