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P E R S P E C T I V E : 
N O N G R O U P  M A R K E T 
W E B  E X C L U S I V E  

23 October 2002

Ensuring Health Security:
Is The Individual Market Ready for Prime Time?

Expanding the current system through a tax-credit scheme relying on an
unregulated individual market would only magnify the system’s inequity.

by Karen Pollitz and Richard Sorian


ABSTRACT:

Proposals to expand coverage of the uninsured through federal tax credits rely heavily on the individual insurance market. Yet the current market makes coverage less accessible, less affordable, and inadequate to meet the needs of many people without insurance, especially those who have modest incomes or are in less-than-perfect health. States’ efforts to regulate the individual market can improve access for the vulnerable but, absent subsidies, may place coverage out of reach for the young and healthy. A combination of subsidies and market reforms could make insurance available to millions of Americans.

Federal and state policymakers debating ways to expand health insurance coverage for the thirty-eight million Americans who are uninsured should keep four questions in mind: (1) Will coverage be accessible to people when they try to get it? (2) Will the insurance be adequate to pay for the care people need? (3) Can people afford to pay the premiums? (4) Once obtained, will insurance remain available, adequate, and affordable?

Leaders from both parties have advanced proposals to offer tax credits to subsidize the purchase of coverage in the individual market.¹ It is important, then, to see whether the individual market meets these tests or if it can be modified to do so.

Accessibility

In most states, people trying to buy individual health insurance must undergo medical underwriting. Insurers have the right to reject someone judged to be too high risk. An oft-cited rule of thumb holds that only 1 percent of Americans are “uninsurable” because of their health condition or history.² In June 2001 the Henry J. Kaiser Family Foundation released an analysis of medical underwriting practices in the individual market by researchers at Georgetown University. That study suggests that many more Americans with even mild health conditions could be turned down or priced out of the market if they apply for individual health insurance.³

For example, a hypothetical twenty-six-year-old woman in good health but suffering from seasonal hay fever had five of sixty applications (8 percent) denied. Other hypothetical applicants with more serious health problems were turned down more frequently. Considering the prevalence of these conditions in the United States (Exhibit 1), the previous 1 percent estimate of the uninsurable is almost certainly too low.⁴

Medical underwriting of individual health insurance is now permitted in forty-five states and the District of Columbia. In twenty-one states it is allowed for all products, against all people, all year long. Under current rules, therefore, access to individual insurance can be difficult or impossible for people unless they are in perfect health. If this market is to be the avenue for future coverage expansions, new rules will be needed to ensure that coverage is accessible for the uninsured with health problems, or alternatives to individual market coverage will have to be offered.

Adequacy

Individual insurance policies provide much less comprehensive coverage than group health plans provide. Maternity coverage is rare; prescription drug and mental health benefits are limited; and annual deductibles average $1,500–$2,200, far higher than those typically imposed in group health plans.⁵ Extending such coverage to uninsured persons, most of whom have limited incomes, will not adequately ensure access to care.

Adequacy is a subjective term. Nevertheless, most privately insured Americans have group coverage and report being satisfied with that level of coverage.⁶ It is reasonable to expect that they might consider individual market coverage to be less than adequate. Research on take-up rates for bare-bones policies suggests that the low-income uninsured are not likely to find such policies adequate or attractive.⁷

People with health problems face further threats to the adequacy of coverage in the individual market. Insurers typically impose riders that eliminate coverage for a current or past health condition, or otherwise limit benefits. In the Kaiser/Georgetown study, nearly two-thirds (167 out of 266) of the offers made by insurers to six hypothetical applicants for individual coverage imposed one or more such restrictions. Some were limited in scope (for example, excluding coverage for hay fever), although most were more extensive (for example, eliminating coverage for asthma, cancer, knees, breasts, and respiratory and circulatory systems). This may be one reason why people with chronic illness are more likely to be underinsured.⁸

Insurers argue that riders are necessary to guard against adverse selection. Yet riders are imposed on people regardless of their coverage history, which makes it harder for people with health problems to maintain continuous coverage when circumstances (such as a move or job change) force them into the individual market. Riders also add to the cost of a policy for the consumer. If a policy excludes coverage of a needed medication that costs $800 a year, the cost of that policy just jumped $800. But many riders are less specific than that, which makes it more difficult for consumers to estimate the trade-offs they are being asked to make, let alone to obtain coverage.

Under current state rules, it may be difficult for many of the uninsured to find adequate coverage in the individual health insurance market—especially if they have health problems. The Health Insurance Portability and Accountability Act (HIPAA) of 1996 prohibits insurers from imposing riders on people who are “federally eligible” but otherwise does not protect the adequacy of coverage in the individual market.

