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Will U.S. learn state’s health lesson?

The difference between a government program that works and one that fails spectacularly can be razor thin. A few words here, a loophole there, and you can turn a boon for the consumer into a windfall for big business.

That lesson should be fixed in the frontal lobes of everyone in Congress working on the healthcare reform bill, and especially on a piece of the reform puzzle known as the insurance exchange -- a key element of the reform plan backed by congressional Democrats and President Obama.

Here in California we know all about the pitfalls of an exchange that doesn’t work, because we established a statewide version in 1992 and attended its funeral in 2006. The state exchange, known originally as the Health Insurance Plan of California and later as PacAdvantage, was designed to give California’s small businesses the collective clout to negotiate with health insurers for lower premiums and consumer-friendly standards. The hope was that customers in these markets would end up with the same range of choices as employees of big companies, which have that kind of bargaining power.

Even though it failed, in death it left a legacy of do’s and don’ts for federal lawmakers to consider.

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“If it’s done right, there’s unbelievable value to an exchange,” says John Grgurina, who was the last president of PacAdvantage and now heads San Francisco’s city-run health plan.

Indeed, if done right, in some parts of the country an exchange may even fulfill some of the goals of the much-maligned public option in healthcare reform -- providing an affordable option to millions of Americans orphaned by the current system. In regions dominated by a small number of big insurers, a public option may still be needed to break their quasi-monopoly.

As written into the benchmark bill in the House of Representatives (H.R. 3200), the federally supervised exchange would be the sole marketplace where individuals and employees of small businesses could buy health insurance. By mandating insurer participation, the exchange would provide customers the choice they don’t get in the market today. By requiring all plans to offer identical base policies it would enable buyers to compare them by price and quality. That’s an improvement over today’s market, in which insurers try to confuse buyers with a dizzying variety of benefits, co-pays, deductibles and premiums.

In his healthcare speech Wednesday, Obama endorsed the principle, comparing it to the way government employees, including members of Congress, get to choose their coverage.

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California’s exchange, a purchasing pool that was part of a reform package for small-business groups enacted in 1992, had similar goals but several differences. The reform required insurers in the small-group market to sell policies to business buyers with as few as two employees and barred exclusions for pre-existing conditions. But it didn’t require all businesses to buy insurance or all insurers to participate in the market, its premium limitations were weak, and it didn’t subsidize small employers or low-income workers.

Nevertheless, the exchange looked like a success at first. When it opened, 24 insurers were participating, lured by the opportunity to access a big market.

But the exchange’s fatal flaw was that it was voluntary. Insurers could offer competing policies outside the exchange. Employers weren’t required to offer insurance and didn’t have to use the exchange if they did.

The promise of a big mass of potential customers therefore faded fast. At its peak, the exchange enrolled 150,000 members, but that represented only about 2% of the state’s small-group market, says Elliott K. Wicks, a Washington health economist who wrote about the exchange for the California HealthCare Foundation.

Insurance brokers began using the exchange as a dumping ground for the riskiest groups -- that is, the smallest employers -- a process known as “adverse selection.” Left without bargaining power against insurers, the exchange had to charge higher premiums than the outside marketplace.

As enrollment shrank, insurers bailed out, the risk profile of the members rose and premiums climbed, a vicious cycle. In 1996, the exchange was taken over by the Pacific Business Group on Health, a business co-op which closed it 10 years later. By then it was down to 110,000 members and three insurers (Kaiser, HealthNet and Blue Shield).

“The chicken-and-egg problem was that in order to be successful at lowering premiums you have to be big,” Wicks told me, “and you can’t get big without being successful.”

The only solution to that problem is to give the exchange a captive market, either by requiring all sales to the target market to go through the exchange or by requiring all policies, whether offered through or outside the exchange, to offer the same minimum benefits. If insurers can choose whether to participate or on what terms, says John Ramey, who helped draft the 1992 California law, inevitably they’ll try to keep the lowest-risk customers in their nonexchange policies, and stick the exchange’s pool with the riskier applicants.

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“That becomes a no-win situation for everybody,” says Ramey, who is now executive director of Local Health Plans of California, an organization of public managed care plans.

The drafters of H.R. 3200 plainly took such lessons to heart. The bill requires every individual to have insurance, with a subsidy provided for low-income buyers. It requires that all individual and small-group policies offered from 2013 on meet minimum policy standards set via the exchange.

Insurers won’t be permitted to deny coverage to anyone in the target market or drop them except for nonpayment of premiums. Minimum benefits must include preventive care, mental health services, and maternity and well-baby coverage.

Insurers will want to be in the exchange, because the individual mandate will create a huge market they can’t serve any other way. Individuals and employees, therefore, should have a large number of policies to choose from, all easily comparable because they’ll all offer the same benefits.

But we’re still at the starting line. A lot of mischief can be committed on a bill’s path to enactment. The threat to a functioning exchange will come from vested interests trying to water down the mandates. Insurance companies will want the right to offer catastrophe-only coverage, which is a big moneymaker, or to specialize in the yacht-owning executive market. Lobbyists for health savings accounts, who are carrying water for financial services companies lusting after the fees these accounts generate, will insist on an HSA loophole. And politicians in some states will want to export their bare-bones coverage standards nationwide so they can lure health insurers into headquartering there, the way one-horse states without usury limits, such as South Dakota, made themselves the credit card-issuing capitals of America.

Any loophole will set the stage for others, until the exchange becomes a useless, tattered dream. “If there’s a gap or a loophole, the market will exploit it,” Grgurina says.

There lies the ultimate lesson of the California experience: In creating an exchange, it’s all or nothing. And at this point, who wants to walk away with nothing? Repeat after me: No loopholes!

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Michael Hiltzik’s column appears Mondays and Thursdays. Reach him at michael.hiltzik@latimes.com, read him at www.latimes.com/hiltzik, and follow @latimeshiltzik on Twitter.


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