Chapter
4

Proposals Affecting the Choice of an Insurance Plan

Proposals could affect the options available to individ­uals when choosing a health insurance plan—and the incentives they face when making that choice—in a num­ber of ways. For example, proposals could:

• Establish or alter regulations governing the range of premiums that may be charged or the terms under which insurers may sell or renew coverage.
• Reveal more fully the relative costs of different health insurance options by reducing or eliminating the cur­rent tax subsidy for employment-based insurance, encouraging or requiring the establishment of man­aged competition systems, or providing more readily accessible information about those costs.
• Have the federal government create additional insur­ance options, either by offering a new health insurance plan through the Medicare program or by providing access to the health plans that are available to federal employees.

The effects of those options would not just depend on the factors that affect the premium for a given insurance pol­icy or on the share of the premium that enrollees have to pay; those effects would also reflect the market dynamics that arise as individuals shift among coverage options and as policy premiums adjust to those shifts. In particular, the risk that some plans would experience "adverse selec­tion"—that is, that their enrollees will have above-average or higher-than-expected costs for health care—can have important implications for the operation of insurance markets and for proposals that would regulate those oper­ations or introduce new insurance options. To the extent that proposals had an impact on average premiums, they would also affect the federal costs of any premium subsi­dies as well as coverage rates and spending on health care. Many of the considerations that arise in designing a new option for individuals to enroll in Medicare would also affect the analysis of proposals to replace the current mix of private insurance and public programs for the nonelderly population with a single-payer, Medicare-for-all system.

Regulating Insurance Premiums and Sales

Proposals may seek to create, remove, or modify regula­tions governing health insurance markets in order to make insurance more affordable for people with chronic health problems or to provide consumers with more choices, but those goals may conflict with one another. For example, proposals could limit the extent to which premiums for people in poor health can exceed those for people in better health (as some states currently do). Such provisions would reduce premiums for individuals who have higher expected costs for health care, but they would also raise premiums for healthier individuals and thus could reduce their coverage rates. Other proposals might give people greater choice among insurance plans—for example, by allowing them to buy insurance across state lines. That approach would counteract tight limits on variations in premiums; that is, younger and relatively healthy individuals living in states with such limits could purchase a cheaper policy in another state that does not regulate premiums, but older and less healthy residents who continued to purchase individual coverage in the tightly regulated states would probably face higher premi­ums as a result. Those trade-offs stem from the proposals’ differing effects on the composition of insurance pools.

As those examples suggest, federal efforts to alter the reg­ulation of insurance markets would also have to take into account states’ current regulatory practices. Although existing state regulations might limit the impact of any federal initiatives, they also provide insights about the manner and magnitude of effects that similar proposals at the federal level would have on both premiums and insur­ance coverage. The effects of existing regulations also indicate the likely impact of federal proposals that would override or restrict state-level provisions.¹

Although federal legislation regulating insurance markets could have substantial consequences for the operation of those markets, by itself that legislation would tend to have a relatively small impact on the federal budget. An exception could arise with proposals to expand high-risk pools, which subsidize premiums for individuals who are denied insurance coverage or face very high premiums because of their health problems. The federal costs of such proposals would depend on the scope of those subsi­dies, the way they were financed, and the number of peo­ple who took advantage of them.

Background on Insurance Pooling Arrangements and Regulatory Structure

People purchase insurance policies to protect themselves financially against the risk of an expensive adverse event, such as a car accident, house fire, or serious health prob­lem. Insurance markets that work well do not simply shift that financial risk from individuals to insurers, however; such markets actually reduce that risk by pooling policy­holders together. Even if the cost of insuring a given indi­vidual may vary widely, the average cost of insuring a large group can be fairly stable and predictable—making it less risky (and thus less costly) to offer insurance. For example, if there are 100,000 subscribers to a given hom­eowners’ insurance policy, only a few will submit claims in a given year; if the frequency of incidents that result in a claim remains stable, the growth in the average claim and the policy premium over time will reflect only the ris­ing costs of repairing or replacing the lost, stolen, or dam­aged goods that are covered by the policy. Because home­owners are unlikely to know before purchasing insurance whether they will need to submit a major claim, the pool of policyholders is also likely to be stable, with each one willing to pay premiums to protect against the risk of an accident or other incident someday.

A challenge facing health insurance markets is that indi­viduals have some ability to predict their future use of health care.² In particular, a substantial minority of peo­ple have at least one chronic health condition and are likely to incur higher health care costs year after year, whereas others can expect to have lower costs. According to one recent study, about 30 percent of people ages 18 to 64 have at least one of seven chronic health problems (including heart disease, high blood pressure, diabetes, and asthma).³ Among that population, average health care costs also tend to rise with age, at least partly reflect­ing a higher prevalence of chronic conditions. In some cases, those conditions may have only a limited impact on the expected use of health care; for example, high blood pressure was the most common chronic condition examined in that study, and another recent study indi­cates that the average annual costs of treating that condi­tion are relatively low.⁴ Other chronic conditions such as diabetes and heart disease are more expensive to treat, however, and a smaller subset of the population has sev­eral conditions simultaneously. Determining what share of health care spending is truly predictable from one year to the next is difficult, but some experts suggest that the overall share probably exceeds 20 percent to 25 percent.⁵

The large share of health care spending that is unpredict­able provides a strong incentive for most people to pur­chase health insurance. To the extent that health care spending varies in predictable ways, however, insurance coverage in general—or plans that offer more extensive benefits in particular—could attract enrollees with above-average costs for health care. Those who expect to have lower expenditures, meanwhile, might wait until they develop a health problem before purchasing coverage, or they might prefer a plan that offers less extensive coverage and lower premiums. If a health plan experiences such adverse selection, its costs may exceed the premiums it has charged; premiums could be raised, but that might encourage relatively healthy enrollees to switch to other plans. In extreme cases, adverse selection could trigger a spiral of rising premiums and declining enrollment that leads to the plan’s demise.

In practice, such spirals are rarely observed—in part because insurers take steps to avoid them—but the potential problems caused by adverse selection are a more common concern. The available evidence suggests that roughly 20 percent of applicants for individually pur­chased health insurance have expected costs for health care that are substantially above the average for their age group. Similarly, employers seeking to offer insurance coverage to their workers may differ substantially in terms of those workers’ average costs for health care, and they may be concerned that workers with above-average costs will be more likely to enroll. For applicants with higher expected costs, health insurers face competitive pressures to charge higher premiums, limit coverage of preexisting health problems, or deny coverage altogether to keep pre­miums down while remaining profitable.

To address concerns about the operations of markets for private health insurance or to achieve other policy goals, policymakers have adopted various laws and regulations governing those markets, and over time some important distinctions have arisen in that regulatory structure. State governments are generally responsible for regulating the business of insurance; as a result, any policy that individ­uals and firms buy from insurance companies is regulated at the state level. In some cases, however, federal legisla­tion has established provisions that supersede or limit states’ efforts. In particular, federal law exempts from state regulation any coverage that is offered by an employer who chooses to bear the financial risk of pro­viding health insurance to its employees and their depen­dents; in those cases, the employer effectively serves as the insurer. (For additional discussion of the Employee Retirement Income Security Act, which established that exemption, see Box 1-1.)

Though open to all employers, the option of bearing insurance risk is generally taken by larger firms—those with enough employees to form a more certain estimate of the cost per enrollee. As a result of that distinction, policies for individuals and most small employers must comply with requirements that vary by state regarding the benefits they cover, the premiums that insurers may charge, and other terms of purchase. Insurance coverage provided through larger firms, by contrast, typically faces few regulatory or legal constraints regarding its benefits and premiums.

One exception is that employers, regardless of size, can­not charge different premiums for similarly situated workers on the basis of health-related factors—that is, for workers who are in the same class of employment and work in the same geographic location, the employees’ contribution for health insurance cannot vary on the basis of such factors as health status, medical condition, claims experience, or medical history. Reflecting a con­cern that having a uniform contribution could lead to adverse selection, however, insurers have typically required that a substantial share of employees participate in an employer’s plan in order to help stabilize the average cost of providing that coverage. One way employers seek to achieve that goal is by contributing a large share of the total premium. In addition, employers typically allow their employees to sign up for health insurance only at selected times—when they are first hired or during an annual open-enrollment period—in order to mitigate selection pressures.

Types of Regulations

Many state and federal regulations have an impact on insurance premiums, either directly or indirectly. Some regulations affect premiums directly by restricting the amount by which they can vary or the factors that may be used to adjust them. (Many states require certain benefits to be covered by health insurance, which also affects insurance premiums.) Other regulations can affect the cost of health insurance indirectly, through their impact on the composition of the insured population. Some reg­ulations aim to guarantee the offer or renewal of insur­ance policies, a step that primarily affects people who might not otherwise be offered coverage. In addition, provisions may limit or prohibit insurers from excluding coverage for preexisting medical conditions—health problems that are present at the time of application. Many states have also established high-risk pools, which offer subsidized insurance to people who have been denied coverage in the private market because of their health problems.⁶

Guaranteed Issue and Renewal. The federal government and many states have taken various steps to require that insurers offer coverage to applicants (a practice known as guaranteed issue) and that they renew policies that are not delinquent (guaranteed renewal). The existing provi­sions differ between the individual and small-group mar­kets, however. The Health Insurance Portability and Accountability Act (HIPAA) requires insurers that offer coverage to small businesses (those who have fewer than 50 employees) to accept all applicants; before the enact­ment of that federal legislation in 1996, most states had the same or similar requirements.