Affordability

Premiums for individual coverage vary greatly. Inexpensive premiums are offered to people who are young and healthy, live in low- cost areas, and will accept higher cost sharing (such as a $5,000 annual deductibles). High-price coverage is the more likely norm for others. People in Miami, for example, pay twice as much for coverage as people in Chicago pay. People in their early sixties pay three to five times more for coverage than do people in their early twenties. Those with health conditions pay even more when insurers impose premium surcharges, or rate-ups, based on health status. In the Kaiser/Georgetown study, insurers applied rate-ups on 105 of 266 offers. Almost half (46 percent) of these rate-ups exceeded the maximum tax credit proposed by President Bush ($1,000 for individuals and $3,000 for families). Three-quarters of the rate-ups (76 percent) would have consumed half or more of these subsidies.

Any effort to expand coverage in the individual market would have to take into account such price disparities to assure affordability of coverage for everyone. A flat subsidy that can secure coverage for a young, healthy person in a rural area might buy only a few weeks of coverage for an older city dweller with past or ongoing health problems.

Additional regulation of this market would redistribute costs from those who now benefit from underwriting to those who pay the price, by spreading the costs over the entire insured population. It also is important to recognize that the current market redistributes costs to people who are older and in poorer health. The current system is unfair; expanding it through a tax-credit scheme relying on an unregulated individual market would only magnify that inequity.

Security Over Time

People need health insurance to be accessible, adequate, and affordable all the time, not just when they first buy it. Here, again, the individual market presents unique challenges resulting from age rating. Insurers argue that age rating reflects the higher costs and risks of older persons. For many carriers, rates climb the most steeply after age forty. For example, in Maryland the premium for Golden Rule’s Basic Plan increases by a total of 15 percent between ages 22 and 42, a relatively affordable amount. Between the ages of 42 and 62, however, the premium jumps 231 percent.⁹ In other words, middle-aged policyholders can expect a 6 percent premium increase on each birthday, even before inflation and utilization are applied.

In theory, age-adjusted tax subsidies for individual health insurance could offset this impact. However, none of the current proposals for tax credits are age-rated, so the gap between the subsidies and the actual premiums grows quite wide for those who are in their forties, fifties, and sixties.

“Re-underwriting” also threatens affordability over time by imposing large renewal rate increases on people as their health declines. Although re-underwriting is not widely used by most carriers and is frowned upon by many, some observers have speculated that competition could spread its use unless limited by marketwide rules.¹⁰

Finally, staying covered in the individual market can be difficult for people who need to change policies and can no longer pass medical underwriting. Fewer than a dozen states protect “portability” in this market, which would permit people to move from plan to plan without penalty. Federal law provides no protections for people in these circumstances.

Unless rules are adopted to help people maintain their coverage in the individual market over time, building a coverage expansion strategy on individual health insurance could mean that some newly insured persons will find themselves uninsured and uninsurable again in the future.

Can It Be Fixed?

States have passed laws to protect access to and adequacy of coverage in the individual market. Community-rating laws make the price of insurance more uniform regardless of age or health status. Five states (Maine, Massachusetts, New Jersey, New York, and Vermont) provide this combination of protections to all residents and have done so for years. Another eleven states protect people when they are leaving group coverage, but not necessarily at other times. Adding subsidies to these protections could cushion the trade-off between sick and healthy that detractors of reform deplore and make coverage more accessible, adequate, and affordable to people in the individual insurance market, regardless of health status.

In the 106th Congress, one bill proposed a tax credit that could only be spent in a new, nationwide individual health insurance market patterned after the Federal Employees Health Benefits Program (FEHBP), the program through which members of Congress and other federal workers obtain guaranteed-issue, community-rated coverage from comprehensive health plans.¹¹

Some argue that tax subsidies alone will bring millions of young, healthy people into the individual market for the first time, thereby enabling insurers to be less selective in their underwriting and still spread risks.¹² In a voluntary market, though, it seems just as likely that insurers would continue to avoid risk rather than to spread it. After all, it would still take a full year’s tax credit from hundreds of people to pay for the cost of just one organ transplant, one heart bypass, or one low-birthweight baby. The competitive advantage of avoiding such risks would still exist.

Tax credits could also spur efforts on the part of the insurance industry to develop additional lower-cost policies. Assuming that credits were capped at $1,000 per person, however, these policies would likely cover even less than today’s market offers.¹³ Moving people from the ranks of the uninsured to the underinsured arguably is incremental reform, but will it make the uninsured meaningfully better off if they still cannot afford care?

Finally, using subsidies to promote nongroup coverage will almost certainly have an impact on group health coverage. Economists who have analyzed tax credits estimate that they will lead at least some employees and employers to drop group coverage.¹⁴ People thus will be moved from a market with greater benefits and legal protections to one where coverage is slim and “insurability” uncertain.

