Limited benefit or non-Affordable Care Act (ACA)-compliant health insurance products are much discussed of late, since a proposal to ease restrictions on short-term health plans is currently under consideration. Critics have argued that these plans hurt both consumers and the individual market, while defenders have suggested that those who can benefit from this competitively priced option should be free to do so. That these plans may be harmful to at least some consumers is difficult to dispute. In its comment letter, the National Association of Insurance Commissioners supported increased disclosure requirements, noting that many consumers reported feeling “confused or misinformed when they purchased a policy that appeared similar to a major medical policy,” but in important ways was not. Yet evidence of harm to consumers is neither necessary nor sufficient to make the case that limited benefit plans are bad for the market.
In the absence of the limited benefit option, some consumers might not buy insurance at all, while others might purchase ACA-compliant plans. That decision breakdown is not known, but what we know about the size of the limited coverage market suggests that the base may not be trivial. The limited coverage segment is hard to measure, since it includes many different products, some of which are designed to supplement group coverage. But enrollment in a few of the major categories, including noncomprehensive, short-term, and “other” individual coverage (calculated from industry financial data reported by Mark Farrah Associates), exceeded seven million in 2016. While this figure most likely includes some enrollment that should not be counted, it may also underestimate in other ways by excluding plans categorized as “individual accident” or named “disease coverage,” or coverage that is offered through associations but is actually sold to individuals. It seems fair to posit that the availability of limited benefit plans results in at least some reduction in enrollment in the ACA-compliant market.
The ACA enrollment loss is not just consequential in terms of volume but also selection, since limited benefit plans are underwritten and are not sold to people with preexisting conditions. And the selection is even more significant than that suggested by medical underwriting alone. In the event that costly conditions develop among this healthy population, the designers of these plans intentionally use the ACA-compliant market as their backstop. In its promotional literature for its Premiere Choice plan (not currently available on the Internet), the Freedom Life Insurance Company of America offers prospective enrollees the opportunity to purchase a rider, which allows them “a onetime right to additional coverage…without additional medical underwriting.” But this additional coverage is effectively a one-way ticket out of the plan, designed to help enrollees “bridge the gap” between the limited benefit plan and “the earliest possible effective date of coverage for an ACA qualified health plan that could be purchased by you.”
These plans practice an extreme form of cherry picking that governs both entry and exit. While they may be affordable to the people who buy them, this is largely because they are free-riding on the ACA-compliant market. Even members of an underwritten cohort that enter an insurance product without any preexisting conditions have some likelihood of developing costly health problems through an accident or illness. These plans don’t price for that risk but create a virtual trapdoor through which they drop these unfortunate customers back into the guaranteed issue market at the next available opportunity. It is hard to argue that they are priced “actuarially fairly,” when in fact they don’t pay for the right tail of their distribution—that cost is exported to the ACA-compliant market to be shared by its customers and US taxpayers. The idea that these plans represent a type of competitive alternative to the ACA that should be embraced in the name of freedom of choice ignores the reality that the entire business model is built upon using the guaranteed issue market as a source of free reinsurance. It stands to reason that these plans impact this market, since they do so by design.
The business practices of limited benefit plans create negative externalities in the ACA-compliant market, which make that market smaller and more expensive than it would otherwise be. It seems reasonable to consider some strategies for minimizing these spillover effects. One approach to externalities is regulation. A number of states have eliminated limited coverage plans through insurance market regulation, and their individual markets appear to be healthier as a result. A recent analysis showed that nearly all states with adverse market outcomes have permitted the sales of limited coverage and transition products, providing more support for the idea that the effect of limited coverage products is not trivial.
Another idea would be to internalize the externalities through taxation. Enrollees in limited coverage plans are not currently paying for their reliance on the ACA-compliant market. A remedy would be to price these plans so that they more closely reflect their true costs and create a transfer to the guaranteed issue market. It would essentially be a “free rider” tax. While some might say this is accomplished by the payment of the individual mandate, that payment is not targeted at those most hurt by this adverse selection—other customers in the state’s guaranteed issue market.
While it is impossible to come up with an exact method for establishing the size of such a tax, one approach would be to use the medical loss ratio limits established by the ACA. These regulations require that individual carriers spend no less than 80 percent of premiums on health care services for members. Plans that do not achieve that level must provide refunds to their customers. In general, the experience of many carriers has been to have medical loss ratios far in excess of this minimum, so that the issuance of rebates has been a fairly rare occurrence. A tax to be levied on the limited coverage carriers could be based on the idea that they should also meet that standard. For example, in their financial data (as reported by Mark Farrah Associates), Freedom Life Insurance reported a loss ratio of 63 percent on its individual business for 2016. A transfer to the guaranteed issue market of about 15 percent of premiums would approximate a loss ratio of about 80 percent for the limited coverage plans and would compensate the guaranteed issue market for serving as a source of reinsurance for these plans.
Such a tax would probably be reflected in the premiums of limited coverage plans, which may lose enrollment, yet this would actually represent an improvement in efficiency, since the prices of these plans would more closely approximate their true costs. At the same time, such a tax would offset the negative impact of these plans on the guaranteed issue market and may improve enrollment and lower premiums there. This approach is based on a reasonable premise but clearly approximates instead of specifically measures the exact impact of the limited coverage plans on the guaranteed issue market. Yet while there are alternative ways to conceptualize this tax, the concept is theoretically and directionally appropriate, as it attempts to remedy an inefficiency in the market, in which free-riding by one segment of a market has caused spillovers in another. States that want to keep short-term plans could develop some type of “rough justice” tax along the lines suggested here and implement these transfers. While not every state feels the need to protect consumers from limited coverage products, all should be motivated to protect their market from free-riding that undermines their residents’ ability to choose comprehensive coverage.