By contrast, only a handful of states currently require insurers in the individual insurance market to offer poli­cies to all individuals and families who apply for coverage, and federal legislation does not generally mandate that such offers be made. HIPAA prohibits insurers from fail­ing to renew policies for health reasons, however, whether those policies are purchased in the individual market or by employers. Insurers may still terminate policies for fraud or failure to pay premiums, and they may also require that plans purchased by employers meet a partici­pation requirement (for example, that a specified percent­age of employees remain enrolled in the plan).

Federal legislation has addressed in a more limited way the question of guaranteed offers of coverage in the indi­vidual market and the related issue of whether new poli­cies may exclude coverage for preexisting medical condi­tions—steps designed to increase the portability of insurance coverage. Specifically, HIPAA essentially requires insurers to offer coverage to anyone who had held insurance through a previous job but was losing or had recently lost that coverage (for example, because he or she changed jobs). The requirements differ somewhat depending on whether the new coverage is purchased in the individual market or comes through the new employer’s group plan, but under most circumstances the new policy may not limit coverage for preexisting condi­tions. The law, however, does not restrict the premium that insurers may charge for new policies purchased in the individual market.

HIPAA allows states to take additional steps to regulate the portability of insurance, and many states have done so. For individuals who were not previously insured, however, states generally give insurers broad latitude to exclude certain benefits or services from coverage in the individual market. Currently, 38 states permit health care services that are related to preexisting conditions to be excluded from coverage permanently, and most states also allow insurers to determine whether a condition was in fact preexisting by examining more closely the medical history of enrollees when they submit a claim. Proposals that limit the ability of insurers to exclude high-risk indi­viduals and preexisting conditions from coverage might benefit less healthy individuals, who might not be offered coverage otherwise, but the effects of those proposals on insurance premiums would depend on the rules that apply in each state.

Direct Regulation of Premiums. All insurers—whether they cover health care, property, automobiles and their drivers, or another type of risk—seek to set premiums so that the aggregate payments will at least cover the expected payouts for the policies they sell as well as the administrative and other costs they incur in providing insurance. Other things being equal, expected costs for health insurance are higher for older people and for peo­ple with more, or more serious, health problems. In the­ory, that relationship could yield premiums for individu­ally purchased coverage that vary widely, with some enrollees paying many multiples of the average quote for a given policy to reflect their higher expected costs for health care.

In practice, however, premiums in the individual insur­ance market do not vary as widely as do individuals’ expected costs for health care, for several reasons. First, insurers may find it difficult or costly to obtain informa­tion about each applicant’s health status, so assessments of the applicant’s expected costs (a practice known as "medical underwriting") are far from perfect. Second, to the extent that underwriting efforts are successful, insur­ers tend to limit coverage for or screen out applicants who have preexisting health problems that are costly to treat. According to a 2005 study, about 70 percent of appli­cants for individual coverage are quoted a standard rate based only on their age; about 20 percent are either charged a higher premium (generally not exceeding twice the standard rate for their age group) or are sold a modi­fied package that does not cover treatments for their pre­existing health conditions (at least for some period of time); and about 10 percent are denied coverage.⁷ Some applicants are charged a premium that is only modestly higher than the standard rate, so the share of applicants that are either charged a substantially higher premium or denied coverage is probably on the order of 20 percent.

A third reason that premiums in the individual market vary less than do enrollees’ expected health care costs is the states’ regulation of those premiums, which takes var­ious forms. Many states restrict premium "rating"—that is, they directly limit the extent to which premiums are allowed to vary according to the age or health status of enrollees. The specific restrictions vary widely, however, in ways that differ between the individual and small-group markets. According to one survey of states’ prac­tices in the individual insurance market, three states require pure community rating of premiums, meaning that insurers may vary premiums for a given policy only by the size of the enrolling family and their place of resi­dence within the state.⁸ Six other states allow adjusted community rating, meaning that health insurance premi­ums are allowed to vary by family size and residence as well as by age and sex—but not by health status. Twelve states apply rating bands that allow premiums to vary on the basis of age and sex but prohibit insurers from deviat­ing from the standard rate by more than a specified per­centage for reasons relating to health.

Regulations may also affect the extent to which premi­ums can be changed over time. In the individual market, states generally preclude the practice—sometimes called "re-underwriting" or experience rating—of adjusting a particular enrollee’s premium on the basis of his or her insurance claims or changes in health status after purchas­ing the policy. Thus, premiums for a given policy would generally increase over time to reflect higher expected costs for health care on average, but they do not vary across individuals to reflect updated estimates of each one’s expected health costs. Insurers could circumvent those restrictions, however, by raising premiums for all enrollees in an existing policy and simultaneously offer­ing a new, cheaper product whose applicants would be subject to underwriting. That practice would tend to dis­courage individuals who had developed expensive health conditions after enrolling in the original policy from changing plans, so they would pay the new, higher pre­mium for that policy. It is not clear how common that practice is, however.

Premiums charged to small employers may be somewhat less volatile than are premiums in the individual market, for several reasons. First, those premiums reflect the aver­age costs of their enrollees, so high expected costs for one person would be spread across all enrollees. Second, insurance is regulated more extensively in the small-group market than in the individual market. According to a 2003 survey, 35 states employed rating bands in the small-group market, 10 used adjusted community rating, 2 used pure community rating, and only 3 states and the District of Columbia chose not to regulate rates offered to small firms.⁹ Some states also limit the degree to which premiums for small employers can increase from one year to the next to reflect enrollees’ costs or changes in their health status (for example, permitting no more than a 15 percent adjustment for those reasons). In other states, however, high health care costs for an employee or a dependent in one year can lead to substantial increases in the average premium charged to the employer in the fol­lowing year, and lower-than-expected claims can lead to corresponding reductions in premiums.

The overall effect of those state regulations is generally to compress the range of premiums offered. Although insur­ers could comply with a rating band by reducing the pre­miums charged to the least healthy enrollees or groups, they could also satisfy those regulations by raising their standard rates. In practice, they appear to do some of both, and rating restrictions have been found to increase premiums for healthier enrollees, decrease them for sicker enrollees, and to raise average premiums (primarily because of the resulting increase in enrollment of predict­ably higher-cost individuals).¹⁰ The net impact of regula­tion of premiums on the number of people who have insurance coverage is difficult to predict in the abstract because some people face increases in premiums and oth­ers face decreases.

High-Risk Pools. Another approach to reducing health insurance premiums is to separate people with the highest health risks from the rest of the pool and partially subsi­dize their coverage. High-risk pools, as they are called, are a mechanism employed in varied forms by more than 30 states, primarily to assist individuals who are unable to obtain health insurance for medical reasons. Typically, such individuals must apply for private insurance and be denied coverage or be quoted a high premium before they can enroll in the pool. Enrollees are then charged a pre­mium that usually ranges between 125 percent and 150 percent of the standard rate for their age group.

Those premiums are generally insufficient to cover those enrollees’ costs for health care, however, so high-risk pools require subsidies to remain solvent (typically aver­aging several thousand dollars per enrollee). To limit the cost of those subsidies, states may cap enrollment in high-risk pools. As of 2007, however, all states with pools but one (Florida) appeared to be accepting new applicants.¹¹ In many cases, the costs of subsidizing high-risk pools are financed by an assessment or tax on other health insur­ance policies sold in the state; in recent years, the federal government has also provided some financial assistance to defray the costs of starting and operating high-risk pools. As of 2007, about 200,000 people were enrolled in high-risk pools nationwide—about half of that total came from five states—so those enrollees account for about 2 percent of the approximately 10 million nonelderly people who purchase health insurance in the individual market.

High-risk pools obviously reduce the health insurance premiums that their enrollees pay, but covering those high-cost individuals separately could also lower premi­ums for other purchasers because it would reduce the average costs of the remaining enrollees. The strength of that ripple effect on premiums depends on the extent to which premiums are allowed to vary within the state. At one extreme, if no rating restrictions were in place and all enrollees were charged a premium exactly in accordance with their own expected expenses—or if high-risk appli­cants had been denied coverage—then establishing a new pool for those with the highest expected costs would have no effect on the premiums of other policyholders. In a community-rated state, by contrast, separating high risks could reduce premiums for the remaining enrollees in rough proportion to the share of covered costs that high-risk enrollees had generated. In states with rating bands, the likely effect would fall between those extremes; reduc­tions in the costs of covering high-risk enrollees could make the bands less constraining and thus could lead insurers to reduce their standard rates.

Effects of Proposals on Insurance Markets

Proposals to change the regulations governing insurance markets would generally have modest effects on the fed­eral budget, and many of them would entail trade-offs between reducing average policy premiums and making insurance less expensive for individuals with health prob­lems. Although generalizing about the precise effects of such proposals is difficult because their content might vary substantially, some indication of the likely magni­tudes of budgetary effects and changes in insurance pre­miums and coverage can be gleaned from the Congressio­nal Budget Office’s recent analysis of legislative proposals to modify state regulations or to allow individuals to buy insurance across state lines. In addition, some quantita­tive or qualitative information can be provided to help illustrate the potential effects of or key considerations sur­rounding proposals for which CBO has not previously generated a cost estimate.

The Health Insurance Marketplace Modernization and Affordability Act of 2006 is one example of a proposal affecting the regulation of insurance markets that CBO has analyzed.¹² That legislation would have created a more uniform set of regulatory standards for the individ­ual and small-group health insurance markets—standards that would have fallen somewhere between the strictest and most lenient state regulations currently in place. CBO estimated that those changes would decrease the average premium paid by policyholders in those markets by 2 percent to 3 percent, primarily by overriding some benefit mandates and reducing costs that insurers incur in complying with varying state rules. The legislation would have increased insurance coverage by about 600,000 peo­ple, on net, but it would have tended to increase premi­ums (and thus reduce coverage) for people with health problems.

