August 23, 2004 - Government reinsurance - a proposal in which the government would pay a portion of the medical costs of the highest spenders and a component of Democrat John Kerry's health care plan -- would spread risk more broadly and lower the cost of health insurance for some people, according to an Urban Institute study published in the journal INQUIRY. Findings show that targeting such a program to the small employer and individual market would be the most cost-effective approach.

The study, "Government as Reinsurer: Potential Impacts on Public and Private Spending," by Linda J. Blumberg and John Holahan, researchers at the Urban Institute's Health Policy Center in Washington, D.C., appears in INQUIRY's summer issue, and is available at http://www.inquiryjournalonline.org/i0046-9580-041-02-0130.pdf.

Addressing the costs of higher-risk people is important because health insurance companies generally determine premiums by averaging the costs of all enrollees in a particular risk pool. This presents risk issues, however, since a small portion of the population incurs a large share of health expenditures, while many individuals spend little or nothing on health care in any given year.

Risk is greater in the small group and individual insurance markets, where a relatively low number of high-spending enrollees can have a major impact on premiums because the enrollee pools are too small to efficiently spread the costs associated with the very sick. Public reinsurance is a strategy aimed at alleviating such burdens by having the government fund, or reinsure, through general revenues or taxes a percentage of the "excess costs" of high-risk people. The plan of Democratic presidential candidate Kerry calls for the government to reimburse health plans for 75% of costs above a catastrophic threshold of $50,000.

Using 1998-2000 data from the Medical Expenditure Panel Survey-Household Component, Blumberg and Holahan assessed the impact of an array of government reinsurance options. They found that if the government were to reimburse insurers for 75% of costs exceeding a $50,000 threshold -- as Kerry is suggesting -- out-of-pocket and private health insurance spending for the population covered by employer-sponsored insurance (ESI) would fall by 5.9%; cost to the government would be $26.2 billion. The same policy implemented in the group market covering establishments with fewer than 100 workers would reduce private expenditures by 4.5% in that market and cost the government $5.2 billion.

While lowering the threshold produces more savings, it raises costs for the government considerably. For example, if the government paid 75% of ESI costs above a $15,000 threshold, the reinsurance price tag would jump to $71.5 billion. However, limiting the provision to the market covering businesses with fewer than 25 or 100 workers would lower the government's cost substantially to $12.6 billion and $16.6 billion, respectively.

"The results do show that it is possible to design a targeted reinsurance policy that could have many desirable effects," the authors say. "Insurance in the small group market and the nongroup market is expensive. Providing reinsurance in these smaller markets could significantly lower private costs and, in turn, premiums without dramatically increasing government expenditures."

Their results suggest that if a public reinsurance policy paid 75% of excess costs for the top 3% of spenders (comparable to the $15,000 threshold) in the individual and small employer (fewer than 100 employees) markets, the government's cost would be about $23 billion a year. Under such a program, private expenditures would drop by 16% in the small group market and 22% in the individual market.

Despite modest effects at some thresholds, reinsurance likely would lower premium costs more than the reduction in private expenditures because insurers would see less variance in their spending, the researchers predict. With government spreading the risk of high-cost cases among all people in the country, low-risk individuals might be more inclined to purchase insurance and some high-risk individuals better able to afford it.

"Subsidizing high-cost cases through reinsurance is meant to provide more stable private health insurance markets, thus making those markets more attractive and accessible to individuals of all risk classes," the authors note. "Such reforms, however, will have to be coupled with expansions of public programs and/or direct subsidization of the purchase of private coverage for low-income populations in order to comprehensively address the problem of the uninsured in the United States."

INQUIRY is a peer-reviewed scholarly publication. Now in its 42nd year, it is published quarterly by Excellus Health Plan, Inc. Press releases and article abstracts are available at www.inquiryjournal.org.