Why Don’t Health Insurance Exchanges Work?

My previous entry reported and discussed the lackluster — basically non-existent — results of the Utah Health Exchange, and promised to explain why unsubsidized exchanges are unlikely to attract significant numbers of beneficiaries from the small-group market.  The answer, I believe, is pretty straightforward: The administrative costs of operating an exchange plus the administrative costs to a small business of migrating to the exchange are almost certainly greater than the administrative costs of participating in the traditional small-group market (or taking account of other “work arounds” promoted by some insurance producers).  Therefore, unless an exchange is subsidized from non-exchange sources (as per Obamacare), it will not attract many participants.

While straightforward, this conclusion is not necessarily intuitive.  Indeed, the primary goal of an exchange is to free small businesses and their employees from the Internal Revenue Code’s perverse provisions that exclude employer-based benefits from taxable income, but not individually owned health insurance bought by an employee.  Because Congress has never made any serious attempt to correct this malformation of the tax code, certain states have considered arguments to create exchanges or “connectors” to wriggle around the provision. Imagine if a state could create an exchange whereby an individual working a number of part-time jobs, none of which offered health benefits, could get each of his employers to contribute some pre-tax income to the exchange, allowing him to buy his own health insurance from a large “menu” of choices.  Or even an exchange whereby people with full-time jobs could move from one employer to another within the same state without disrupting their coverage.  That would be a great achievement.

Consider, a counter-example: Suppose the Internal Revenue Code did not grant people a mortgage-interest tax deduction, but instead defined employer-based housing as a non-taxable benefit.  Most employed people would live in homes arranged and paid for by their employers.  The situation would clearly be overly bureaucratized and ineffective at satisfying people’s residential needs, but we would suffer it nevertheless, because of the tax benefit.  If a well governed state established a housing exchange, into which employers made fixed contributions, that allowed employees to choose their own homes, surely employers would stampede into the exchange.

Or would they?

First, the exchange would threaten the livelihoods of the realtors and other intermediaries who profit from employer-based housing.  Why would they want people living in their own homes for years, maybe decades, instead of relying on housing chosen by their employers via arrangements negotiated annually with high friction costs?  Therefore, to minimize political resistance, the state would have to satisfy the income needs of the intermediaries, by ensuring that the exchange pays their commissions and other fees.

Second, the federal law would not be as simple as described above.  Thousands of pages of regulations would be emitted by the U.S. Department of Labor, the U.S. Department of Housing and Urban Development, the Internal Revenue Service, et cetera, and the state’s exchange would not be able to indemnify employers from these regulations — which are in constant flux.  So, employers would still have to pay some species of consultant (either directly or indirectly) to ensure compliance with federal laws and regulations.

These two conditions appear to prevail in the Utah Health Exchange.  Examining the payment process flowchart, or (reading between the lines) the memoir of the exchange’s first leader, one can only conclude that the exchange increased complexity, and protected (or, at least, did not challenge) the turf of those who profit from the status quo.  In summary, the Utah Exchange almost certainly adds administrative costs to small businesses’ decisions to offer health benefits, without subtracting administrative costs from the old way of doing business.

Outside exchanges, there may be ways for employers to make legal contributions to Flexible Savings Arrangements (FSAs)  or Health Reimbursement Arrangements (HSAs) without providing group health benefits.  This frees up employees’ own income to buy individual health insurance.  This appears to be the business model of Bloom Health (which refers to itself as a “private exchange,” but I view that as simply a promotional term in sync with the times), LyfeBank, and certain individual brokers and advisers.  However, some industry experts of my acquaintance suggest that these folks are not quite be “coloring within the lines” and might face regulatory retaliation.  Furthermore, this platform appears not to have achieved significant market share.

Eliminating employer-monopoly health benefits in favor of individually owned health plans is a critical goal of health reform.  The evidence strongly suggests that this can only be done through federal tax reform.  Unfortunately, those brave souls who attempt it through non-Obamacare, state-based exchanges are engaged in a fruitless quest.

Comments (5)

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  1. Buster says:

    Health exchanges don’t work because excessive regulations are designed to force healthy young people to pay higher premiums so older, less healthy people get a better deal. When the healthy people seek better deals outside the exchange, the risk pools in the exchange collapse.

