Private Exchanges

I recently completed a paper for the Citizens Council for Health Freedom on private health insurance exchanges. In this paper I describe the impulse behind exchanges, including –

  • The desire of employers to better control their health care costs.
  • The desire of employees to choose the benefit program that works best for their own families.
  • The need for real portability as workers move between jobs.
  • The need for two-income families to combine their resources into a single benefits program for the whole family.

These all would make our health care system more accountable, efficient, affordable, and predictable. But there are many regulatory obstacles.

They include:

  • The tax code, that advantages employer-provided coverage but not individually-owned coverage.
  • Insurance regulations, that draw a bright line between “group” and “individual” coverage.
  • A tradition of paternalism by employers.

Health insurance exchanges are meant to overcome these obstacles and provide the benefits listed above. In particular, they bridge the gap between employer payment and individual ownership. They are enabled by the IRS regulations creating Health Reimbursement Arrangements (HRAs). HRAs allow employers to designate a sum of money to pay for the health care needs of employees, whether through an insurance program or through the direct payment of medical services. The exchanges combine this employer-paid HRA contribution with employee-paid Section 125 contribution, all on a tax-free basis.

HRAs are very much like the advent of 401k retirement plans in the 1980s. They allowed employers to switch from “defined benefit” to “defined contribution” approaches to pensions. These were so successful that employers began to look for ways to do the same thing with health benefits.

The enactment of, first Romney’s Connectors in Massachusetts, and now Obama’s Exchanges has increased awareness of the concept of an exchange. However, as I argue in the paper, these public exchanges are doomed to fail, for a number of reasons –

  • Rather than facilitating the market, they are aimed at controlling the market.
  • They add yet more regulations to a system already overburdened with regulations.
  • Being politically created and bureaucratically organized, they will not be able to respond to changing conditions.
  • As political entities, they must conform to political, not market, boundaries.
  • Focusing on individual and small group coverage, they miss the most stable (and lucrative) part of the health benefits market.

I argue that, even if these public exchanges are created (no sure bet), they will be so clumsy and inefficient that few will actually use them. One example is the role of “navigators” in Obama’s exchanges. This function is supposed to replace what agents and brokers have traditionally done, but it has been politically defined by a liberal Congress to be more like community organizers than marketers.

As an alternative, there has been a rush by entrepreneurs to create private exchanges. I place these private exchanges into three categories depending on who is organizing them –

  • Those created by business associations,
  • Those created by insurance companies, especially Blue plans,
  • And those created by independent entities, including consulting firms such as Towers-Watson and Aon.

Each type of organization has its own plusses and minuses.

There has been a very large amount of money invested in these efforts in the past year or so, and they have enormous advantages over the public exchanges of the Affordable Care Act, including –

  • Existing relationships with clients.
  • Outstanding technological services.
  • The ability to scale the technology beyond political boundaries
  • The ability to target receptive markets, including small, midsized and large group, and retiree health programs.
  • The ability to combine traditional health products with related products (dental, vision, disability, retirement, etc.).
  • The ability to offer administrative services, such as HRA administration, to employer clients.
  • A more sensible approach to the use of agents and brokers.

Importantly, I do not argue that exchanges will create a better distribution system than what already exists in most states. I think the existing networks of producers work well, though they may be improved by online information services like The primary value of any exchange is solving the regulatory obstacles created by an irrational government. If these obstacles could be removed, the need for an exchange approach would disappear.

Comments (20)

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  1. Cindy says:

    The dual-income families argument is really a good one. This is a reality that current benefits programs don’t really account for very well — and it’s likely that the incidence of two income families will only go up.

  2. Buster says:

    Health Insurance Exchanges sound like a great idea on paper. Indeed, the notion of a Walmart-sized health insurer (for lack of a better description) providing one-stop-shopping for health coverage conveniently available at your fingertips sounds like something that would boost efficiency in a stodgy health insurance market.

    That is mostly where agreement ends. Free market people want a lightly-regulated Exchange with transactions among willing parties. Liberal public health advocates want a regulated Exchange, where captive consumers willingly over-pay for services they don’t want or need so others (deemed deserving) get a huge subsidy. Advocates want coverage guaranteed (at no extra cost) to those with pre-existing conditions. Insurers, on the other hand, don’t want to cover those who have waited until they are sick to seek (comprehensive) coverage. The trouble is: people who are sick willingly seek coverage when it’s highly subsidized. By contrast, people who are healthy don’t want to purchase coverage until they need care because the costs are so high and there is no penalty for waiting.

  3. Jackson says:

    “Rather than facilitating the market, they are aimed at controlling the market.”

