11 Dillman RO. Seagren SL. Propert KJ. et al. A randomized trial of induction chemotherapy plus high-dose radiation versus radiation alone in Stage III non-small-cell lung cancer N Engl J Med 1990.323 940-5

12. Mattson K. Hoist LR. Holsti P. et al Inoperable non-small cell lung cancer. radiation with or without chemotherapy Eur J Cancer Clin Oncol 1988.24. 47-82

SOUNDING BOARD

REFORMING THE HEALTH INSURANCE MARKET FOR SMALL BUSINESSES

FACED with possible extinction, the private health insurance industry has emerged as a vocal advocate of retorming the way it does business. Since January 1990, the Health Insurance Association of America HIAA has proposed extensive regulation of the pricing, marketing, underwriting, and design of policies sold to small-business groups. Similar proposals for retorm have been made by the Blue Cross and Blue Shield Association and by the National Association of Insurance Commissioners (NAIC). It is remarkable to see a reform proposal coming from the industry most likely to oppose it. It is also surprising that, with the rest of the debate over health care reform in gridlock the basic structure of these measures has broad political support and is viewed by many as having a high likelihood of passage, both in individual states and early in the course of federal retorm. President Bush and several congressional leaders from both parties have recently endorsed some or all aspects of the industry's proposed reforms. It is therefore imperative to understand precisely what small-group-market retorm will and will not accomplish toward the twin goals of universal access and cost containment.

THE PURPOSE OF REFORMS IN THE SMALL-GROUP MARKET

Reforming the small-group market is intended to arrest the disintegration of the health insurance market for small businesses, which is currently in a death spiral. In 1990 only 36 percent of firms with fewer than 25 employees offered their workers health insurance, as compared with 87 to 99 percent of larger firms. Stated even more starkly, among firms that do not offer coverage. 98 percent have fewer than 25 emplovees. These dramatic statistics result in part from a market dynamic that has forced insurers to treat small businesses more like purchasers of individual policies than like group purchasers. but without the regulatory protections that apply to the individual

market.

In previous decades. Blue Cross. health-maintenance organizations (HMOs), and even many commercial health insurers tended to charge one rate for all small groups in a given community, usually adjusting only for age and sex. In recent years. however. commercial insurers and many HMOs and Blue Cross

Supported in past Robert Wood Johnson Foundation Health Finance Fel

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plans have been forced to abandon this modified form of open enrollment and community rating for much more selective marketing practices. The root of these destructive market forces lies in the steeply rising cost of health care. Aggressive price shopping by healthier work forces has forced health insurers to gauge more accurately the actual risks of different groups and to screen out high-risk individuals and groups. Rather than repeat the specifics of widely publicized cases, I will describe the general market tendencies. 810

Underwriting (the process of assessing risk) for individual medical conditions becomes more cost effective as the size of the insured group decreases. This follows as a simple application of the statistical law of large numbers. For larger groups. aggregate claims experience is highly predictive of future costs, whereas smaller groups are more likely to have extreme fluctuations from year to vear. The consequence of this statistical logic is that insurers (responding to emplover demands) have adopted several practices that make it difficult or impossible for some small groups. or individuals within small groups, to obtain suthicient insurance. Insurers sometimes exclude high-risk people in small groups entirely or subject them to lengthy exclusion periods (as long as two years for preexisting conditions or to permanent exclusions of their major health conditions. In extreme cases. entire small groups are refused coverage or are quoted extremely high prices, either at the outset of coverage or at renewal. More routinely, employees who have lasted through lengthy preexisting-condition periods are afraid to change jobs, producing a phenomenon known as "job lock" that may affect 30 percent of Americans."

Frequently, large price increases and refusals to serve an entire small group are not based on any actual adverse history of claims. Some insurers engage in "tier rating," which classifies various groups on the basis of the insurer's experience that workers in certain occupations and industries are likely to have higher claims. Even favorably rated groups are subjected to "durational rating," which is the practice of offering a low premium to groups identified as low risks at the outset, but raising the premium steeply at each annual or semiannual renewal period, reflecting the tendency of the predictive power of the initial risk assessment to wear off. Medical underwriting tends to wear off because of the statistical phenomenon known as regression to the mean, according to which outliers (both low and high) tend over time to move closer to the norm. Prices also rise over time simply because the initial period during which preexisting conditions are excluded expires. At the most extreme. insurers may refuse altogether to renew the coverage of groups with initial low ratings, which constitutes the phenomenon known pejoratively as churning.