CBO also estimated the budgetary impact of that legisla­tion, concluding that it would increase federal revenues by about $3 billion over 10 years and would reduce fed­eral spending for Medicaid by about $1 billion over that period. The increase in revenues would reflect a net reduction in spending on employment-based health insurance (stemming from the decline in average premi­ums). Reflecting CBO’s assumption that total compensa­tion would not change, that development would shift some compensation from a form that is tax-preferred (health insurance premiums) to a form that is taxable (wages and salaries). Because employment-based insur­ance would become somewhat less expensive under the proposal, some people who would be covered by Medic­aid under current law would switch to private coverage and federal Medicaid spending would decline.

Alternatively, proposals could allow individuals to avoid the requirements set in their home state by purchasing insurance across state lines. In particular, that approach would allow individuals who are relatively healthy and live in states that regulate insurance more extensively to purchase a less expensive policy.¹³ CBO analyzed one proposal to allow cross-state purchasing of insurance—the Health Care Choice Act of 2005—and concluded that over 10 years it would increase federal revenues by about $13 billion and federal spending for Medicaid by about $1 billion.¹⁴ The increase in revenues would result largely from a reduction of about 1 million in the number of people who receive health insurance through employment-based plans, which would occur because individually purchased insurance would become relatively attractive (especially to people with lower expected health care costs). The increase in Medicaid spending would reflect the net impact of an increase in spending for people who would lose private coverage and a decrease in spending for those who would gain it. Overall, CBO esti­mated that the legislation would not have a substantial effect on the number of people who have health insur­ance because the number who would gain coverage (including previously uninsured people who would pur­chase coverage in the individual market) would roughly offset the number who lost it.

CBO’s previous estimates of federal proposals to add new regulatory requirements also indicate the important influ­ence that existing state practices have on those estimates. For example, the effect of the requirement under HIPAA to guarantee renewal of insurance policies was judged to be limited because nearly all states already had such a requirement in place. Similarly, CBO estimated that HIPAA’s requirement for portability of insurance from group to individual coverage would have a relatively small effect on insurance premiums in the individual market. Although insurers would have to offer coverage to rela­tively unhealthy individuals who would otherwise have been turned down, CBO estimated that in most cases the premiums for those policies could be set to reflect the expected costs for health care for those enrollees and thus would not have a substantial effect on premiums for other enrollees.¹⁵

Rather than add or remove regulations, the federal gov­ernment could seek to affect the operation of insurance markets by offering additional subsidies for high-risk pools. The costs of such proposals and their effects on coverage rates and premiums would depend primarily on the following factors:

• The number of individuals who would be eligible for and enrolled in those pools;
• The scope of the insurance coverage they would receive;
• The premiums they would have to pay themselves; and
• The mechanism used to subsidize the difference between enrollees’ costs for covered health care ser­vices and those premium payments.

Because nearly all states with high-risk pools are accept­ing new applicants, there may not be substantial unmet demand in those states given the coverage and premiums they currently feature (although additional subsidies could encourage more active efforts by states to enroll eligible individuals). Lower premiums for enrollees and more extensive coverage would generate higher enroll­ment but would also increase subsidy payments and make it more likely that individuals who would have been insured otherwise would switch into the high-risk pool.

The financing of subsidies for high-risk pools raises a number of issues. Larger federal subsidies could lead more states to create high-risk pools and could encourage states to expand existing pools, but they could also cause some substitution of federal funds for existing state funds. Proposals might also address whether payments would be made to states that currently require guaranteed issue and use community rating or narrow rating bands in the indi­vidual market; residents of those states might never meet the eligibility terms for a high-risk pool. Payments could be made to those states in an effort to reduce premiums in the individual market, but doing so would raise the cost of the proposal. More generally, the impact of a pro­posal on the federal budget would depend on whether and to what extent the costs of the subsidy payments were shared between the federal and state governments; a higher federal share would encourage states to participate but would also reduce the incentive for them to control the pool’s costs.

Revealing the Relative Costs of Health Plans

Most Americans with health insurance are shielded from—or may not be aware of—the price of their cover­age, either in absolute terms or relative to other options. Many employers pay a large share of the premium for their workers; even though employees as a group ulti­mately bear that cost, they may not know its magnitude. Moreover, the tax code subsidizes employment-based health insurance by excluding the employer’s contribu­tions to the premium from the employee’s taxable wages and income; in most cases, the employee’s contribution is also excluded. Those features encourage people to have insurance coverage, but they also lead workers to buy more extensive insurance than they would if they faced the full price of their policy; those features also may limit the extent of price competition in the insurance market.

Some proposals would make consumers bear the cost of their health insurance more directly, either by paying the full cost themselves or by paying the added cost of more expensive policies. Proposals could achieve that goal by:

• Reducing or eliminating the current tax subsidy for employment-based insurance, perhaps replacing it with a tax credit or some other fixed-dollar subsidy (an approach discussed in Chapter 2); or
• Establishing a managed competition system, in which a range of plans is offered and the employer’s or the government’s contribution to the premium is a fixed amount—for example, the premium of the average plan or the least expensive plan available—thus requir­ing consumers to pay the additional cost of more expensive plans.

Those approaches—taken separately or in combina­tion—would provide stronger incentives for enrollees to weigh the expected benefits and costs of policies when making their decisions about purchasing insurance. As a result, enrollees would generally choose health insurance policies that were less extensive, less expensive, or both, compared with the choices made under current law. A related option would be to give workers more readily accessible information about the full costs of their cover­age, including the employer’s contribution. Whether and how that information might affect their choice of a health plan is less clear, however.

Reducing or Eliminating the Tax Exclusion

The current tax treatment of health insurance premiums constitutes a relatively large subsidy—known as a tax expenditure—for the purchase of employment-based insurance, amounting to $145 billion in forgone federal income taxes and $101 billion in forgone federal payroll taxes in 2007.¹⁶ Individuals living in states that have income taxes receive an additional subsidy because those states generally follow federal definitions of taxable income and thus exclude the costs of employment-based health insurance as well. The total tax subsidy averages about 30 percent and generally ranges from about 20 per­cent to 40 percent of the premium for most workers, depending on their tax bracket and state of residence.¹⁷

Although the subsidy provides an incentive to purchase insurance—and to do so through one’s employer—it also encourages people to buy policies that are more extensive or more expensive than they would purchase otherwise. Reducing or eliminating that exclusion thus could have a large effect on insurance premiums and coverage because it could substantially increase the effective price of any given policy—by 25 percent for someone who had been receiving a 20 percent subsidy and by two-thirds for someone who had been receiving a 40 percent subsidy.¹⁸ (The impact of such changes on whether people purchase insurance is discussed in Chapter 2.)

Relevant Studies. Several studies have attempted to quan­tify how removing or limiting the favorable tax treatment for employment-based insurance would affect insurance coverage, insurance premiums, and total spending on health care. Ideally, a study would compare systemwide outcomes with and without those tax preferences, hold­ing all other factors equal. In practice, however, that type of comparison cannot be readily made because income and payroll tax rates are largely determined at the federal level—so the rules are similar across all states at any given time. Although federal tax rates have changed over time, many other aspects of the health care system and the national economy have simultaneously changed, making it difficult to separate cause and effect when comparing one period with another. As a consequence of those methodological challenges, the findings of older studies using aggregate data on tax rates and insurance premiums vary widely, depending on the period they examined and the assumptions they made.

Two recent studies have attempted to address those meth­odological issues more carefully, but some concerns remain about using their results to estimate the impact of eliminating the tax exclusion. A 2004 study by Gruber and Lettau examined how employers’ spending on health insurance varied across states with different tax structures, exploiting the fact that state income tax rates changed at different times (and did so in ways that were not caused by trends in health insurance).¹⁹ Extrapolating from those results, they estimated that eliminating the tax exclusion for health insurance premiums—which in the sample that they studied would increase the effective price of health insurance by 58 percent, on average—would yield a 29 percent reduction in health care spend­ing by employers who continued to offer coverage. In other words, the reduction in those employers’ contribu­tions would be about half as large (in percentage terms) as the increase in the effective price facing enrollees.

Gruber and Lettau’s paper improved substantially on ear­lier work by better isolating the effect of the net price of health insurance on premiums, but it still has limitations. In particular, their estimate is based on relatively small differences in state tax rates, and extrapolating the effects of those differences could overstate the impact of larger changes. One way that employers could reduce premiums would be to limit the extent of the coverage they offer (for example, by increasing cost-sharing requirements). But that approach would also heighten the variability of health costs for employees, and workers might become increasingly reluctant to accept higher levels of cost shar­ing as their degree of financial risk grew. At the same time, more rigorous management efforts by health plans (or shifts in enrollment toward more tightly managed plans) would yield somewhat lower premiums, but more substantial reductions might become increasingly diffi­cult to achieve. In other words, existing differences in employers’ contributions across states could largely reflect the use of cost-control options that represent the "low-hanging fruit."

Another limitation of the study is that it includes the impact of employers changing the share of the premium they pay in response to different tax rates. In that case, employees would see their contributions rise but the total premium for their coverage would not change. Even with that effect included, the impact of changes in tax rates that the study found barely meets the standard threshold for statistical significance—that is, the odds of getting their results by pure chance (assuming that the true effect of the tax exclusion was zero) were only slightly less than one in twenty. Gruber and Lettau estimated, on the basis of other studies, that reductions in the share of the pre­mium that employers cover would account for about one-fourth of the effect on employers’ spending that they report. But if that component was removed, the remain­ing effect they found might not meet a test of statistical significance.

