Might High-Risk Pools Bear Unintended Consequences?

Cross-posted from The Agenda on National Review Online.

The Summer 2010 issue of Yuval Levin’s National Affairs is out, and it contains three intriguing articles on health care reform.

The first, by Paul Howard and Stephen Parente (subscription required), effectively summarizes the debate of the last 15 months. Howard and Parente propound free-market ideas for reform, such as: interstate insurance competition; voucherizing Medicare, Medicaid and Obamacare’s insurance subsidies; and turning Obamacare’s “Cadillac Tax” into a “Buick Tax” so as to further the conversion of the employer-based insurance market into an individual one. Importantly, from their perspective, these reforms could be implemented whether or not the Affordable Care Act is repealed.

In a separate piece, John Hood presses the case for reform of Medicaid, which is an underappreciated driver of our fiscal crisis because its responsibilities are shared between the states and the federal government. Fundamentally, Hood shares the view of Howard and Parente that vouchers will help rationalize Medicaid spending and budgeting.

Hood points out a worrisome trend: that many well-off people game the Medicaid system by transferring assets to other family members, so that they can fall under the wealth threshold for Medicaid subsidies.

Hood favors eliminating these loopholes, along with the direct federal role for managing Medicaid, instead advocating block grants to the states. Block grants incentivize states to experiment with productive Medicaid reforms, because they retain the savings from any successful innovations. In addition, block grants allow for predictable budgeting.

Another idea raised by Howard and Parente is assembling a system of high-risk pools as a way of improving access to health insurance for those with pre-existing conditions. James Capretta and Tom Miller take up the subject of high-risk pools in depth, in an original and provocative article. Capretta and Miller argue that a fully-funded system of high-risk pools would spend around $17 billion a year to cover the 4 million people who need them, and by isolating those people from the rest of the insurance pool, make insurance coverage far more affordable for everyone else. Their piece contains a number of thoughtful proposals for ensuring that the pools would function as intended.

Controversially, they argue that the federal government should directly fund these high-risk pools, since fiscally-constrained states have not been able to adequately do so thus far. My preference would be that high-risk pools remain the province of the states, so that states can experiment with their structure—something that can only happen if states are not constrained by the myriad distortions of federal policy.

There are two other large challenges with high-risk pools that merit further debate (though Capretta and Miller do address them). The first is: what sort of mechanism could be erected to ensure that high-risk pools don’t metastasize into moderate-and-high-risk pools, and eventually all-risk pools? That is to say, is it possible to define “high-risk” in such a way as to sufficiently constrain the political temptation to expand such risk pools to cover larger constituencies? Just as with pension packages for government employees, it would be easy for a politician to expand the size of a high-risk pool, knowing that the full costs of doing so would show up decades later, when the patients are older, and when that politician is off sipping piña coladas on some tropical island. Insurance lobbyists will fight hard for such risk pool expansions, knowing that their own businesses will prosper by dumping risky individuals onto the state.

Capretta and Miller suggest that capping federal expenditures at some dollar figure, such as $15 to $20 billion, might do the job. But there will always remain the risk that a more spendthrift Congress will blow through the cap. This is another reason why it might be better for the states to run these pools—states’ inability to sustain deficits will prevent the programs from getting out of hand.

There is a second, related problem, one that John Goodman has raised: that the government is fundamentally incompetent at pricing risk. “Price setting errors that government makes in the market for risk,” writes Goodman, “will invariably be worse than in just about any other market.” (Think of what the government has done to the housing market.) The potential is strong for such government intervention to significantly distort the conventional insurance market, as it has done with Medicare and Medicaid.

All in all, the creation of high-risk pools is a promising idea that, I believe, is not yet ready for prime-time. We will need to refine the concept further at the state level before we can jump in with both federal feet. Capretta and Miller deserve our thanks for helping to frame the discussion.