TAKING THE Reform Proposals at FACE VALUE

Various proposals to correct these destructive prac tices share three essential components - guaranteed availability, price regulation, and private reinsurance

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although they vary considerably in their details. I will use the HIAA's state legislative model as the basis for description, noting important variations. These reforms are aimed at the small-group market, defined as emplovers with 3 to 25 full-time workers. (Other definitions go as high as 50 or 100.) Making 3 the cutoff point is intended to create some demarcation in the regulation of individual as compared with group policies, and setting a cap is intended to prevent the regulatory burden from further increasing the incentive of larger groups to self-insure.

The essence of guaranteed availability is the requirement that insurers cover anyone who applies. No group may be denied at least a basic. minimal-benefits health plan. regardless of health status. This requirement is coupled with a "whole-group concept." which prohibits the exclusion (by either the insurer or the emplovers of any individual within a group. Moreover. insurers would be prohibited from refusing to renew any group's insurance except for fraud, nonpayment, or similar malfeasance.

A second aspect of guaranteed availability is to ensure the continuity and portability of coverage by regulating the use of exclusion clauses. Insurers would be prohibited entirely from excluding specinc health conditions. They would be allowed only to place an initial 12-month preexisting-condition exclusion on coverage for any condition manifested within months before the date of coverage. Other proposals apply a 6- and 3-month limit.: To address the problem of "job lock." subscribers would be able to transter to a new insurer. either by changing jobs or changing insurers within the same workplace, without undergoing a new exclusion period.

Guaranteed availability eliminates the worst effects of medical underwriting retusal of coverage and Churning but standing alone it would aggravate huge price variations and fluctuations by torcing insurers to take on the most extreme risks. Theretore, the second component of the reforms is to establish a modified form of community rating for small groups by imposing various price regulations. These complex restrictions vary greatly in their details. but their basic thrust is to dampen durational rating for individual groups over time and to suppress tier-rating practices across the market as a whole at a mo

ment in time.

Both the HIAA and NAIC models limit year-toyear increases in any given group's premiums to 15 percent above the insurer's trend." denned as the increase in the least expensive new business: others propose ) to 5 percent limits. The concept is to allow market-wide cost increases but limit those that reflect group-specific health risks.

Second, the HIAA model would prevent any insurer from varying its prices more than 35 percent above or below its midpoint for groups with similar benefits and ease characteristics. The NAIC model allows only a 50 percent spread 25 percent hove or below The midpoint and bills sponsored by Senators Chafee R-RI and Bentsen D-Tex

"per

Feb. 20, 1992

cent spreads, respectively.' 12.13 The case characteristics that may be used to set different pricing bands include geographic, demographic (age and sex), and industry factors, but the HIAA model allows only a 15 percent variation (a 30 percent spread) on the basis of industry. For instance, if an insurer's average price is $2,000 for a group whose average age is 40 to 50 years. the HIAA pricing band restricts the variation among similar groups to $1,300 to $2,700, with an additional $600 spread according to industry and occupation. However, because this loose form of community rating is age-adjusted, there is no limit on the extent to which pricing bands for groups of different ages may vary from one another. By contrast, other proposals. such as bills sponsored by Senators Rockefeller (DW.Va.) and Mitchell (D-Me.) and Representatives Rostenkowski (D-III.) and Stark (D-Calif.), move very close to pure community rating.

Proposals that allow separate blocks of business add yet another layer of complexity. Some insurers manage separately products that are marketed through distinct sales forces, acquired from another company or designed according to fundamentally different principles (such as capitation or indemnity). In keeping with this tradition. most proposals (but not the HIAA's) follow the NAIC model by appiving their rating limits separately to a limited number of blocks defined in this manner. In order to prevent circumvention of the rating limits. they also limit the pricing variation between block midpoints to a spread of 20 to 40 percent. Within each block, however, there is no limit on the degree of price variation according to the allowable age, sex, and location factors.

The third. and from the commercial insurers perspective the most fundamental, component of smallgroup reform is a mechanism of private reinsurance that allows individual carriers to reinsure any risks that they expect will generate costs exceeding the prices they may charge. Reinsurance encourages insurers to accept all applicants and thus suppresses the incentive to engage in indirect and surreptitious risk selection.

The reinsurance mechanism for small groups would differ in two fundamental ways from state high-risk pools that cover uninsurable individuals. First, smallgroup reinsurance is invisible to the public. The insurer that issues the policy merely cedes the risk to the reinsurer (except for a deductible and possibly a copayment by the ceding carrier). The reinsurer's only role is to indemnify the ceding carrier for its claims expenses; the ceding carrier remains responsible for the administration of the plan. Second, in order to avoid burdening government budgets. the HIAA proposes small-group reinsurance as a primarily private mechanism; it would be run by a nonprofit entity. funded primarily by the insurance industry, and gov erned by a quasigovernmental board.

The principal funding for the reinsurance entity would come from the reinsurance premium paid by the ceding carrier. Carriers could prospectively reinsure either whole groups or high-risk individuals with