A more recent study by Heim and Lurie avoided some of those methodological problems but was based on a rela­tively small segment of the population that may not be representative. The study analyzed spending on health insurance premiums for self-employed individuals, who were able to deduct a growing proportion of their premi­ums from their taxable income over time.²⁰ Their results, which were similar to Gruber and Lettau’s estimate, imply that the reduction in premiums that would result from scaling back the tax exclusion for health insurance would be about half as large as the resulting price increase; that is, an increase of about 50 percent in the net price of health insurance would lead people to choose policies with premiums that were about 25 percent lower than otherwise. An advantage of their study is that it accounts for the full effect on insurance premiums rather than the impact on employers’ contributions, because in their study the employer and the employee are the same person. The self-employed, however, may differ in both observable and unobservable ways from people who work in a firm; to the extent that their study did not fully account for those differences, caution must be used in extrapolating their results to a broader population.

CBO’s Assessment. Reflecting the limitations of those two studies, CBO’s assessment is that removing the tax prefer­ence would have a smaller effect on the level of premiums that individuals choose. Specifically, CBO estimates that a 50 percent increase in the price of health insurance, all else being equal, would lead people to select plans with premiums that are between 15 percent and 20 percent lower than the premiums they would pay under current law. Reaching that point would probably take several years, as health plans, employers, and enrollees adjusted their offerings and choices. A portion of that ultimate decrease in premiums would come from reductions in the extent of coverage that enrollees purchased (that is, fewer benefits covered or higher cost-sharing requirements), and the remainder would come from choosing plans that exercise tighter management over the use of health care (that is, plans might have more features typical of health maintenance organizations such as utilization review, restricted provider networks, or gatekeeper require­ments).

The effect of a specific policy proposal would depend pri­marily on what changes it made in the tax treatment of health insurance. Removing the exclusion of premiums from income and payroll taxation would increase the after-tax price of health insurance by roughly 50 percent, on average, for people currently covered by employment-based insurance. Removing the exclusion only for income tax purposes (keeping the payroll tax exclusion in place) would raise the average price by roughly 30 percent, which would ultimately yield health insurance premiums that are 9 percent to 12 percent lower. In both cases, the reduction in overall spending on health care would be smaller than the reduction in premiums because some costs would be shifted from covered spending to out-of-pocket spending.

Alternatively, proposals could cap the amount of pre­mium payments that may be excluded from workers’ tax­able income—the effects of which would depend criti­cally on the level at which the cap was set. Workers whose premiums exceeded the cap by a substantial margin would have strong incentives to switch to a less expensive plan. Workers whose premiums fell below the cap, how­ever, would not be affected, so the overall impact on pre­miums would generally be smaller. One objective of cap­ping the exclusion might be to target employees who have relatively extensive insurance coverage and, as a result, above-average premiums. Workers who reside in areas with higher-than-average medical costs or whose firms have higher premiums because their covered workforce is older or in poorer health could also be affected by a fixed-dollar cap, however, even if the generosity of their health plan was not above average.

The effects of reducing, eliminating, or capping the exclusion for employment-based insurance would also depend on a number of issues relating to implementa­tion. Insurers and employers would have to report to both employees and the Internal Revenue Service the amount of premiums subject to tax. However, calculating the average premium and allocating those costs among employees could be difficult, particularly for large employers whose plans cover employees’ expenses for health care as they are incurred (in which case timely data may not be available). Limiting or eliminating the exclu­sion would also create incentives for employers to misrep­resent benefits as company overhead or to reallocate costs among subsidiaries so as to reduce their employees’ tax liability. (Those considerations would affect the pro­posal’s impact on revenues as well as the incentives for workers to choose less expensive policies.)

Another source of uncertainty is whether the 41 states (and the District of Columbia) that have their own income tax would continue to follow the federal lead in the tax treatment of premiums for employment-based coverage. If, instead, some states took action to maintain the full exclusion of premiums from taxable income, the incentive for workers to choose a less expensive plan would be smaller. The extent of that difference would depend on the number of states that did not conform their tax systems to mirror the federal tax change and on the tax rate structure in those states.

Establishing a Managed Competition System

The term "managed competition" refers to a purchasing strategy that seeks to create stronger incentives for con­sumers to be cost-conscious in their choice of health plans and for plans to compete more intensely on the basis of premiums and quality of care.²¹ Under that approach, a sponsor—such as an employer or govern­ment agency—would offer a choice of health plans and would make a fixed-dollar contribution toward the cost of insurance. Enrollees would thus bear the cost of any difference in premiums across plans (although that effect would be muted if enrollees could continue to exclude their own premium payments from taxation). Sponsors would give enrollees comparative information about their options. Some versions of managed competition would also involve standardizing the benefits offered—to a greater or lesser degree—in order to foster stronger price competition. In addition, sponsors could adjust pay­ments to health plans to account for differences in the health status of their enrollees (in an effort to limit the impact of those differences on the plans’ premiums).

Background. Most employers do not use the principles of managed competition to purchase health insurance bene­fits for their employees. Indeed, surveys indicate that most firms that offer health insurance do not give their employees a choice of health plans. That statistic is some­what misleading, however, because most firms have few employees. Large firms are much more likely than small firms to offer a choice of plans, and they also account for the majority of workers. Consequently, about 57 percent of workers who are offered insurance have a choice of plans. In the case of firms that do not offer their workers a choice of plans, health plans still compete on the basis of their price and value but do so in an effort to be chosen by the employer. For small employers in particular, the administrative costs of offering several competing plans and the potential problems of adverse selection that could arise may outweigh the benefits of giving their employees more options.

Even among firms offering a choice of plans, fixed-dollar contributions to employees’ insurance premiums—another key feature of managed competition—are less common than fixed-percentage contributions. A 2002 survey found that among Fortune 500 companies (which generally offer their employees a choice of plans), only about one-quarter took the fixed-dollar approach.²² The following example illustrates the incentives created by each approach. Suppose that an employer makes two plans available—one with a total premium of $4,000 per year and one with a premium of $5,000. If that employer pays 80 percent of the total premium for each plan, an employee who chooses the more costly plan pays an addi­tional $200 (20 percent of the $1,000 difference in pre­miums between the two plans). Under a managed com­petition system, however, the employer would contribute the same amount to both plans (for example, 80 percent of the average premium, or $3,600). Employees would face the full $1,000 price difference between the two plans and would therefore have a much stronger incentive to choose the lower-cost plan. Making employees pay the full difference in premiums could also stimulate greater competition among insurance plans to keep their premi­ums down. (Whether enrollees actually faced that full dif­ference would also depend on whether their premium payments were tax-preferred.)

Some proposals that are based on the principles of man­aged competition would require health plans to offer a standard benefit package. In principle, standardizing ben­efits would promote competition among health plans by making it easier for consumers to compare their options; that step would also help prevent plans from structuring their benefit packages to attract enrollees who are less likely to use medical care (which could in turn reduce the plan’s premiums and thus distort the comparison of plans). In practice, however, some aspects of health bene­fits are easier to standardize than others. For example, specifying uniform levels of cost sharing is relatively straightforward, but other aspects—such as definitions of covered services and utilization review procedures—can affect a consumer’s ability to use certain benefits and are more to difficult to standardize.²³ Moreover, having stan­dard benefits has two disadvantages. First, by limiting consumers’ options, standardization would make some people worse off (specifically, those who would prefer a different design). Second, rigid standardization could prevent health plans from developing innovative designs that might lead to more efficient delivery of care.

Another important design issue is whether the sponsor’s payments to insurers would vary to reflect differences in expected health care costs for different enrollees—a pro­cess known as risk adjustment. Under managed competi­tion systems, all enrollees in a given health plan would typically pay the same premium—so if payments to plans were not adjusted, plans that attracted less healthy mem­bers would have higher premiums as a result.²⁴ Because enrollees would have strong financial incentives to switch out of those plans, the adoption of managed competition could trigger an "adverse selection spiral" for plans offer­ing the most extensive coverage or doing little to manage benefits. In fact, some employers that implemented a managed competition system dropped such plans as their premiums skyrocketed and their enrollments plum­meted.²⁵ (Health plans might also drop out of a managed competition system for other reasons that make them broadly unpopular with enrollees, such as being poorly run.)

In principle, adjusting the sponsors’ payments to plans to account for expected differences in their enrollees’ health care costs would limit the impact of adverse selection. If those adjustments worked well, the premiums that enroll­ees faced would vary across plans because of differences in the value of their benefits or the efficiency of their opera­tion, but not because of differences in their mix of enroll­ees. Government programs currently use risk adjustment in cases in which private health plans compete against a government-administered option (as with Medicare Advantage plans or Medicaid HMOs) and against one another to deliver program benefits (as with the prescrip­tion drug plans in Medicare).

In practice, however, risk-adjustment methods are impre­cise, so fully offsetting the effects of enrollees’ characteris­tics on a plan’s premium may not be feasible. Those methods do not need to account for all differences in health care spending across enrollees to be effective; indeed, comparisons of predicted spending using risk-adjustment models with actual spending will inevitably find some enrollees who used more care than was expected and some who used less. What matters is accounting for the predictable differences in spending that might affect an enrollee’s choice of a health plan or a health plan’s efforts to attract or discourage particular types of members. Some experts have indicated that at least 20 percent to 25 percent of health care spending may be predictable from one year to the next, yet studies show that existing risk-adjustment methods account for no more than half of that variation.²⁶ That degree of pre­dictive power may be sufficient to prevent widespread problems from arising because of selection pressures. Even so, individual health plans could receive overpay­ments or underpayments relative to the true expected health care costs of their enrollees.