As currently constructed, the individual insurance market is not a good place to target substantial new resources aimed at lowering the number of uninsured persons. The current market fails the tests of accessibility, affordability, adequacy, and sustainability for all but the youngest and healthiest of American adults. Although it is an important residual market for people going through a transition, it is not prepared to accept millions of new applicants with a variety of health conditions. Tax credits could encourage some younger, healthy people to buy individual health insurance, but it is unclear whether they would come from the ranks of the uninsured or simply shift from employer-based coverage.

Yet the problem of the uninsured persists; millions of people are desperate for relief and cannot afford to wait for the perfect solution. Is it better to give them some help rather than none? Six years ago Congress designated a class of “HIPAA-eligible” people and established rules protecting their access to nongroup coverage but offered no help with affordability or adequacy. Initial estimates that only a handful of people would gain coverage under that law appear to have been borne out. Congress is now contemplating subsidies to make individual coverage more affordable, but with no accompanying rules to guarantee access or adequacy. This piecemeal approach is likely doomed to fail unless policymakers address all of the elements of health security.

The authors’ views are their own and do not represent those of Georgetown University or the Center for Studying Health System Change.

NOTES

1. See Council of Economic Advisers, “Health Insurance Tax Credits,” Council of Economic Advisers White Paper, 14 February 2002; The Relief, Equity, Access, and Coverage for Health (REACH) Act, S. 590, 107th Cong., 1st sess. (21 March 2001); and Fair Care for the Uninsured Act,H.R. 1331, 107th Cong., 1st sess. (3 April 2001).
2. See S. Laudicina, “State Health Risk Pools: ‘Insuring the ‘Uninsurable,’” Health Affairs (Fall 1988): 97–104. See also Communicating for Agriculture, Comprehensive Health Insurance for High-Risk Individuals: A State-by-State Analysis (Fergus Falls, Minn.: Communicating for Agriculture and the Self-Employed, 1996), 6.
3. K. Pollitz, R. Sorian, and K. Thomas, How Accessible Is Individual Health Insurance for Consumers in Less-than-Perfect Health? (Menlo Park, Calif.: Henry J. Kaiser Family Foundation, June 2001).
4. Ibid.
5. J. Gabel et al, “Individual Insurance: How Much Financial Protection Does It Provide?” 17 April 2002, www.healthaffairs.org/WebExclusives/Gabel_Web_Excl_041702.htm (21 August 2002).
6. L. Duchon et al., Security Matters: How Instability in Health Insurance Puts U.S. Workers at Risk (New York: Commonwealth Fund, December 2001), 26.
7. S. Glied, “Health Insurance Expansions and the Content of Coverage” (Paper presented at the Alliance for Health Reform Roundtable Discussion on Tax Credits for Health Coverage, Washington, D.C., 5 June 2002).
8. K.T. Stroupe, E.D. Kinney, and T.J.J. Kniesner, “Does Chronic Illness Affect the Adequacy of Health Insurance Coverage?” Journal of Health Politics, Policy and Law 25, no. 2 (2000): 309–339.
9. According to information found on eHealthInsurance Inc., www.ehealthinsurance.com (31 May 2002).
10. C. Terhune, “Insurer’s Tactic: If You Get Sick the Premium Rises,” Wall Street Journal, 9 April 2002.
11. Health Insurance for Americans Act of 1999, H.R. 2185, 106th Cong., 1st sess. (14 June 1999). In addition, the Trade Act of 2002 (H.R. 3009, now P.L. 107-210) extended tax credits to help certain workers purchase health insurance when they lose their jobs and group coverage as a result of trade-related dislocations. People qualifying for the tax credit can use it to purchase individual health insurance, but only in very limited circumstances. Specifically, the qualifying individual must have been covered under individual health insurance during the entire thirty-day period leading up to the trade-related job dislocation. Otherwise, the tax credit can only be used to buy coverage under COBRA, a spouse’s group health plan, a state high-risk pool, or some other coverage arrangements or programs that states may establish.
12. Council of Economic Advisers, “Health Insurance Tax Credits.”
13. S. Glied et al., Bare-Bones Health Plans: Are They Worth the Money? Issue Brief (New York: Commonwealth Fund, May 2002).
14. J. Gruber and L. Levitt, “Tax Subsidies for Health Insurance: Costs and Benefits,” Health Affairs (Jan/Feb 2000): 6–19.

Karen Pollitz is project director at the Institute for Health Care Research and Policy, Georgetown University, in Washington, DC Richard Sorian is a senior researcher and director of public affairs at the Center for Studying Health System Change, also in Washington.

©2002 Project HOPE–The People-to-People Health Foundation, Inc.