The Right Prescription

Prolegomena to Any Future Healthcare Summit

Immanuel Kant no doubt had a better understanding of metaphysics than Democrats have of health care.

By 2.23.10

Although many commentators have warned against it, Republicans have taken the dare and decided to sit down eyeball-to-eyeball with President Obama Thursday and discuss healthcare legislation. This is not a bad thing. It gives the GOP the chance to put their ideas on the table and shake the moniker as the "party of no."

Going into any such gathering, however, requires having a firm grasp of the situation. There are many seemingly easy fixes to healthcare problems. For example, the Democrats have recently been seized with the idea that all they had to do was repeal the insurance industry's anti-trust exemption and the healthcare mess would be halfway to righting itself. All this was undertaken, of course, without any recollection of why the exemption was granted in the first place. Instead it was based on the premise that certain insurance companies have somehow achieved a "monopoly" in certain states. Whatever monopoly may exist has been purely the work of the state insurance commissions, rather than the sinister powers of any one insurance company. The anti-trust exemption was in fact granted in exchange for other concessions from the insurance industry -- but we'll get to that in a moment.

In any case, when House Speaker Nancy Pelosi summoned the troops, she quickly discovered that repealing the anti-trust exemption without repealing the other half of the 1945 McCarran-Ferguson Act -- forbidding insurance companies from selling across state lines -- would quickly make things worse. Underwriting insurance policies involves collecting a lot of data. The anti-trust exemption allows bigger companies to share their data with smaller competitors, which keeps a lot of small firms in the market. Removing this exemption would only lead to greater industry concentration.

Oh well, nothing is ever easy in healthcare. Democrats don't understand it better than anyone else. In fact they understand less. Their entire philosophy of "reform" has been "bring it all down to Washington and we'll figure it out later."

Before Republicans storm out of any health summit, then -- or before Democrats try to sneak some "reconciliation" effort through in the dead of night -- it might be worth pondering for a few moments how American health insurance became tied up in such knots and what simple steps might be taken to untangle it.

THE SEGEMENTATION OF THE HEALTH INSURANCE MARKET began in 1945 when the South-Eastern Underwriters Association, which controlled 90 percent of the market in six southern states, was challenged by the federal government on anti-trust grounds. The Association challenged the federal government's right to regulate their business. Traditionally, Washington had avoided invoking its interstate commerce powers on the legal fiction that selling insurance was not "commerce." The U.S. Supreme Court quickly cast this aside and ruled that the federal government could indeed prosecute insurance companies. Acknowledging the tradition, however, the Court left open the option that Congress could delegate its powers to the states.

Congress took up the offer by passing the McCarran-Ferguson Act of 1945, a bi-partisan effort co-sponsored by Senators Pat McCarran, a Democrat from Nevada, and Homer Ferguson, a Republican from Michigan. The law reserved licensing and regulation of the industry to the states, assuming they would run it along the lines of a public utility. Because they were setting rates in conjunction with state insurance authorities, the companies were allowed to collaborate on data collection and risk estimates. For this they were exempted from the Sherman Anti-Trust Act.

Thus began the system we have today, where there is no national market for health, fire, or auto insurance but 50 separate state markets. Insurance companies must go through extensive licensing procedures in order to gain permission to sell insurance in each and every state. Some states are very permissive, others are very restrictive. As usually happens in such situations, companies that are already licensed to sell insurance generally oppose licensing other carriers in order to suppress competition. In many states, regulators have formed a virtual partnership with one large carrier -- usually the local Blue Cross.

Democrats have discovered this system of state regulation, however, and concluded that the insurance companies have created the monopolies. Last May, Health Care for America Now!, a lobbying group formed by the AFL-CIO, ACORN,, the SIEU, the Children's Defense Fund, the Center for American Progress, and a host of liberal organizations, published a study revealing that "94 percent of insurance markets in the United States are now highly concentrated.

In Hawaii, Rhode Island, Alaska, Vermont, Alabama, Maine, Montana, Wyoming, Arkansas and Iowa, the two largest health insurers control at least 80 percent of the statewide market.

Senator Chuck Schumer, who spoke at the press event, proclaimed, "A public plan will push down health care premiums by injecting competition into the health insurance market, which right now has too few players and they have a stranglehold over consumers."

What the Democrats do not seem to realize is that these "monopolies" are entirely created by state regulations. Many state insurance commissions are still operating on the 1990s model, which said that one or two big providers will have leverage to beat down prices charged by doctors, hospitals and other medical service providers. This was the era when Health Maintenance Organizations were seen as the key to keeping down costs. The obvious solution is to break up these monopolies by allowing carriers to sell across state lines. This has been proposed many times by Republican Congressmen and Senators. But Democrats would prefer to take us further away from a competitive market by centralizing everything in Washington instead.