Relevant Studies. Limited evidence is available about the effects of managed competition on health care costs. A few studies have conducted in-depth analyses of particu­lar employers that implemented that approach. Other studies have compared employers that make fixed-dollar contributions to their employees’ insurance premiums with employers that use other contribution formulas. Both types of studies have limitations—employers who adopted managed competition (or their workers) may differ from firms that did not, and all of those studies have used data from the mid-1990s or earlier. A more recent example comes from the new Medicare drug bene­fit, which incorporates many elements of managed com­petition, but it has not been operating long enough to permit detailed analysis. In any event, comparisons with alternative designs for the drug benefit would be hypo­thetical because the same approach was adopted nation­wide.

The available evidence indicates that, when compared with systems in which employers make a larger premium contribution for more expensive health plans, setting the employer contribution as a fixed-dollar amount reduces total health insurance premiums (the amount paid by employers and employees combined) by 5 percent to 10 percent.²⁷ Employers that have implemented man­aged competition have seen large numbers of their employees switch to lower-cost plans, which is an impor­tant source of the cost reductions. Some evidence indi­cates that adopting managed competition has also led insurance plans to lower their premiums; whether the plans did so because of changes in benefit design, tighter management of benefits, or reductions in profits or administrative costs is not clear. Studies of managed com­petition systems have generally not involved standardiza­tion of benefits or risk-adjustment of premium payments, however, so the effects of those features are more difficult to determine.

CBO’s Assessment. The effects of specific proposals on average premiums would depend on how extensively they adopted the key features of a managed competition sys­tem; those proposals could vary along several dimensions. First, proposals would tend to have a larger impact if they gave sponsors clearly defined roles in overseeing the com­petition among health plans on the basis of price and quality. For example, sponsors could be responsible for enforcing the requirements that plans must satisfy to be included in the system; providing comparative informa­tion to consumers on the plans’ premiums, benefits, and quality of care; and managing the enrollment process. Less structured systems that relied more on individual enrollees to gather that information would have less of an impact because the cost to enrollees of doing so would be greater and the pressure on insurers to demonstrate value would thus be less intense.

A second key consideration in determining the effects of a managed competition proposal is whether and to what extent enrollees would be required to pay the full addi­tional cost of more expensive plans. The incentives for enrollees to choose lower-cost plans would be strongest if sponsors made a fixed-dollar contribution toward the premium. That contribution could be based on the pre­mium for the lowest-cost plan that is available, the aver­age premium, or some other fixed reference point. The key feature is that enrollees would be able to capture the savings from joining a less expensive plan, which could take the form of a rebate for joining a plan costing less than the employer’s or the government’s contribution.

CBO estimates that widespread adoption of a system involving those two key elements of managed competi­tion—with a sponsor coordinating information about and enrollment in health plans and making a fixed con­tribution toward the premium—would yield average pre­miums that are about 5 percent lower than those typically seen in employment-based coverage today. That effect is at the lower end of the range observed in the studies of managed competition, for several reasons. First, some firms have already adopted those features of managed competition, so the incremental effect in those cases would be smaller. Second, and more important, the expe­rience of those firms may not be representative of other firms or of today’s competitive environment. Some of those studies involved enrollees switching out of a rela­tively high-cost indemnity insurance plan and into a rela­tively low-cost HMO plan. Today, indemnity plans are rare, HMO plans are not available in all areas, and the difference in their costs in areas where they are offered appears to have declined slightly. More generally, the fact that many employers have not adopted that approach suggests that savings might be somewhat more difficult to obtain on a broad scale than the available studies of par­ticular firms would indicate.

Achieving widespread adoption of such purchasingstrate­gies would also involve a number of challenges and trade-offs. In particular, smaller firms would have more diffi­culty implementing those strategies because the fixed administrative costs of setting up a system of managed competition would be divided over a much smaller num­ber of enrollees. Achieving the effects of managed compe­tition for plans offered by small employers would thus probably require establishing a purchasing cooperative or similar arrangement. Setting up such arrangements would involve addressing how premiums would be set for different employers and how policies would be marketed and sold.²⁸ More generally, trade-offs might arise in determining the rules for participation by insurers; limit­ing the number of insurers could reduce complexity for enrollees as they considered their options but could also have a substantial impact on insurers that were not cho­sen and thus could curtail competitive pressures in the future. The extent of those effects would depend on the number of insurers involved and the share of the market encompassed by the managed competition system.

Other features of managed competition could also yield lower average premiums, but their impact is more diffi­cult to quantify. Average premiums would depend heavily on any standards or limits imposed on the scope of cov­ered benefits and cost-sharing requirements for compet­ing plans (as discussed in Chapter 3); for any given set of specifications, the average premium would probably be lower the more that those offerings were standardized. For example, all plans might be required to offer benefit packages that include the same set of covered services and have equal actuarial value.²⁹ Limiting variation in cost-sharing requirements could also generate stronger compe­tition among health plans to offer a low premium.

A downside of greater standardization is that enrollees would have a narrower range of choices and might prefer a design that differs from the standard. In principle, that concern could be addressed by allowing plans to offer supplemental coverage—priced separately—that goes beyond the standard benefit package or reduces its cost-sharing requirements. In practice, the feasibility of that approach would depend on the extent to which adverse selection affected the additional premiums charged for the extra coverage; if that supplemental coverage was most attractive to individuals with higher expected health care costs, it would probably become expensive or diffi­cult to obtain. Trade-offs thus arise in setting a minimum benefit standard; a relatively high standard would ensure that enrollees were offered that level of coverage, but more comprehensive coverage would also be more expen­sive.

Assuming that insurers had to charge all enrollees the same premium, a related issue is whether payments to plans would be risk-adjusted to account for differences in enrollees’ expected health care costs. If those payments were risk-adjusted, the differences in premiums that enrollees face would be more likely to reflect differences in the efficiency of health plans (rather than differences in their mix of enrollees), which in turn would help foster more intense competition among plans on the basis of their value. The resulting reduction in selection pressures would also tend to limit (but would not eliminate) vola­tility in a plan’s offerings from year to year. As with stan­dard benefits, however, the likely impact of risk-adjusting payments on average premiums is difficult to quantify.

Informing Workers About the Full Cost of Their Health Insurance

Some research in the field of behavioral economics sug­gests that workers demand more health insurance than they would otherwise prefer because they are unaware of its true cost. Although employers usually pay a portion of their employees’ health insurance costs, workers may not recognize that they have given up cash wages or other fringe benefits in exchange. Instead, once workers have joined a firm that offers health insurance, they appear to make decisions about whether to purchase coverage largely on the basis of their share of the premium’s costs—ignoring the amount that employers pay on their behalf. To increase the transparency of the total cost of health insurance borne by workers, some experts have recommended that employers report their share of premi­ums to their employees either annually (for example, on workers’ W-2 income tax forms) or on the pay stubs that workers receive periodically.³⁰

Although researchers have not examined the effect of increased information about employers’ contributions on employees’ decisions to purchase health insurance, two recent studies provide some evidence about the impact that the "salience" of prices has on demand for other items. In one study, researchers went into grocery stores and added the sales tax to the price posted in the aisles for 750 different items.³¹ As a result, customers could see the full after-tax cost of a grocery item before they decided whether to add it to their cart. Even though the amount that customers had to pay for those items did not change, sales dropped by about 8 percent as a result of the post­ing. Those researchers found similar results when com­paring how alcohol sales are affected by excise taxes (which are included in posted prices) and sales taxes (which are added at checkout). A related study found that drivers were less responsive to changes in toll rates when states switched to electronic collection of tolls, in which payments are automatically deducted as the car drives through the toll plaza.³²

Although the findings of those studies offer new insight into how people make choices about their spending, more research is needed to determine precisely how employees might respond to reports from their employer detailing the full cost of their health insurance. That response might be muted if the typical worker ignores such notices. Even if the notices are heeded, an individual worker’s cash wages are unlikely to increase substantially because he or she chooses a less expensive health insur­ance plan; as a result, the financial incentive for an indi­vidual worker to act on that information will be limited.

Expanding Access to Federally Administered Plans

In addition to regulating the purchase of privately admin­istered insurance plans, the federal government could be given a more active role in providing or contracting for health insurance in any of several ways:

• By offering enrollees an additional option, such as a plan delivered through the Medicare program, along­side privately administered plans;
• By setting up a new mechanism through which indi­viduals could obtain private coverage, such as allowing them to purchase one of the plans offered to federal employees; or
• By providing a contingent option, or "fallback" plan, that would be available if an insufficient number of private insurers participated in a new purchasing system.

Such options would need to address several questions in order for their effects to be estimated. Depending on its design, a Medicare-based option could be less expensive than comparable private health plans—at least in many parts of the country—but it might also attract relatively unhealthy enrollees, which could drive up its premiums or federal costs. The effects of providing access to the Federal Employees Health Benefits program would also depend on how its premiums were set; if new enrollees had to pay a community-rated premium that fully cov­ered their expected costs, the number of enrollees would probably be limited and the option might not prove to be viable in the market. As for provisions to offer fallback plans, the key question is what conditions would trigger their use.

Proposals could also seek to establish a single-payer sys­tem based on Medicare through which all U.S. residents could obtain their health insurance. The costs of that approach would depend on many of the same factors that affect the analysis of a new Medicare-based coverage option, but the scale of the impact would obviously be much larger if nearly all of the entire population was covered. Whether enrollees would still have a choice of health plans (paid through Medicare) or could purchase private insurance to supplement the government-run plan could have important implications for the system’s operation and costs.