  2. Ken says:

    They don’t work because ehealth can do the same thing at a fraction of the cost.

  3. Brian T. Schwartz says:

    “HSA” –> “HRA” in the following, right?:

    “there may be ways for employers to make legal contributions to Flexible Savings Arrangements (FSAs) or Health Reimbursement Arrangements (HSAs) without providing group health benefits.”

  4. John R. Graham says:

    @Brian T. Schwartz:

    I would say (given what I’ve heard from folks who advise businesses on establishing these mechanisms) that Health Savings Accounts do not work for this purpose. The reason is that FSAs and HRAs reimburse medical expenses – period, full stop.

    However, one only qualifies for an HSA if one has a “High-Deductible Health Plan”. As I read it in IRS Publication 969, it is not necessary that one’s employer provide the HDHP. However, even if one had an individually purchased qualifying HDHP and informed one’s employer that one wanted a contribution to an HSA, I think the employer would consider that skating too close to the edge of the rules.


    I agree. Devon Herrick often mentions the same thing in his comments. However, eHealthInsurance also does not claim that it pulls the same transformation that exchanges assert. That is, if you are an individual seeking coverage through eHealthInsurance, it will direct you to individual plans. If you are a small business, it will direct you to small-group plans. eHealthInsurance does not claim to solve the tax-equity problem that started this whole discussion.

  5. Randy Ray says:

    Mr. Graham wrote an insightful article on the hurdles of proposed Government Exchanges. He mentioned two companies who are creating new solutions today, including LyfeBank. Mr. Graham contemplates where an individual with two or more jobs could get pre-tax contributions from each employer to buy healthcare. Or, what if people could move job to job with their own portable healthcare? Wouldn’t that be “a great achievement?”

    LyfeBank does all of that today.

    We have a restaurant worker with three jobs. Each employer contributes to the staffer for the hours worked. Each restaurant pays what they can afford. The employer sets the amount that they pay, not somebody else. The worker buys and owns his policy. Retention of qualified workers has skyrocketed for these employers.

    We have a husband and wife. Each has separate jobs. Each employer now gives them healthcare cash in a restricted LyfeBank account. LyfeBank combines the money on a pretax basis for the couple and they pick any policy from any carrier they desire. If they move jobs, the policy goes with them. They own it, not the employer. If the restaurant workers or the couple mange the employers’ money better, they keep the surplus, even if they leave the job. All funds are sequestered and can only be spent for 213(d) healthcare costs, even if they leave the job(s). An employee can add pre-tax funds from a second or third job, a spouse’s job, even a dependent’s job all on a pre-tax basis.

    Our average customer has $770 banked after all premiums are paid. Money rolls over year after year. Many LyfeBank customers have surplus balances over $2000, even over $10,000.

    For the employer, they have a 401(k) for healthcare. Employer just makes a defined contribution based on funds earned for healthcare. Every month the money is electronically swept out of employers account and put in employees account. For the employer: No COBRA; No more picking one Group Plan that fits no one; No more management; and No liability.

    Now Mr. Graham’s experts question whether we are “coloring within the lines”. Yes, we are. 2.5 years of legal work before we ever went retail by the best ERISA firm in the nation. If one does not “color within the lines” one is exposing the carrier and the employer with risk.

    Federal Agencies, US Senate and House staff, and multiple Insurance Commissioners from around the Nation have reviewed our legal work. They found LyfeBank complies with State and Federal Laws and regulations.

    National and Regional Carriers have vetted the LyfeBank Platform and found this new Platform is in compliance. We are operating in multiple States today and spreading to more.

    The Economy of the world has changed. Jobs are now tasks. One now moves from one task/job on to the next. Healthcare needs to be portable, too. Everyone forgot to look if the Federal Healthcare legal paradigm changed too. LyfeBank did.

    And LyfeBank fits today and fits after January 1, 2014 when the PPACA is fully implemented. Our market is small, medium, and national large employers, both public and private sectors.

    LyfeBank is the Healthcare of the 21st Century Economy.

    Check out: LyfeBank.com

    Randy Ray
    Creator and Founder of LyfeBank