How rich health care mandates could bust the budget

May 4, 2011, 1:00 PM UTC

By Shawn Tully, editor-at-large

FORTUNE — The Patient Protection and Affordable Care Act aims for a delicate balance that even its champions acknowledge as highly challenging: Making medical services affordable for tens of millions of uninsured Americans, and yet restraining the expenditures needed to vastly expand coverage so that it shrinks, rather than swells, the looming deficits.

Kathleen Sebelius, HHS Secretary

To grasp why the reform bill (PPACA) risks missing both goals — and why the measure’s margin for error is so perilously narrow — it’s crucial to follow the debate over its central provision, what it calls the “Essential Health Benefits” package. That debate is now playing out in a series of wonkish conferences sponsored by the Department of Health and Human Services that the press, pundits and even politicians are mainly overlooking.

But those seemingly routine hearings merit close attention, because they demonstrate that health care reform is still an unpredictable work in progress. Its true costs, and the number of people it insures, depend on decisions still to be made — and none is more important than deciding what goes into the Essential Health Benefits packages.

The PPAC requires that small companies and plans for individuals, the main focus of the Act, provide a uniform set of benefits, called Essential Health Benefits, to all customers after January 1st, 2014. But the bill gives only an extremely broad outline of what’s in that package. It establishes ten major areas of coverage, including prescription drugs, preventive care, and maternity and newborn services.

The medical industry is currently lobbying en force to get expensive treatments not required in the original bill covered under the packages that HHS is empowered to establish. At an HHS-sponsored hearing in January, no fewer than eighteen medical specialty groups contended that the “essential benefits” should encompass dental care, chiropractic services, unlimited kidney dialysis, treatments for autistic children, and unrestricted visits to psychologists for substance abuse sufferers.

If HHS gets the requirement wrong by stuffing those plans with such expensive mandates, it will bust future federal budgets and give small business owners a powerful incentive to cancel coverage. It will also push young people to go uninsured when they’re healthy, then buy policies when they’re sick — the reverse of the Obama administration’s goal of getting as many workers as possible paying into a giant insurance pool.

“HHS cannot both make the plans extremely generous, and also make them affordable so that they cover millions more Americans. Those goals contradict one another,” says Jonathan Gruber, an MIT economist who helped design health care reform in Massachusetts, and a strong supporter of the original Obama bill.

Why are these beams and trusses of health care reform being chosen only now, more than a year after President Obama signed the bill into law? The measure left the categories general, and declined to specify treatments within them, because legislators from both parties recalled the disastrous results when Hillary Clinton proposed a rich, comprehensive package in her 1993 reform proposal. The big projected costs of those mandates helped sink the bill. The broad design could still prove a good idea, if insurers could fill in the details themselves by offering a wide variety of plans ranging from ones that cover virtually every ailment to leaner, less costly options that leave out, say, smoking cessation or obesity treatments.

Crowd-sourcing gone wrong

Unfortunately, the PPAC didn’t require that the categories remain general, and that specific offerings be left to the marketplace. Instead, the legislation took a middle position. It gave full authority to a single official, the Secretary of HHS, to determine the composition of the essential packages, including how specifically to define what the packages must include. Indeed, that opening is a magnet for the medical lobbyists, and makes the bill’s eventual cost extremely uncertain.

The current Secretary of HHS, Kathleen Sebelius, is solely responsible for establishing the essential packages. Although Sebelius is fully in charge, she’s soliciting plenty of advice. She’s asked for counsel from The Institute of Medicine, a prestigious arm of the National Academies of Science. The IOM will submit its report this summer, and Sibelius should deliver the fully formed regulations for the Essential Health Benefits packages by fall. The package will take effect on January 1st, 2014, when PPACA is scheduled to be fully implemented.

The IOM established an 18-member board for this task, composed of prominent physicians, private insurance officials, and representatives from consumer groups. The panel isn’t charged with deciding what ailments and therapies are specifically included in the package, but it’s expected to make recommendations on the general architecture of the plan.

For example, the IOM is likely to recommend that HHS designate only general categories, or do the opposite and create a detailed list of treatments. It will also advise HHS whether to project the costs on different treatments before imposing them – for instance, adding a new therapy to the list only if it replaces another, less important treatment, keeping total premiums at the same, affordable level.

The first hearing came in January at Washington DC’s immense Keck Center, followed by a second session at a hotel in Orange County, California, in March. At the January event, a parade of advocates pushed for two major expansions of the broad packages outlined in the law: First, the medical groups want lots of things included that aren’t even in those ten categories. Second, most private plans hold down costs by restricting how many doctor visits, tests or injections a patient may receive each month or year. By and large, the medical groups recommend scrapping the caps and allowing patients unlimited access to their services.