Offering a Medicare-Based Option

The effects of having the federal government offer new insurance options depend on several factors that any such proposal would need to specify. Those factors may be eas­iest to illustrate under a proposal to add a Medicare-based option to the choices available to enrollees. Establishing such an option for the nonelderly population would involve defining the plan’s benefits, determining the rates used to pay providers, and setting the premium for enrollees and any government subsidy.³³

Another factor affecting the cost of and premium for such an option is that Medicare’s administrative costs are lower than those of large private insurers, although the differ­ences are smaller in dollar terms than they are as a per­centage of the premium. If that option used Medicare’s current payment rates, which are relatively low, it could have lower premiums than comparable private health plans when serving the same population, at least in many parts of the country. However, the broad access that Medicare provides to doctors and hospitals and its very limited use of benefit-management techniques might also attract relatively unhealthy enrollees, which could drive up its premiums or federal costs.

Design and Management of Benefits. The design of a health insurance plan’s benefits plays a central role in determining its premium (see Chapter 3 for further dis­cussion). Under current law, Medicare’s cost-sharing requirements vary substantially across types of health care services; CBO estimates that the program’s overall actuar­ial value for the nonelderly population is about 15 per­cent lower than that of typical employment-based insur­ance plans. Although Medicare covers care from home health agencies and skilled nursing facilities, which are used frequently by its enrollees, those benefits would gen­erally not be used extensively by the younger population that has private health insurance and thus would not con­tribute to the actuarial value for that population. In addi­tion, Medicare does not place an annual limit on out-of-pocket costs for enrollees, whereas most private insurance policies include such a limit. Another factor is that Medi­care’s drug benefit has a lower actuarial value than the drug benefits typically seen in employment-based plans.

Although those features would make Medicare coverage less attractive compared with an average employment-based plan, the difference between Medicare’s actuarial value and that of plans purchased in the individual insur­ance market is smaller. Proposals to establish a new health insurance option based on Medicare could also expand its coverage or restructure its cost-sharing requirements to make its value equivalent to that of a typical employment-based plan, but those steps would also raise its premium.

A related question that arises is whether enrollees in a Medicare-based option would be able to purchase a sup­plemental insurance policy. Most Medicare enrollees have some form of additional coverage that pays some or all of their cost-sharing requirements and limits their out-of-pocket costs. That added coverage raises Medicare’s spending—an effect that is reflected in the program’s cur­rent costs per enrollee. Prohibiting enrollees under a new Medicare option from purchasing such coverage would thus tend to reduce the premium for that option, holding other factors equal. Whether it would be less costly for the federal government to allow those enrollees to buy supplemental insurance or to reduce the cost-sharing requirements they face in the Medicare-based option would depend on the degree of supplemental coverage that was allowed, the extent of the reductions in cost sharing, and the manner in which the plan’s premium was divided between the enrollee and the government.

Two additional issues would be deciding whether and to what extent any benefit-management techniques would be applied under the new option and determining what role the private insurers that currently offer Medicare benefits would play. The traditional fee-for-service Medi­care program does relatively little to manage benefits, which tends to reduce its administrative costs but may raise its overall spending relative to a more tightly man­aged approach. In addition, most enrollees can obtain their Medicare benefits from a private health plan, including an HMO, so a proposal would need to specify whether that option was also available and how new enrollees would access it.

A further complication stems from the fact that Medi­care’s drug benefit has an unusual design and is delivered exclusively by private health insurers. To provide a drug benefit that is similar to the ones typically seen in private insurance plans would either require Medicare to select an exclusive contractor for that benefit (which could be more costly) or involve having Medicare’s drug plans bid separately to provide the new drug benefit. Whether enrollees might choose not to purchase the drug benefit (as Medicare enrollees are allowed to do) and whether premium surcharges would be imposed for late enrollees (as is generally done in Medicare) would also need to be addressed.³⁴

Payment Rates for Providers. In addition to the design of a plan’s benefits, another key determinant of average costs per enrollee is the payment rates for doctors, hospitals, and other providers of health care. Medicare’s payment rates are, on average, lower than private rates—nearly 20 percent lower for physicians’ services and as much as 30 percent lower for hospital services in 2006. (See Chapter 5 for a more detailed comparison.) Using those payment rates would tend to make a Medicare-based health insurance plan less expensive than a comparable private plan, holding other factors equal. Providers, how­ever, might be reluctant to accept those payment rates for new patients, which could limit enrollees’ access to care. Because Medicare’s fees for physicians are determined by a statutory formula that is intended to cap total payments to physicians, proposals would need to address whether and how payments made on behalf of new enrollees would factor into that calculation or be adjusted over time.

Administrative Costs. The Medicare program and private insurance plans have different administrative costs, and Medicare’s costs are commonly cited as an example of low administrative spending for a large insured population. The share of costs in the fee-for-service Medicare pro­gram that are devoted to administration (about 1.5 per­cent) is lower than the share observed for large employers’ plans, whose administrative costs average about 7 percent of premiums. (See Chapter 3 for a discussion of adminis­trative costs for private insurers.) To some extent, those differences reflect both the characteristics of the Medicare population and the unique features of the program.

Differences in current administrative costs between Medicare and private insurers partly reflect differences in the tasks that each performs. Medicare has little need to advertise or seek out enrollees because eligible individuals are usually enrolled by default on the basis of Social Secu­rity records, which determine their eligibility. By contrast, private health plans need to establish and solidify their market presence and must compete with each other for enrollees and for employers as clients, generating costs for advertising, marketing, and sales. Further, Medicare does not employ many of the cost-management techniques used in the private sector, such as conducting utilization reviews or requiring prior administrative authorization for tests or procedures. (The use of such techniques is dis­cussed more fully in Chapter 3.) At the same time, costs per enrollee for adjudicating and processing claims may be higher for Medicare because its enrollees use more ser­vices, on average. Medicare also takes steps upon which private insurers sometimes piggyback, such as making decisions about what treatments to cover or establishing and maintaining payment systems.

Another source of the difference in administrative costs between private insurers and Medicare is that private insurers retain profits. Those profits, which represent about 4 percent or 5 percent of the insurers’ premium revenues on average, constitute a return on investment for the companies’ owners or shareholders. A portion of that return compensates those investors for effectively lending funds to the company (rather than using them for their own consumption), and a portion constitutes a "risk premium" to compensate for the risk that insurers will incur financial losses (if, for example, the premium levels they specify in advance are not sufficient to cover the insured costs their enrollees actually generate). The Medicare program, by contrast, does not generate profits. The federal government bears financial risk for operating the program, but the economic costs of doing so are not reflected in the federal budget under current accounting practices.

One factor that complicates the comparison of adminis­trative costs in Medicare and private health insurance plans is that Medicare enrollees are either elderly or dis­abled, so their average health care costs are much higher. As a result, the share of the premium accounted for by administrative costs is likely to be lower simply because the denominator for that calculation is larger. For the same reason, private insurers that offer Medicare’s basic benefits (known as Medicare Advantage plans) report having lower administrative costs as a share of their total costs per enrollee—about half as high as for their enroll­ees under the age of 65 as a percentage of the premium.³⁵ Comparing administrative costs for Medicare and large private plans in terms of dollars spent per enrollee shows much smaller differences. In 2007, administrative costs per enrollee were on the order of $150 for Medicare and about $300 for large employment-based health plans.³⁶ By contrast, the administrative costs of policies purchased by smaller employers and individuals were much higher—roughly $1,000 per enrollee.

The amount of administrative costs that would be incurred per enrollee if a Medicare-based option was made more broadly available could differ from the pro­gram’s current costs and would depend on the tasks involved. In particular, more effort would probably be required to seek out and process applications for enrollees than is the case for the current Medicare population, thereby raising average administrative costs. Any fixed costs of operating the program would be divided over a larger number of enrollees, however, which would tend to reduce the amount of administrative costs per enrollee.

Setting Premiums for Likely Enrollees. Another impor­tant consideration is the terms of the competition between a plan run by the federal government and plans that are privately run, especially with respect to how pre­miums for enrollees in the federal plan would be set. If the federal plan had to charge a community-rated pre­mium that was designed to cover the full costs of expected enrollees but competing private plans did not face the same requirement, the federal plan would be most attractive to enrollees with health problems, and its premium would have to be correspondingly higher.

That effect could be attenuated if the premium for the government-run plan was adjusted so that it did not reflect the relative (and presumably higher) risk of its enrollees. Covering the difference between the plan’s expected costs and those premium payments, however, would either generate federal costs or require some mech­anism to recoup the difference from competing plans. Alternatively, providing a premium subsidy would make the government-run plan more attractive to a broader range of enrollees, but it might put the private-sector plans at a disadvantage in trying to compete with the gov­ernment’s plan. Even then, adverse selection into a Medi­care-based plan could occur because Medicare currently provides broad access to doctors and hospitals and makes limited use of the benefit-management techniques com­monly employed by private health plans—features that would make Medicare relatively attractive to people with health problems. The impact on the premium for a Medicare-based option would depend on how effectively any risk-adjustment mechanism could offset that impact.³⁷

Range of Estimates. Depending on how those questions are resolved, the impact of adding a Medicare-based insurance option could vary substantially. Assuming, however, that such an option offered benefits comparable with those of private health plans, used Medicare’s pay­ment rates for providers, and based its premium on the costs of serving a broadly representative group of enroll­ees in the same region, that option would have lower pre­miums than those private plans in many parts of the country and would have comparable premiums in other areas. (In a few areas, Medicare’s costs would be higher than those of private plans.) The primary basis for that assessment is the observation that many of the private plans now participating in Medicare have average costs to deliver the same package of basic benefits that are higher than those in the fee-for-service program.³⁸

The main reason for that disparity appears to be Medi­care’s lower payment rates, which in many areas of the country more than offset the effects on costs per enrollee of employing fewer benefit-management techniques in the fee-for-service program. Depending on the number of people expected to enroll in a Medicare-based option, the extent to which providers would accept those payment rates for a larger number of patients could require further analysis. The differences in payment rates and costs also vary geographically, however, and in some parts of the country the HMOs participating in Medicare are able to provide its benefits at costs comparable with those observed in the fee-for-service program.

