Under the current system virtually all employers and group insurers have perverse incentives to attract the healthy and avoid the sick. Once people have enrolled, the incentives are to overprovide to the healthy (to encourage them to stay) and underprovide to the sick (to encourage them to leave).
Managed Competition in the Healthcare Exchanges
The problem with managed competition under the Affordable Care Act is that the pressures to act on the incentives will be much more intense. In the health insurance exchanges, health plans will be forced to charge the same premium, regardless of health status, and potential enrollees will be able to easily compare premiums. In this way, the insurers will be forced to aggressively compete on price.
To the degree that a plan succeeds in attracting an above-average share of healthy enrollees or a below-average share of sick enrollees, its average cost will be lower than that of competing plans. That means it will be able to charge a lower premium than other plans and enjoy a competitive advantage in the health insurance exchange.
There are provisions to offset some of the expected perversity with so-called “risk adjustments.” Yet no system of risk adjustment works well. Currently, the Medicare Advantage program has the most sophisticated risk adjustment mechanism—employing as many as 60 or 70 variables. However, studies show that the system predicts individual health costs very poorly and the health plans are still able to game the system and attract an above-average healthy enrollment. [1,2]
A Better Alternative: Creating a Market for the Care of the Sick
Instead of requiring insurers to ignore the fact that some people are sicker and more costly to insure than others, we should adopt a system that compensates them for the higher expected costs—ideally, making a high-cost enrollee just as attractive to an insurer as a low-cost enrollee. At a minimum, this means that when individuals switch health plans, they always move at market prices, not artificial prices.
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