Chiropractors, plastic surgeons, and nutritionists

On January 13th, the National Kidney Foundation argued for unlimited dialysis treatments. The American Chiropractic Association declared that mandating access to its practitioners would lower medical costs. The Children’s Dental Health Project championed full dental benefits, a category absent from the ten covered areas, as is chiropractic services — the dentists are also arguing that good tooth care prevents heart attacks. The American Society for Plastic Surgery requested coverage for cleft palate and ear deformations. The American Congress of Rehabilitation Medicine asked for “no preconceived limitations on benefits.” Other groups asked HHS to cover benefits for autistic children, obesity treatments, and nutritional guidance.

All of these groups make a plausible case that their therapies would improve Americans’ health. But the more of them that pack the plan, the more expensive and potentially unaffordable it becomes. That presents a potentially big problem for both of the markets the bill is designed to address: small businesses and individuals who buy policies on their own. For employers, the law effectively requires all companies with fewer than 100 employees to offer the standard package if they provide insurance. Those benefits must be equal to those of a “typical employer health plan.” The HHS asked the Department of Labor to survey those employer plans to determine what’s typical — and it didn’t ask DOL to distinguish between the usually comprehensive care offered by large companies, and the frequently leaner plans provided by small employers.

The danger is that HHS will force employers to offer packages far richer than the ones they provide today. “If that happens, the economic logic could lead employers to drop coverage. Their employees would then buy subsidized policies in the exchanges,” says Dr. Robert Graboyes, an economist with the National Federation of Independent Business.

That’s a possibility, since those exchanges represent a major change in the marketplace: They provide the option of obtaining full, affordable coverage outside the workplace, for the first time ever. For example, a family of three earning around $40,000 a year could get the full package, which might cost a total of $10,000 a year, for just $192 a month.

The legislation aims to discourage dumping by imposing a tax on companies that don’t offer insurance. The penalties, however, are low. For an employer with 100 workers, it comes to just $1400 a year per head. If the plans are too expensive, employers would be sorely tempted to hand their folks a raise, cancel coverage, and guide them to the exchanges. “It probably wouldn’t be attractive to a law firm, but it might be irresistible to a startup with low margins that can’t afford expensive policies, or a company with lots of low-paid employees,” says Graboyes.

Low stakes for the uninsured

A rich essential package could also defeat the reform plan’s objectives for individuals, a market where some 40 million Americans lack insurance. The broad areas outlined in the law already include three mandates excluded from most individual plans — prescription drugs, mental health and substance abuse, and comprehensive maternity and newborn care. “In the individual market, these services are usually available via a rider option at additional cost and not part of the basic benefit package,” says Carmella Bocchino, EVP of America’s Health Insurance Plans. Adding even more requirements would further lift the cost for the very folks the administration wants to bring under its health care umbrella.

Under the PPACA, a single person earning $44,000 or more a year would exceed the threshold for a government subsidy, and would need to pay the full cost of his insurance. If he or she is young and healthy, and getting covered for substance abuse, mental health and lots of other benefits they don’t need is simply too expensive, the youths might well shun coverage completely. If a policy costing less than 8% of income isn’t available, no penalty is imposed. Even if a plan at under 8% is offered, the penalties uninsured are low, starting at just $125 a year.

A costly package would also radically rewrite the administration’s budget projections. It’s crucial to understand that the PPACA caps what Americans at different salary levels must pay for coverage at a fixed dollar amount annually. A family of four making around $67,000, for example, pays $6365 a year, whether the premium is $12,000 or $20,000. The entire difference between an extremely rich, generous plan and a lean one, just what HHS must determine, is paid by the federal government in the form of higher taxes or bigger deficits. In effect, the government is taking all the risk if the plans explode the forecasts.

According Gruber of MIT, a 10% increase in the cost of the Essential Health Benefits Package — as evaluated by the Congressional Budget Office from the original bill — would increase federal spending by $67 billion through 2019 and reduce the number of Americans with insurance by 1.5 million. A 20% increase would wipe out the $132 billion deficit reduction the administration, and the CBO, now forecast.

It’s hard to predict whether Sebelius will lean to the side of affordability and budgetary rigor, or endorse the sumptuous plans the providers want. One fascinating twist is that the states already require some 2000 mandates, from hair transplants to fertility treatments. The PPACA stipulates that if the mandate isn’t included in the new federal law, the state must pay for the extra benefit. So the providers know that if they can’t get their pet benefits into the national bill, the states may drop them rather than shoulder the extra expenses.

That threat is putting intense heat on medical groups to enshrine their therapies in the essential package. If they succeed, they’ll be even better off. They’ll accomplish at the federal level what’s impossible to do on a state-by-state basis — to get their counseling, injections and procedures covered from coast-to-coast.

That’s why this debate isn’t an exercise for wonks, but the contest that will chart the future of health care in America.

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