State regulations had other flaws as well. One of the most unfortunate is the everlasting temptation of state legislators to mandate coverage for particular services. This is a very predictable process, fueled by well-meaning health crusaders plus the desire of particular providers to make sure their bills are going to get paid. Typically the providers of some marginal health service such as chiropractic or treatment for alcoholism will come to the legislature and insist that theirs is a service essential to all humanity. Often crusading consumers of chiropractic or alcoholism treatment second their efforts. The legislature responds by mandating that every insurance policy include coverage. Before long, people are being forced to buy coverage for services they don't want or need. The result is that insurance costs go up for everyone. The Council on Affordable Health Insurance estimates that there are now 2,133 separate mandates in the 50 states for services as diverse as podiatrists, midwives, occupational therapists, athletic trainers and pastoral counselors. CAHI estimates these mandates raise the price of insurance 20 to 50 percent.

All this state meddling would have provoked a public outcry years ago except for one thing -- 55 percent of the working population has found a way of getting around these state regulations. It is called the Employee Retirement Income Security Act of 1974 -- "ERISA."

ERISA was adopted after the Studebaker Corporation went bankrupt in the 1960s, leaving its retirees without their pensions. Pressure mounted for the federal government to insure corporate pensions and in 1974 Congress passed the law. Most retirement programs were administered by labor union and funds for health benefit plans were often intermingled, so in order to avoid an accounting nightmare, Congress threw in coverage of health benefits as well. From now on, the federal government was on the hook if a fund failed.

Fearful that benefits programs would be drained by state regulations, Congress threw in another provision - all ERISA plans were exempted from state insurance regulation. In order to qualify for ERISA, however, corporations could not just go out and buy insurance. They had to form their own insurance pools among employees and their dependents. Thus, "self-insurance" became the key to avoiding costly state mandates. Because insurance pools must be large enough to spread the risks, however, a company generally needed at least 200-300 employees to form an ERISA plan. Thus, "good benefits" became the sole province of very large employers and their labor unions.

The practice of offering employees health and retirement benefits in place of wage increases began long before ERISA. It is generally traced to World War II, when wage and price controls prevented employers from offering wage increases to retain scarce wartime workers. Instead, employers started offering health benefits, which were not counted as wages. The system received another huge boost when the Internal Revenue Service ruled that health and retirement benefits did not have to be taxed. Thus, increasing benefits became a convenient, tax-free way for employers to reward their employees without the government getting its share. By the 1960s, "greater take-home pay" (i.e., more health benefits with employers picking up more of the premiums) became a standard bargaining tool in labor negotiations.

ERISA sealed the deal. Now employers could offer generous, tax-free health benefits at a time when health insurance was becoming more and more expensive because of restrictive state regulations. By the 1970s, unionized employees of large manufacturers were getting lavish "first-dollar" coverage of medical expenses with no co-payments or deductibles, extending right through retirement. Keeping up with these expenses became a major cost of doing business. Even today, the estimate is that every car that comes off the assembly line at General Motors carries $1,500 in health benefits for current employees and retirees. When President Bill Clinton started talking about healthcare reform, major corporations expressed eager interest in sloughing these costs onto the federal government.

But there was a downside to ERISA plans that generated much public dissatisfaction. Because they were not subject to state regulations, ERISA plans had no trouble writing their own rules -- denying employees coverage for pre-existing conditions and even kicking people out of the plan if their expenses became too high. In campaigning for national healthcare reform in 1993, Hillary Clinton produced horror story after horror story about ailing people being cut off by their insurance plans. What she never mentioned was that nearly all these horror stories involved ERISA plans. While most states had outlawed such practices, ERISA plans were outside jurisdiction. State insurance regulator tore their hair at these atrocities but had no power to stop them. In fact, they usually got the blame for lax regulation.

After Hillarycare failed, some of these excesses were corrected by the Health Insurance Portability and Accountability Act of 1996. ERISA plans were prohibited from refusing coverage for pre-existing conditions or cutting off benefits for serious illness. But the general advantages for ERISA plans remained -- they did not have to abide by state mandates. In addition, there was the "healthy worker effect," which says that anyone fit to work for a large corporation is probably in good health anyway. This kept down costs and reduced premiums for the group.

Soon after, innovative entrepreneurs began trying to extend health benefits by setting up ERISA plans for smaller and smaller employers. With "stop-loss" insurance provided by major insurance companies, it became possible for companies with as few as 35-to-50 employees to set up ERISA plans. Groups of artists and other independent professionals were also able to aggregate insurance pools through organizations such as the Freelancers Union.

As a result, ERISA plans have proliferated widely. In 1999, 44 percent of all workers were in ERISA plans. Today it is 55 percent. Still, ERISA remains mainly the province of large corporations. (As the ERISA Industry Committee, which defends self-insurance programs, describes it, "We're basically the Fortune 500.") Whereas 62 percent of employees in companies with more than 5,000 workers were covered by ERISA in 1999, the figure in 2007 was 86 percent. Meanwhile, the number covered in companies with 3-199 workers has remained steady at 13 percent.

