State Regulation: What Have We Learned So Far?

Of all the different health insurance venues in the United States, small group and individual markets consistently engender the most complaints. Compared to large group purchasers, small groups and individuals suffer more from administrative diseconomies of scale, difficulties in spreading risk among themselves, and the absence of bargaining power with insurers and providers alike. These conditions lead to higher and more volatile premiums for the same or less generous benefits than large group purchasers usually obtain. Volatility and the apparently inexorable upward trend of health premium costs have led to considerable interest in reform of these markets, of which the recent national debate over comprehensive reform, in retrospect, was but a brief interlude in a history of federalism that spans half of the twentieth century (Nichols and Blumberg 1998).

Because of its relative size and organized interests, most of the attention of health insurance market reformers and critics has been focused on the small group market, rather than on individual markets. Over forty-five states have passed small group reform laws since 1989, though only twenty-five states had implemented individual market reforms prior to the Health Insurance Portability and Accountability Act of 1996. This federal law compelled all states to either pass certain conforming acts or to suffer direct federal regulation of their insurance markets for the first time. Recently, empirical and case studies of the effects of small group reforms have begun to appear (Jensen and Morrisey 1996; Sloan and Conover 1998; Marsteller et al. 1998; Hall 1998). This article, along with the other essays in this issue, attempts to redress this relative imbalance by focusing exclusively on the individual market.

Individual Health Insurance Market Performance

What Are the Issues?

This section will briefly describe an economic framework for evaluating individual health insurance markets and for interpreting the case study findings discussed in this issue. I organize this background discussion around three questions: (1) How should "good" market performance be defined? (2) What are the preconditions for good market performance, so defined? (3) How might various insurance market regulations affect the likelihood of good performance?

How Should Good Market Performance Be Defined?

This is the key question, since the answer determines the context for all other discussions of individual insurance. While the overarching goals may seem obvious--more coverage, lower prices--there are (at least) two broadly different views of "good" individual health insurance market performance. Nearly seven years ago in this journal Deborah Stone (1993) described the two views as actuarial fairness and social solidarity. I will use economic theory to highlight certain features of these competing visions and to distinguish between them. Theory can also help clarify the evolution of individual health insurance markets as well as predict how these markets will react to certain kinds of regulations.

Stone argued that actuarial fairness--charging each person the expected average cost of the risk class to which they are assigned by insurers--is a method of organizing mutual aid to satisfy a community's insurance needs that ultimately leads to the destruction of mutual aid. This is because those who are expected to need more medical care will have to pay more if their predictable risk remains higher than average; there is no guarantee that their ability to pay will be commensurate with this higher risk. Thus actuarial fairness will, according to Stone, eventually result in private insurance coverage only for the relatively healthy and the rich.

The concept of economic efficiency subsumes Stone's definition of actuarial fairness and elucidates a worldview that favors segmentation of health insurance markets. Economic efficiency is concerned with society's overall resource allocation and is technically achieved when price equals marginal cost for all commodities. This is possible in competitive health insurance markets only when insurers are free to assign individuals to risk classes as they see fit and to charge applicants different prices based on...