July 30, 2007 | WebMemo on Health Care
Seeking to establish a framework for a consumer-centered health insurance marketplace, many state policymakers are considering the concept of a statewide health insurance exchange. Similar to a stock market or farmers market, a health insurance exchange serves as a market organizer and central clearinghouse for buying and selling health insurance and managing related information and financial transactions. An exchange performs the administrative functions associated with individuals choosing and paying for health insurance within the context of employer-sponsored coverage, thereby allowing individuals to obtain portable individual health insurance within the federal-law construct of "employer-sponsored" plans. As such, an exchange functions like a common human resources department for participating employers and their workers.
Creating a Hybrid Market
The first step is for a state, using its power to regulate commercial insurance, to create a new hybrid insurance market that combines the most attractive features of the now separate individual and group markets. Specifically, a new hybrid market would offer participating workers broad choice of major medical insurance products, and coverage would be individually owned and portable. Those are the most attractive features of the current individual market that traditional employer group plans cannot offer. At the same time, coverage would be "guaranteed issued" and would not be individually underwritten, and an individual's future coverage options would not diminished if his or her health status declines. In addition, individuals would be able to use pre-tax dollars to purchase coverage and even out-of-pocket medical care through FSA, HSA, and HRA arrangements. These are the most attractive features of the current employer group market that are not available--either at all or to the same extent--in the current individual market.
Having authorized the sale of the new hybrid insurance products, the state can charter a health insurance exchange as the market organizer for the new arrangement. An employer can then voluntarily sign up to designate the exchange (and all the insurance products sold through it) as its employer group "plan" for its workers. Because this arrangement qualifies as an employer-sponsored "plan" for purposes of federal law, the employer's workers could purchase coverage of their choice through the exchange on a pre-tax basis.
A state might also opt to further leverage the exchange mechanism by folding its current individual insurance market into the new hybrid market administered by the exchange or by using the exchange to administer premium support contributions to supplement individual and employer funding for one or more categories of low-income residents. Massachusetts's exchange has taken on both of these roles.
Note that the basic design of an exchange does not include any policymaking, regulatory, or adjudicative functions. While it is possible for a state to assign its exchange one or more of those governmental functions (as in Massachusetts), state lawmakers pursuing such an approach would be well advised to treat those functions as separate within the exchange and to budget for them separately as well. Because the primary purpose of an exchange is to provide administrative services for participating individuals, employers and insurers, it is fair to charge participants a fee to cover the cost of those services. However, it would be unfair to burden only exchange participants with the additional costs incurred by an exchange performing what are essentially broader, governmental functions. Thus, if a state wants to "contract out" to its exchange the job of performing certain functions on behalf of the general public--for example, conducting enrollment and eligibility verification for public assistance programs--the fair approach is to pay for those services out of general state tax revenues; the same as if they were retained in an existing state government agency.
In designing a state health insurance exchange, lawmakers need to plan for five main financial components:
Finally, it should be noted that many of the functions of an exchange--both core functions and any additional roles lawmakers assign to the exchange--can be competitively bid out to private vendors with relevant expertise, such as third-party administrators, benefits consulting firms, payroll servicing firms, and data management firms. In any case, state officials should seek assistance from these firms in developing cost estimates for the creation and operation of an exchange.
The ongoing costs of running a state health insurance exchange will be quite low, approximately equivalent to the administrative costs incurred by the human resources department of a very large employer for administering its workers' health benefits. Indeed, a good starting point for calculating ongoing expenses is the state government's experience administering health coverage for state workers. Furthermore, if the state government initially joins the exchange as an employer, then those functions could effectively be privatized into the exchange along with their current funding.
Unlike other areas of health care, the administrative functions that a health exchange is designed to handle are subject to economies of scale, and through the exchange, the benefits of those services and savings can be extended to a state's small employers, giving them something that they currently lack--a large, expert human resources department to manage their employee health benefit programs.
Greg D'Angelo is Research Assistant, and Edmund F. Haislmaier is Senior Research Fellow in Health Policy Studies, in the Center for Health Policy Studies at The Heritage Foundation.
 Ideally, an exchange should service a single, inclusive market, open to all consumers and employers, regardless of firm size. An exchange should serve as an administrative mechanism to implement state insurance market reforms that create a broad, consumer-choice health insurance market. An exchange can also be a mechanism for administering government subsidies to obtain private health insurance, for aggregating employer and employee contributions to health plans, for disseminating price and quality information, and for processing premium payments, paperwork, electronic transactions, and other administrative functions. For a brief description of the concept, see Robert E. Moffit, Ph.D., "The Rationale for a Statewide Health Insurance Exchange," Heritage Foundation WebMemo No. 1230, October 5, 2006, at http://www.heritage.org/research/healthcare/wm1230.cfm.
 For a brief discussion of the Massachusetts reform, see Nina Owcharenko and Robert E. Moffit, Ph.D., "The Massachusetts Health Plan: Lessons for the States," Heritage Foundation Backgrounder No. 1953, July 18, 2006, at http://www.heritage.org/Research/HealthCare/bg1953.cfm.
 Personal communications with Jon Kingsdale, Executive Director of the Massachusetts Health Insurance Connector; Vince Ashton, Executive Directorof New York Health Pass; and Ken Comeau, Vice President of the Connecticut Business & Industry Association. The "percent of premium" method should be used only as a simplified estimating convention. Actual administrative costs should be charged on a fixed, per-enrollee basis.
 Presentation by Vince Ashton,Executive Director of New York Health Pass, to the Delaware Public Policy Institute, June 12, 2007.
 For example, the California Health Care Foundation was created out of the proceeds from the sale of California's Blue Cross plan.