Published May 25, 2009

National Review VOL. LXI, NO. 8

The most powerful constituency in the debate over the future of health care in the United States comprises those families enrolled in stable, employer-based health plans run by large and medium-sized companies. Conservatives need to get these voters on their side, both to block the worst elements of President Obama's agenda and to take the first steps in building a rational marketplace.

What's crucial to understand about this segment of the electorate is their ambivalence about the whole reform enterprise. Yes, they see the problems of gaps in coverage and rapidly rising costs. Most would support an effort to cover the uninsured, as they worry about where they would get insurance if they lost their jobs. But by and large these workers are satisfied with the coverage they have and are more than a little reluctant to trade it for anything that seems less certain to provide ready access to the doctors and hospitals they trust.

Their risk aversion is understandable. Employer-sponsored plans tend to contract with the best networks of doctors and hospitals in their communities, with very limited financial exposure for the enrollees. That's hard to beat.

Indeed, it was this large group of already-insured who were crucial to killing the Clinton health-care plan of 1994. Polls in 1993 showed strong support for the concept of universal coverage; that sounded like more security to most Americans. But when workers found out the plan being crafted by then–First Lady Hillary Clinton would force many firms to drop their coverage and sign their workers up for government-arranged insurance, support for the effort sank like a rock. By mid-1994, members of Congress were looking for an exit strategy — and the bill never came up for a vote.

The Obama administration is hoping to avoid the same fate, which is why the president and his aides keep saying that, under their plan, workers can keep the coverage they have today if they want to — even though it's not true. The Lewin Group, a health-policy consulting firm, estimates some 120 million Americans with private coverage today would end up in government-run insurance under an Obama-like plan, mainly because tens of thousands of employers would choose to stop offering plans to their workers. Still, the president's insistence that his plan would result in no such thing is instructive. He clearly thinks he can't win this fight if workers with good job-based coverage turn against him.

He is right to be worried about them — as John McCain could testify. Last year, while running for president, McCain finally did what many conservatives had wanted Republican political leaders to do for years: He offered a bold plan to fix what's wrong with American health care that could compete with the Democrats' statist plans. He put on the table the idea conservatives have long argued must be the centerpiece of an effective, market-based fix: ending the tax break for employers who offer coverage, and replacing it with a tax break for all individuals who buy insurance, whether through their employers or in the individual market.

It's true that the employer tax break has been instrumental in encouraging the middle class to buy insurance since World War II. But today, it's the Achilles heel of American health-care policy.

For starters, when a firm buys insurance for its workers, the workers don't own their policies. When they leave their jobs, they can't take the health insurance with them (there is a special 18-month continuation period for certain workers — but the worker must pay the full premium with after-tax dollars). This lack of portability causes many people to experience gaps in coverage while they are between jobs. Some 80 million people went at least one month without insurance between 2004 and 2005.

Moreover, job-based coverage doesn't work nearly as well for workers in smaller firms. Insurers charge premiums based on the known risks of the group they are covering, and the smallest firms simply are not big enough to spread these risks broadly. Most states have rules requiring insurers to treat all small businesses as if they were part of one large group, but there's usually some give in the rates they can charge, allowing for adjustment based on a business's recent claims history. Consequently, it is not uncommon for a small business with one or two workers newly diagnosed with cancer to see premiums jump 20 or 30 percent, and sometimes even more, in just one year.

It doesn't help matters that smaller companies tend to pay less, and to hire more part-time and seasonal workers. An offer of employer-based insurance is worth less to a low-wage worker than to a high-salaried one — the former is likely to prefer higher wages, both because he needs the money more and because he'll pay a lower tax rate on the additional income. The result is a high concentration of the uninsured in the nation's smallest businesses. More than 30 percent of all workers in firms with ten or fewer employees are uninsured, while only 10 percent of workers in firms with at least 1,000 employees are uninsured.