    -This is the fundamental problem with Obamacare.

  4. Anderson says:

    If only more people (and by people I mean policy makers, government regulators and every other employer) could understand and interpret exchanges this way, I believe taxation and all these enforced regulations could become less of a worry to us as individuals and working class. This is an excellent reasoning!

  5. Cindy says:

    Sounds like the character of these exchanges can be highly variable — it’ll be important for people to educate themselves on basic proposals.

  6. seyyed says:

    yes it seems that the most important thing to do is for people to educate themselves on what works best for them

  7. Ashley says:

    “exchanges will be the primary way for employers to move to a defined contribution approach to health benefits, and employees can move to individual choice and ownership of their own health benefits.”

    At least that is a plus.

  8. Ian Duncan says:

    Greg: I have been looking at the AON/Hewitt exchange for a client. An important difference between the exchange and the client’s current self-insured plan is that the exchange offers insured products. The problem with this is that self-insurance will (in aggregate) always be cheaper than an insured market because insurance regulation requires risk-based capital, premium tax, and mandates. What may happen is what we see today: employers will self-insure until they have a large claim, and then select against the exchange when premiums on the exchange are lower than their experience.

    Providers of private exchanges are claiming that competition between carriers for the exchange’s lives will reduce premiums. There is actually some evidence of this in Massachusetts where the CommCare exchange has driven a 5% rate decrease in each of the last 2 years. But I just dont see competition overcoming the sum of premium tax, capital and mandates, which are not trivial items.

  9. Don McCanne says:

    Whether retirement plans or health benefit programs, many would dispute that the shift from defined benefit to defined contribution has been “successful.”

  10. Richard Matthews says:

    Hey Greg,
    As usual you hit the nail on the head. I would only add that there is a fourth Private Exchange – and that is from independent agents/brokers that use powerful, inexpensive software now available to create a real private exchange for customers and prospects. Every day more solutions are being invented/offered by clever marketing organizations for agents and brokers to use for their client base as they move them to Defined Contribution type plans. Many of these now come from TPAs, but independent software companies are popping up everywhere.

    Indeed, I just interviewed a company that will offer complete Private Exchange software (including electronic data feeds to any and all carriers)along with online enrollment and total benefit admin for $3000 per year per agency! This is amazingly affordable. There is no limit to the amount of companies or employees that can use the system. A broker with a large book of business can offer this type of solution for pennies per employee.

    These types of Private Exchanges my not be used to a great extent initially. But as agents and brokers adjust and as more and more people become very comfortable working with the Internet, I believe this will be the way most Americans that work for small and medium sized employers will get their health insurance. This will level the playing field and drive down the costs of admin and marketing for everyone.


  11. Jordan says:

    Very nice Greg. The dual-income contribution to a single policy is a fantastic idea, and one that we don’t hear about often.

  12. H D Carroll says:

    If exchanges are offering small group, all or nothing (i.e., the entire employer group is purchasing within a small set of choices) options, then “total” defined contribution can’t apply, at least to my understanding. If the idea is that the employer offers $X to each employee, and then they are on their own to shop in the exchange, and the exchange is “individual” policies, then you have just unraveled the group principle, and older employees will not be able to buy anything with the $X. I cannot see an insurer willing to offer a variety of individually selected plans within a group offering without varying the premium rates by the maximum allowed by law in those environments. I am waiting patiently for these people setting up the private exchanges to explain, in detail, how a “model” employer funded defined contribution arrangement using an HRA leads to purchases of what kind in that exchange. I haven’t seen an explanation offered yet, which doesn’t meant it isn’t out there. Can anyone direct me to a firm example that describes exactly how it will work? And please don’t mention Massachusetts or California – they don’t fit this bill.

  13. Ian Duncan says:

    Massachusetts (which I know I am not supposed to mention but here goes) tried a Defined contribution/employee choice model. There was a somewhat complicated arrangement for converting an employee contribution (variable according to whichever plan you chose) into a notional employer contribution, which differed by age in order to maintain equity in employee contributions. Anyway, we piloted it for a year or so and enrolled all of about 100 employees (speaking from memory; dont quote me). Employers and their brokers seemed satisfied with the current offerings from the (single) insurers.

    The administration of multiple choice option is complex, particularly maintaining the 2:1 rate compression (3:1 in the ACA).

  14. Studebaker says:

    The best example out there is the exchange operated by This is a private exchange where people enter their information and obtain a quote for coverage. After it was started, it quickly became the largest independent agent in the nation. There were no regulations that told it would it could charge. There were few regulations that told it who it could accept. But, this is not the type of exchange envisioned by the supporters of the PPACA.