According to the Employee Benefits Research Institute, 132 million people -- 43 percent of the population -- is covered by employer-run self-insurance. This is the largest bloc of the population. The proportion of people who buy private insurance on the open market -- 6 percent -- has not changed in 20 years. The other sectors are:

Medicare - 43 million (14 percent)
Medicaid -- 43 million (14 percent)
Public employees -- 28 million (9 percent)
Private insurance - 17 million (6 percent)
Military personnel -- 12 million (4 percent)

The different categories add up to 90 percent but there is some overlap. Those that remain outside these groups -- 46 million people, 15 percent of the population -- are the ones to whom we are trying to extend coverage.

SO WHAT IS the best strategy? The Democratic impulse is to tear down the whole system, put the insurance companies out of business and substitute a public option -- without touching union benefits, of course.

Their first step would be to forbid insurance companies from underwriting -- i.e., screening customers and charging higher premiums for previous health conditions or bad habits. These reforms have already been implemented in many states, with generally disastrous results. New York, for example, has imposed both "community rating" (everybody pays the same price) and "guaranteed issue" (everyone is guaranteed a policy). As a result, people with serious health conditions flooded into the program, raising prices for that small 6 percent that buy insurance on their own. Forced to buy insurance at the same rate as sick old people, healthy young don't buy insurance at all. The private market has now shrunk to an incredible 1 percent. Politicians and editorial writers fulminate about how everyone must "share the costs" of covering the sick, of course, but they themselves are usually covered by ERISA or public employee plans.

On a national scale we can expect the same thing. Imposing guaranteed issue and community rating will force up premiums to the young and healthy. That is why it has been necessary to say these people will be fined or even imprisoned if they do not buy coverage. Since the fines have been reduced to only a fraction of the cost of insurance and since it may prove difficult to enforce the law anyway, this provision is not likely help defray costs. The Democrats next tried to tax "Cadillac" plans -- until they realized those were loyal union supporters driving the Cadillacs. That was when they decided to tax suntan parlors instead.

Even if these jerry-rigged solutions are imposed, the system will still contain huge inequities. Moreover, these inequities have enormous implications for our economy. Almost all new job creation comes out of small and new businesses. These are precisely the firms least capable of providing their employees with insurance. First, they are too small to form ERISA plans. Second, they don't have the extra cash. Saddling these small start-ups with healthcare costs will stifle economic growth. Anyone who tries to start their own business or move outside an established firm faces the same dilemma. All this makes for a stagnant, sluggish economy.

So what can we do to level the playing field, decoupling insurance from employment while taking care of people with serious medical conditions?

Here are a few suggestions:

• Take the tax advantages enjoyed by people under ERISA plans and extend them to everybody.

• Scrap the antiquated system of state licensing and allow insurance companies to sell policies across state lines.

 Don't mandate coverage. Instead, let insurance companies practice UNDERWRITING, charging people according to their health, age and other factors that predict how much medical service they are going to be demanding.

• For those people whose medical condition prices them out of the market, set up high-risk pools along the lines of those used to cover high-risk drivers.

• Adopt a few simple measures of tort reform that have proven to limit doctors' insurance costs without depriving injured patients the right to compensation. The simplest is to put upper limits on now open-ended claims for "non-economic damages" and "pain and suffering." Adding a statute of limitations of five years for claims is usually sufficient to bring the worst excesses of malpractice law under control.

The best way to equalize the system would be to offer everybody a $3,000-5,000 tax exemption for purchasing medical expenses and insurance. Then tax everything above that level as regular income. This would avoid such ridiculous schemes as the ridiculous 40 percent "Cadillac" tax (which everyone will figure out how to avoid anyway) while curbing the impulse of employers to funnel their employees tax-free benefits.

This, of course, is the outline for Health Savings Accounts, the most successful reform to come out of the 1990s efforts. America's Health Insurance Plans (AHIP), the industry research organization, estimates that more than 8 million American now have HSA's -- 3 percent of the population. These people are paying their own way without the help of the government.

Democrats object to this -- and have attempted to eviscerate HSA's -- because they claim that these people are "opting out of the system." Democrats make the same charge against young people who they say will buy only minimal coverage -- which is why part of their health plan involves having Congress write insurance policies the same way they have been mandated for decades in the states. If Congress doesn't require sufficient coverage, they argue, people will be ducking out on covering other people's costs.

Nothing could be further from the truth. A person who buys a $3,000 high-deductible policy is making every bit as much of a contribution as the person who loads down with a $20,000 of first-dollar coverage. Why? Because he or she is making fewer demands on the system. That is what underwriting is all about --anticipating people's demands on the system and charging them accordingly. If Congress would just leave the insurance companies alone to underwrite insurance according to actuarial principles, consumers could buy what they want and only minimal subsidies would be necessary to get everybody covered by the system.

The Democratic health plan is an elephant that will bring forth a mouse. All the bureaucracy and federal dictates will only produce a system that is less than what we already have. There is a much simpler way.

Allow insurance to be sold across state lines, level the tax advantages between people who get their insurance at work and those who buy on the market, let insurance companies do the underwriting without government mandates, and then provide targeted subsidies to people with serious medical conditions. Those are the parameters. If anything else remains to be done, pass another law next year.

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William Tucker is news editor for