Today's open-ended tax break for employer-paid premiums is also one of the main reasons for rapid health-care-cost inflation. Because cash wages are taxed and employer-paid premiums are not — in effect, the federal treasury subsidizes about 40 cents of every new dollar paid by employers for health coverage — high-income workers have a strong incentive to take more and more compensation in the form of health benefits. Predictably, companies have responded by offering more expansive insurance, with lower deductibles and looser networks of preferred providers, than they would if their workforce had to pay the full financial consequences of such a design.

Senator McCain wanted to take on all of these problems at once. His plan would have replaced today's tax preference for employer-paid premiums with a fixed, refundable tax credit worth $2,500 for individuals and $5,000 for households. Workers could use the credit to pay for insurance organized by their employers, or they could use it to buy insurance on the open market.

There's little doubt that, if adopted, the McCain plan would have gone a long way toward addressing many of the shortcomings prevalent in health care today. Workers could have gotten portable insurance, eliminating “job lock” (the tendency of people to stick with jobs they don't like just for the insurance) and closing gaps in coverage for those temporarily out of the workforce. Millions of workers who are now passive enrollees in their company plans would have become cost-conscious consumers looking for value in the marketplace. With a fixed tax credit that did not change based on the insurance purchased, workers would have had strong financial incentives to sign up for low-premium offerings, and insurers would have been rewarded for meeting the market demand with lower costs and greater efficiency.

Further, a universal tax credit would have been something like a universal-coverage plan. Every household would have gotten it — even ones that paid no income taxes. All experience indicates most households would have bought something so as not to let the credit go to waste. There would have been a dramatic reduction in the ranks of the uninsured.

Unfortunately, the voting public never got past some initial reservations about the idea. Granted, McCain was not the ideal spokesman. He had not invested much of his lengthy Senate career in mastering the complexities of health-care policy. When the Obama campaign launched a barrage of attacks on his plan, McCain seemed unable to produce timely and effective responses.

Still, one cannot write off the problems McCain encountered as nothing more than ineffective communication. His tax-credit idea was widely aired, and explained in countless ways and settings. The public heard the messag
e — but wasn't convinced it was the way to go.

Why? In short, Senator McCain ran into the same brick wall that stopped the Clinton plan in the 1990s: People with good, job-based coverage saw it as more of a threat than an improvement.

The Obama campaign certainly helped voters reach that conclusion. It ran scores of attack ads claiming the McCain plan would unravel the employer-based health-insurance system. If young and healthy workers could take their tax credits and leave their employers' plans for better deals in the individual market, it would raise the average risk — and thus the premiums — of those who remained. In a worst-case scenario, an insurance death spiral could occur as these premium hikes encouraged even more young and healthy people to leave, leading in turn to even higher premiums. Unfortunately for McCain, many large employers essentially agreed with the Obama critique — and said so both to the national press and to their workers.

Certainly the attack was over-the-top, as attacks often are the month before an election. The McCain campaign was able to cite estimates that the migration out of job-based plans would be very modest, at least at the outset of a switch to individual tax credits. And many conservatives rightly countered that there's nothing wrong with people's exiting employer groups to buy insurance on their own — in a sense, that's the whole point of the reform, as it would lead to portable, and thus more stable, coverage.

Nonetheless, the critique struck a nerve with the electorate — because voters value the access to group-rated insurance premiums that job-based plans essentially guarantee. Today, in most employer plans, all of the workers pay the same premium, regardless of their age and health. Many states have rules that attempt to pool insurance risks similarly in their individual-insurance markets, but they almost have to allow some variation in premiums — to ensure that the young and healthy don't just walk away. Moreover, many families have been in this market themselves. They know it is entirely possible for someone with a history of illness or disease to face sky-high premiums and meager benefits.

To reassure voters, Senator McCain proposed a much-expanded role for government-run high-risk pools. The federal government would directly subsidize insurance premiums for the very sick. That would obviate the need for elaborate, state-enforced insurance regulations intended to socialize high risks through premium payments. Directly subsidizing the most expensive cases — a relatively small number — would allow the premiums for everyone else in the individual market to come down, and thus encourage the young and healthy to enroll.