Medicare-for-All. Many of the considerations that arise in designing a new option for individuals to enroll in Medi­care would also affect the analysis of proposals to establish a single-payer system based on Medicare through which all U.S. residents could obtain their health insurance. In particular, the federal costs of such a proposal would depend primarily on the benefits that the system pro­vided; the rates it used to pay doctors, hospitals, and other providers of health care; and the extent of any pre­mium subsidies it offered to enrollees—all of which could differ from Medicare’s current design. The rules and pro­cesses used to determine eligibility for the program and to enroll individuals who are eligible would also have signif­icant implications.

Even under a single-payer system, individuals could have a choice of insurance plans or benefit designs, but the extent and nature of those options would also depend on the features of the proposal. If enrollees were allowed to choose a private health plan paid through Medicare or could purchase supplemental private insurance (as many Medicare enrollees currently do), the rules governing those choices and the possibility of adverse selection would remain important considerations. If, instead, the Medicare plan was the only option offered and all resi­dents were required to enroll in it, then adverse selection would not occur. That approach could reduce the admin­istrative costs that doctors and hospitals currently incur when dealing with multiple insurers. Some enrollees might prefer a different design, however, and the lack of competition from private health plans could take away a benchmark that is commonly used to assess the adequacy of Medicare’s payments and the efficiency of its perfor­mance. More generally, that approach would raise impor­tant questions about the role of the government in man­aging the delivery of health care.

Providing Access to the Federal Employees Health Benefits Program

Some proposals would allow individuals and firms out­side the federal government to purchase coverage through the Federal Employees Health Benefits program, which offers health benefits to current and former federal employees and their families. In 2008, FEHB included approximately 300 private health plans and about 8 mil­lion enrollees. Most of those plans are available only in a specific region of the country, but a few are available nationwide, so a given enrollee may have 10 to 20 plans from which to choose. The federal government makes a contribution (as an employer) that covers 75 percent of each plan’s premium, subject to a cap set at 72 percent of the national average premium.³⁹

The FEHB program thus incorporates some elements of managed competition, but not all of them. In particular, the formula for the federal subsidy provides relatively strong incentives for enrollees to consider whether a plan with above-average costs is worth the additional payment, but it gives enrollees only 25 percent of the savings when they choose a plan that has overall costs below the national average. Some plans therefore seem to compete for enrollees by providing additional benefits rather than by offering lower premiums. In addition, payments to the plans participating in FEHB are not risk-adjusted to account for the differing health status of their enrollees. As a result, over the years a few plans that offered more extensive coverage—and thus attracted relatively unhealthy enrollees—have seen their costs and premiums escalate because of adverse selection.

The effects of providing broader access to FEHB would largely depend on who was eligible to enroll in the pro­gram and how premiums for the new enrollees were set, which could be determined in various ways. For example, FEHB plans could be made available to the general pub­lic and the premiums could be set in the same way that they are currently set by other insurers in the individual and group markets; that is, those premiums could vary across individuals and firms to the extent that such varia­tion was allowed in each state. Relative to current law, however, that approach would probably do little to expand insurance coverage. Insurers participating in FEHB could already have pursued that approach if they had wanted to (and some have). More important, the options available to individuals and firms under that approach would not differ substantially from those avail­able in the individual and group markets today.

Alternatively, FEHB plans could be required to charge a community-rated premium reflecting only the costs of the new nonfederal enrollees. Assuming that FEHB plans could not deny coverage to applicants, that option would be most attractive to people who expected to have above-average costs for health care—those who currently face relatively high premiums or have been denied coverage in the individual market. As a result, the total premium charged to nonfederal enrollees would probably be sub­stantially higher than those observed in the program today. Depending on the specific features of the proposal, an equilibrium could be reached in which a group of enrollees were willing to pay an above-average premium that covered their health care costs (and related adminis­trative expenses for the insurers). But another possibility is that an adverse selection spiral could ensue, resulting in very high premiums and little or no enrollment under this option.⁴⁰ The fact that insurers participating in FEHB could offer community-rated policies in the indi­vidual market today—but generally do not do so—sug­gests that they would be reluctant to participate.

Providing access to FEHB would probably have a greater effect on insurance coverage rates if a proposal included some type of subsidy for new enrollees, either implicit or explicit; unlike the approaches discussed above, such alternatives would also generate some federal costs. An implicit subsidy could be provided if the premium charged to new nonfederal enrollees was the same as the one for federal enrollees. To the extent that nonfederal enrollees had higher average costs for health care (or gen­erated higher administrative costs), the uniform premium would rise but the effect would be averaged across federal and nonfederal enrollees. (The implicit subsidy would then be the difference between the average cost of cover­ing nonfederal enrollees and the uniform premium.) Compared with the previous alternatives, the lower pre­miums under this option would make it somewhat more attractive to nonfederal enrollees, but higher total premi­ums for FEHB plans would also mean higher payments for federal enrollees. To the extent that average premiums rose, the government’s costs for its contribution on behalf of federal enrollees would increase.

Finally, providing access to FEHB plans would be most likely to attract enrollees if the federal government also provided an explicit premium subsidy. If that subsidy was available only to enrollees in an FEHB plan, however, people with individually purchased or employment-based coverage would have an incentive to drop that coverage and switch to the FEHB system; the strength of that incentive would depend on the size of the subsidy. Limit­ing eligibility for the FEHB option to people who had been uninsured for some period of time and did not have an offer of health insurance from their employer would constrain the potential number of enrollees somewhat but would still lead some individuals and employers to drop their existing coverage; limiting eligibility in that way might also be viewed as penalizing people who had purchased coverage or had sought out jobs that offered it. If, instead, subsidies for health insurance were not limited to FEHB plans, then enrollment in those plans would depend on their attractiveness relative to other options in the individual and group markets. (See Chapter 2 for a broader discussion of premium subsidies.)

Creating a Fallback Plan

To lessen the impact of potential errors in the design or implementation of a new insurance system or to guaran­tee broad access to new health insurance options, propos­als to expand or restructure health insurance coverage could include provisions for fallback plans, in which the government would offer or support a plan of last resort. Such options can address concerns that private insurers might be unwilling to meet the terms of participation set for them or might be reluctant to participate because of uncertainty about who will enroll or the costs of provid­ing the proposed benefits. As a result, provisions for fall­back plans may entail having the government step in to bear some or all of the financial risk involved in providing insurance coverage, either by contracting with a private entity whose role is limited to administering the benefit or by having the government offer the benefit directly.

Both the role and the potential effects of fallback plans are illustrated by CBO’s analysis of the provisions that were included under the Medicare drug benefit.⁴¹ Because of the novelty of that benefit—stand-alone drug insurance—and uncertainty about its costs, there was a chance that the private insurers that were expected to deliver it would not participate, at least in some areas of the country. The legislation thus specified that a fallback plan would have to be made available if too few private insurers stepped forward, but it also placed restrictions on the organizations serving as fallback plans in an effort to prevent the prospect of low participation by insurers from becoming a self-fulfilling prophecy. After analyzing the overall incentives facing insurers, CBO assumed that the probability that fallback plans would be needed was rela­tively low and would decline over time. As it turned out, a large number of insurers chose to participate in the drug benefit and the fallback provisions were never triggered.

More generally, the effect of such provisions on the expected costs of a proposal would depend on two fac­tors: the likelihood that the provisions would be trig­gered, and the relative cost of such plans if they were used. The likelihood that fallback plans would be needed depends largely on the attractiveness to private insurers of participating in the system, which in turn depends on the requirements they would face if they participated and on the risks they would face if they did not. The terms under which fallback plans would cease being offered would also affect the attractiveness of that option and thus the odds of triggering the fallback provisions in the first place.

The relative costs of such plans would depend on many of the same factors discussed above: the design of the ben­efit package, including the scope of the coverage and cost-sharing arrangements, the provisions or incentives for managing costs, the administrative costs involved, and the method for setting the enrollee’s share of the pre­mium. If the requirements for private insurers to partici­pate in a revised system of health insurance were similar to those they currently face—or, as illustrated by the Medicare drug benefit, even if they were not—those insurers would be very likely to participate, so fallback provisions would probably not be triggered.

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1

For additional analysis of issues related to the regulation of insur­ance markets, see Congressional Budget Office, CBO’s Health Insurance Simulation Model: A Technical Description (October 2007); and The Price Sensitivity of Demand for Nongroup Health Insurance (August 2005).

2

That challenge is not unique to health insurance; the likelihood of an automobile accident or a homeowners’ insurance claim can also vary across policyholders in predictable and observable ways. See Chapter 1 for additional discussion about the predictability of health care spending.

3

Catherine Hoffman and Karyn Schwartz, "Eroding Access Among Nonelderly U.S. Adults with Chronic Conditions: Ten Years of Change," Health Affairs, Web Exclusive (July 22, 2008), pp. W340–W348. The other chronic conditions examined were stroke, emphysema, and cancer.

4

Kenneth E. Thorpe and others, "The Rising Prevalence of Treated Disease: Effects on Private Health Insurance Spending," Health Affairs, Web Exclusive (June 27, 2005), pp. W5-317 to W5-325.