  15. Philip Thwing, MD says:


    Have you ever researched or commented on Health Care Co-ops (I am a member of MediShare, a Christian one) as an alternative to health insurance?

    My deductible is very high ($7000), but being self-employed I saved that much in premiums already this year. So far, I have no complaints – do you have any experience or throughts on the subject? These seem to be a much better option than BC/BS or the exchanges you talk about in this article

  16. frank timmins says:

    I guess I cannot get over the notion that “exchanges” are simply re-invention of the wheel. It seems that (regarding private exchanges) all these legislative changes in healthcare financing rules could have been done through the existing marketing structure.

    Why is it necessary to create a new distribution system in order to achieve the goals of tax equalization between individual and group health insurance products. What is the magic of exchanges?

  17. Bob Geist says:

    Greg, I agree with Timmins’ free market approach.

    So next, what legislation, aside from repeal of Obamacare, would be needed to encourage the free market and take the dead hand of the government exchanges off our back? And if private exchanges have any benefit, what legislation is needed to garner such benefits?

    Thanks, Bob

  18. Robert says:

    Indeed, the notion of a Walmart-sized health insurer (for lack of a better description) providing one-stop-shopping for health coverage conveniently available at your fingertips sounds like something that would boost efficiency in a stodgy health insurance market.

    I can’t help but imagine some bizarre dystopian future: Oh, you’re going to need a medicated stent..that’s in the back, over in aisle 9, next to the pacemakers.

  19. Greg Scandlen says:

    Wow, lots of comments to reply to —

    HD Carroll, I can’t help you here. This whole thing is so new there really are no models to follow. I disagree generally that “the group principle” really provides much of value. As I’ve written on this blog before, I believe that groups concentrate, rather than spread, risks — barring a jumbo company. The essential purpose of insurance companies is pooling risks, and they do it far better than any but the largest employer can.

    Dr. Thwing, I am a big fan of MediShare ministries, but the affinity group model obviously has limits.

    Frank T and Bob G, I agree entirely. As I said in the post, I do NOT think these exchanges will improve the distribution system. The main value is to overcome (or at least manage) the regulatory obstacles. Especially the tax code and oppressive, fragmented and contradictory insurance regs. I need to do a paper on the mess that insurance regulations have become since the Supreme Court decided insurance is “interstate commerce.”

  20. Beverly Gossage says:

    You may recall that I have been promoting employer defined contributions to private policies since 2006.

    See reasons here:

    you mentioned it here:

    We are introducing a similar bill in KS that allows a state tax deduction for private policies and does not subject those policies (which are reimbursed through an HRA) to small group state regulations.

    We wrote this bill to give choice, ownership, portability and primarily tax parity to the individual. Most of us would agree that to bring down the cost of health care and health insurance, we must put the consumer closer to the purchasing decisions.

    What’s most frustrating to me is that this bill and most other health insurance and health care reform legislation would be virtually unnecessary if we would remove the tax deduction for health insurance completely or pass it to the individual.

    Without the tax incentive, employers would be less likely to offer health insurance. Imagine a business owner able to focus on running his company rather than dealing with claims issues, quotes, plan selections, enrollment periods, HRAs, FSAs,rate increases, wellness programs. These employers could compete strictly on salary because they have reduced their per employee cost.

    Employees would not be subjected to employer’s effort to reduce his health insurance costs by treating them like children, giving them stickers or bonus points if they stopped smoking, joined a gym, reduced their BMI or turned in their pedometer.

    Instead, employees could be grownups, take responsibility for unhealthy lifestyle choices and use their larger paychecks to make purchases of their choosing, including health insurance coverage. Insurance carriers would compete for their business and design benefits exclusively for this private shopper.

    This happens NOW in 50% of small businesses across the country who do not offer group health insurance. Those employees have discovered the convenience and portability in the private marketplace. A few shop directly with a carrier, but most of them enjoy the convenience of using an independent agent who can assist in comparing a variety of plans from multiple carriers generally using a quoting software website that some call a private exchange.

    This employee shopping for plans will continue to a degree under PPACA since small employers are not subject to the employer mandate…yet and larger employers are predicted to drop coverage.

    Unfortunately PPACA rules and regulations will cause individual policy premium rates in KS and MO to skyrocket by as much as 100% to 400% and plan options to diminish according to exchange vendors and carrier actuaries. Expect private exchanges to give way to public exchanges since they are the exclusive conduit for subsidies.

    I will continue to advocate for decoupling of health insurance from the employer and the promotion of private ownership of policies.

    Great piece, Greg!