High-risk pools, properly created, are certainly one way to reduce premiums for people with expensive preexisting conditions, but that idea alone wasn't nearly enough to close the sale for McCain. To begin with, high-risk pools are already in place in many states — and they haven't worked particularly well, because the funding has been far below the level necessary to subsidize all of the eligible people. There's also the concern that, with high-risk pools, insurers have a strong incentive to offload costs onto taxpayers by liberally designating potential insurance enrollees as “high risk.” It's also not entirely reassuring to some that the private market will apparently work better if those most in need of health services are essentially pulled out of the regular pool.

However, by recognizing that many Americans want to stay with their current insurance and turning that fact to their advantage, conservatives can both prevent Obama's government-centered approach and advance market-based reforms. Conservatives must recognize that they need the well-insured — those in plans run by medium and larger firms — on their side in their fight against Obamacare. That means making a strategic decision to leave them where they are — for now. And, ironically, the only way to do that is to allow employers to make the decision to keep the entire group together: If a company decides to continue with a plan, the employees of that company would be able to use their tax credits only to offset the premiums for job-based coverage. Some workers might still leave by piggybacking on spouses' tax credits in the individual market. But, by and large, leaving control with the firms would ensure that stable job-based coverage could remain in place, if the firms wanted to keep offering it.

Some conservatives will find this compromise uncomfortable, because it would limit the freedom of some employees to go outside their places of work for health insurance. Unfortunately, the only way to fully guarantee the stability of existing employer groups is to make it unlikely that most people enrolled could do better by going outside of them. But this need not be a permanent feature of reform. Once a consumer-driven marketplace is built for everyone else, it will be easier to convince everyone remaining in job-based plans that they could get portable insurance at good rates outside of their employer plan. Leaving the well-insured where they are for now would also allow conservatives to focus the political debate on those who don't have good options today.

The best approach is therefore a federal-state partnership to build a consumer-driven marketplace outside of employer-provided care. In general, it should be something like the program through which federal employees select their coverage every year from competing private insurers. Eligible state residents would have sufficient information about the offerings, and their tax credit would get sent automatically to the plan of their choice. States would be required to ensure that the price and quality differences between competing options were clear, transparent, and easily accessible via the Internet. When residents chose more expensive plans, they would pay the difference out of their own pockets. When they chose less expensive plans, they would get to keep every dollar saved.

The trickiest issues will involve spreading insurance risk. States currently regulate private health insurance, and there is a long and not-so-happy track record of trying to enforce uniform premiums in voluntary marketplaces — which has tended to drive out the young and healthy, raising premiums for everyone else. This will be less of a problem if residents lose their tax credits with non-participation. And here's another way to encourage all residents to sign up for some kind of plan: Offer a time window during which residents who sign up will enjoy certain premium protections if they get sick. Those who miss the window would have to pay higher premiums if they wanted to get insurance later.

States should also give serious consideration to establishing a behind-the-scenes risk-adjustment system among the private insurers offering plans in the new marketplace. Such a mechanism would require these insurers to share revenue from premiums with their competitors based on the risk profiles of those who select their plans, using formulae agreed to in advance. Insurers that ended up with more unhealthy enrollees would thereby get compensation from those covering a healthier-than-average group. This way, insurers would compete with one another by offering better coverage at lower cost, rather than by excluding the people most likely to get sick.

Senator McCain deserves credit for advancing the most important and sweeping conservative reform idea ever put forward — full conversion to a consumer-driven health-care system. But now it's important to convince the public that we can move in that direction without disrupting arrangements that aren't in need of immediate attention. This can be done — and if it is, it will be President Obama who is cast as the radical pushing for unnecessary and greatly harmful changes.

— Mr. Capretta is a fellow at the Ethics and Public Po
licy Center. He was an associate director at the Office of Management and Budget from 2001 to 2004.

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