5

Joseph P. Newhouse, Melinda Beeuwkes Buntin, and John D. Chapman, "Risk Adjustment and Medicare: Taking a Closer Look," Health Affairs, vol. 16, no. 5 (September/October 1997), pp. 26–43.

6

Many other laws and regulations govern health insurance but are beyond the scope of this report. State insurance agencies are gen­erally charged with monitoring the financial health of insurance firms to ensure that they will be able to meet their promises to pay claims. Furthermore, many of those agencies regulate the sales practices of insurers. Federal law also establishes reporting and dis­closure requirements and fiduciary standards for the plans’ admin­istrators. All of those regulations can also affect insurance premiums and coverage.

7

See Mark Merlis, Fundamentals of Underwriting in the Nongroup Health Insurance Market: Access to Coverage and Options for Reform, NHPF Background Paper (Washington, D.C.: National Health Policy Forum, April 13, 2005). In principle, insurers could charge a higher premium to applicants who have very high expected costs, but in practice they appear to assume that individuals who would be willing to pay premiums exceeding twice the standard rate would be likely to have even higher covered costs for health care—so rather than charge a very high premium, insurers gener­ally deny coverage to such applicants instead.

8

Ibid. A recent analysis also found that in three states, a dominant insurer used community rating even though the state did not require all insurers to adopt that practice; see Congressional Budget Office, The Price Sensitivity of Demand for Nongroup Health Insurance, Background Paper (August 2005).

9

General Accounting Office, Private Health Insurance: Federal and State Requirements Affecting Coverage Offered by Small Businesses, GAO-03-1133 (September 2003).

10

See M. Susan Marquis and Stephen H. Long, "Effects of ‘Second Generation’ Small Group Health Insurance Market Reforms, 1993 to 1997," Inquiry, vol. 38, no. 4 (Winter 2001/2002), pp. 365–380; and Amy Davidoff, Linda Blumberg, and Len Nichols, "State Health Insurance Market Reforms and Access to Insurance for High Risk Employees," Journal of Health Economics, vol. 24, no. 4 (July 2005), pp. 725–750.

11

Information on the status of high-risk pools comes from www.statehealthfacts.org. See also Bernadette Fernandez, Health Insurance: State High-Risk Pools, RL31745 (Congressional Research Service, October 1, 2008).

12

Congressional Budget Office, cost estimate for S. 1955, the Health Insurance Marketplace Modernization and Affordability Act of 2006 (May 3, 2006).

13

A similar approach would facilitate the formation of association health plans, which can be offered by trade, industry, or profes­sional associations to their member firms. That option would be attractive for smaller firms with relatively healthy workers that are located in states that regulate premiums more extensively or have more extensive benefit mandates. For an analysis of a recent legis­lative proposal, see Congressional Budget Office, cost estimate for H.R. 525, Small Business Health Fairness Act of 2005 (April 8, 2005).

14

Congressional Budget Office, cost estimate for H.R. 2355, Health Care Choice Act of 2005 (September 12, 2005).

15

See Statement of Joseph Antos, Assistant Director for Health and Human Resources, Congressional Budget Office, before the Sub­committee on Civil Service, House Committee on Government Reform and Oversight, October 8, 1997.

16

Joint Committee on Taxation, Tax Expenditures for Health Care, JCX-66-08 (July 30, 2008).

17

One offsetting consideration is that excluding health insurance premiums from taxable wages reduces future Social Security bene­fits, which are based on average earnings, at the same time that it reduces payroll tax payments.

18

Assume, for example, that an insurance policy has a total premium of $5,000. Someone receiving a 20 percent tax subsidy would thus pay $4,000 on net. If the tax subsidy was eliminated, that person would pay $5,000, or 25 percent more. Someone receiving a 40 percent tax subsidy would currently pay $3,000 for that policy. If the tax subsidy was eliminated, that person would pay $5,000, or 67 percent more.

19

Jonathan Gruber and Michael Lettau, "How Elastic Is the Firm’s Demand for Health Insurance?" Journal of Public Economics, vol. 88, no. 7 (July 2004), pp. 1273–1294.

20

Bradley T. Heim and Ithai Lurie, "Do Increased Premium Subsi­dies Affect How Much Health Insurance Is Purchased? Evidence from the Self-Employed" (draft, Department of Treasury, Office of Tax Analysis, January 7, 2008).

21

See Alain C. Enthoven, "The History and Principles of Managed Competition," Health Affairs, vol. 12 (Supplement 1993), pp. 24–48.

22

James Maxwell and Peter Temin, "Managed Competition Versus Industrial Purchasing of Health Care Among the Fortune 500," Journal of Health Politics, Policy, and Law, vol. 27, no. 1 (2002), pp. 5–30.

23

For a discussion of this issue, see Mark McClellan and Sontine Kalba, "Benefit Diversity in Medicare: Choice, Competition, and Selection," in Richard Kronick and Joy de Beyer, eds., Medicare HMOs: Making Them Work for the Chronically Ill (Chicago: Health Administration Press, 1999), pp. 133–160.

24

Under a managed competition system, insurers could be allowed to vary individuals’ premiums so that the premiums reflected each enrollee’s expected costs for health care, in which case those premi­ums would already be adjusted for risk. In many respects, such an arrangement would resemble the current market for individually purchased insurance.

25

David M. Cutler and Sarah J. Reber, "Paying for Health Insur­ance: The Trade-Off Between Competition and Adverse Selec­tion," Quarterly Journal of Economics, vol. 113, no. 2 (May 1998), pp. 433–466.

26

Newhouse, Buntin, and Chapman, "Risk Adjustment and Medi­care." Studies finding that at least 20 percent to 25 percent of health care spending is predictable largely reflect comparisons of individuals’ average spending over several years and thus account for any reason that one person’s spending is higher than another’s. Risk-adjustment models, by contrast, generally adjust payments using information only about individuals’ age and sex and the dis­eases or health conditions with which they have been diagnosed. Those models thus do not take into account other differences among individuals (such as their preferences about health care) that affect their spending. Those features reflect an apparent reluc­tance to assign different adjustment factors to people who have the same demographic characteristics and health problems.

27

For a discussion of that evidence, see Congressional Budget Office, Designing a Premium Support System for Medicare (Decem­ber 2006), pp. 31–35.

28

For a discussion of those challenges, see Elliot K. Wicks, Health Insurance Purchasing Cooperatives, Commonwealth Fund Issue Brief No. 567 (November 2002), www.commonwealthfund.org.

29

A plan’s actuarial value reflects the share or amount of health care costs that it would cover for a given population; see Box 3-1 on page 64 for additional discussion.

30

Jeff Liebman and Richard Zeckhauser, Simple Humans, Complex Insurance, Subtle Subsidies, Working Paper No. 14330 (Cam­bridge, Mass.: National Bureau of Economic Research, September 2008).

31

Raj Chetty, Adam Looney, and Kory Kroft, Salience and Taxation: Theory and Evidence, Working Paper No. 13330 (Cambridge, Mass.: National Bureau of Economic Research, August 2007).

32

Amy Finkelstein, E-ZTax: Tax Salience and Tax Rates, Working Paper No. 12924 (Cambridge, Mass.: National Bureau of Eco­nomic Research, February 2007).

33

Many of the same issues are raised by proposals to establish a "pre­mium support" system within Medicare, under which private health plans and the fee-for-service program would compete for enrollees. For a discussion, see Congressional Budget Office, Designing a Premium Support System for Medicare.

34

For a discussion of those issues, see Congressional Budget Office, Issues in Designing a Prescription Drug Benefit for Medicare (Octo­ber 2002).

35

James G. Kahn and others, "The Cost of Health Insurance Administration in California: Estimates for Insurers, Physicians, and Hospitals," Health Affairs, vol. 24, no. 6 (November/Decem­ber 2005), pp. 1629–1639.

36

Administrative costs for Medicare borne by the Centers for Medi­care and Medicaid Services were $6.5 billion in calendar year 2007 (including both mandatory and discretionary funds); that figure includes payments to the Social Security Administration to cover its costs related to administering the Medicare program. Total program expenditures for that year were about $441 billion. About 44 million people were enrolled in Part A, Part B, or both in that year (including about 8 million enrollees in private health plans providing those Medicare benefits).

37

For an illustration of how inadequate risk adjustment could lead to higher premiums for beneficiaries in the traditional Medicare program, see Thomas Rice and Katherine A. Desmond, "The Dis­tributional Consequences of a Medicare Premium Support Pro­posal," Journal of Health Politics, Policy, and Law, vol. 29, no. 6 (December 2004), pp. 1187–1226.

38

That analysis reflects the bids that those private plans submit and not the payments they receive, which are generally higher than the bids. Plans’ bids reflect their expected costs for providing Medi­care benefits in the service area where the plan is offered (gener­ally, a county or a multicounty region). In 2008, about half of the enrollees in Medicare Advantage plans are in plans whose bid exceeds the average cost of Medicare enrollees in the fee-for-ser­vice program who live in the plan’s service area.

39

For more information, see Mark Merlis, "The Federal Employees Health Benefits Program: Program Design, Recent Performance, and Implications for Medicare Reform" (briefing prepared for the Henry J. Kaiser Family Foundation, May 30, 2003).

40

For additional discussion, see Mark Merlis, Opening the Federal Employees Health Benefits Program to Individual Purchasers (report prepared for the Department of Health and Human Services, Office of the Assistant Secretary for Planning and Evaluation, July 31, 2001), www.markmerlis.com.

41

For a more extensive discussion, see Congressional Budget Office, A Detailed Description of CBO’s Cost Estimate for the Medicare Pre­scription Drug Benefit (July 2004), pp. 8–11.