Ezra Klein wrote that he is fairly pessimistic on the effectiveness of the new health insurance exchanges. He should be–but not for the reasons he outlined. (As I have noted, health insurance marketplaces do a poor job reducing cost and need very strong risk adjustment mechanism.) Klein states:

In the House health-care reform plan, the exchanges are expected to serve 21 million people in 2019. Almost all of those people come from the uninsured population or don’t make enough money to afford the coverage their employer offers. That is to say, almost all of those people will be eligible for premium subsidies. The numbers in the Senate finance bill are very similar.

First of all, the CBO predicted that the House bill will have 30 million people using the exchange in 2019: 21 million getting individual coverage, and 9 million who have employer-provided exchange coverage. Basically, the employer gives the employee a voucher to buy whatever plan they want on the exchange. Secondly, the estimates by the CBO on the number of people who will use the exchange is very conservative. By 2016, every employer with 100 or fewer employees would be able to get coverage on the exchange. According to the Census Bureau, roughly 42 million individuals (not counting dependents) work for companies with 99 or fewer employees. That is a huge number of people who could potentially get coverage on the exchange through their employer. Also, in 2016, the Secretary of HHS technically has the power open access to the exchange for all employers, regardless how large, in theory expanding access to the exchange to everyone.

The second problem with Klein’s analysis is that he misinterpreted how affordability tax credits would be calculated and given out:

Imagine that my family makes $45,000 a year. That puts us at about 250 percent of the poverty line. In the Senate finance bill, our premium contribution is capped at $4,349. Surveying our options, I see a plan from Aetna that costs $10,000, a plan from Kaiser that costs $9,000 and a plan from Cigna that costs $11,000. All seem pretty similar, but then, I’m not an expert in these things. Which do I choose?

You might say I should choose the Kaiser plan. But why? It’s cheaper, but it’s not cheaper to me. After all, my contribution is capped at $4,349. Moreover, it’s generally true that things that cost more are better. It stands to reason that Cigna is giving me something for the extra $2,000. Indeed, I’m being subsidized to the tune of $7,000, as opposed to $5,000. It’s clearly a better deal.

The Senate Finance committee bill does not cap premium contributions at a flat percent of your income regardless of which plan you select. Affordability tax credits are based on just one single plan on the exchange:

The share of premium enrollees pay would be held constant over time. The premium credit amount would be tied to the second lowest-cost silver plan in the area where the individual resides.

How this would work in Klein’s scenario (assume all three plans are at the silver level) is that the family would get a flat $5,651 tax credit to help purchase any plan they wanted. That is determined by taking the second least expensive plan (Aetna at $10,000) and subtracting the sliding scale premium cap based on income ($4,349). If they family selected Aetna they would only pay $4,349 (10,000 – 5,651 = 4,349). If they selected Kaiser they would pay only $3,349 in premiums (9,000 – 5,651 = 3,349). On the same note choosing Cigna would cost them personally $5,349 in premiums. People would have a strong incentive to choose a lower cost plan.
This set up does produce a very different problem. Since the government will cover all the cost for the second lowest cost plan over a set level of income, there is a strong incentive for insurance companies not to compete to lower prices. Most markets have very few insurance companies, making it easy to collude to keep prices high and relatively equal. After all, if in the above scenario all three companies cut their insurance premiums by $1,000 next year, the three plans would cost the family the exact same amount because of how the tax credits are structured. Until there is a large number of people on the exchange not getting tax credits, the insurance companies are better off keeping prices high, as long as their few competitors do as well.

There is plenty of reason to be pessimistic about the exchange. The CBO and CMS both concluded it would lack sufficient risk adjustment mechanisms. Most importantly, health insurance marketplaces like exchanges just don’t have a history of holding down costs. But the concern about the size of the exchange and the incentive inherit for individuals purchasing insruance with tax credits is unfounded.