Tax Credits and Purchasing Pools: Will This Marriage Work?

Issue Brief No. 36 | April 2001 | By Sally Trude and Paul B. Ginsburg

Federal tax credits gained bipartisan support in Congress as a mechanism for helping low-income families purchase health insurance. One prominent proposal would have provided refundable credits of up to $2,500 annually for uninsured families, potentially extending coverage to roughly one-quarter of the estimated 43 million uninsured Americans. But structuring these credits effectively required addressing a fundamental challenge: ensuring that chronically ill individuals could actually obtain affordable coverage.

The Individual Market Problem

Using tax credits in the individual insurance market posed significant difficulties. Compared with group coverage, the individual market offered fewer insurer choices, gave consumers less bargaining power and carried much higher administrative overhead. In most states, individual policies were fully risk-rated, meaning older and sicker applicants paid substantially more or were denied coverage outright. Pre-existing conditions were frequently excluded. A tax credit alone might not be sufficient for someone with a serious health history to find or afford meaningful coverage.

Reforming the individual market carried its own risks. If regulators constrained insurers' ability to price based on health status, competition would shift toward risk avoidance -- designing benefit packages that appealed to healthier enrollees while discouraging sicker ones from signing up.

Purchasing Pools as a Solution

Linking tax credits to purchasing pools offered a way around these problems. Purchasing pools grouped risks in the same way large employers do, pooling the sickest enrollees with the healthiest so everyone paid the same premium for a given plan. Using community rating within these pools meant chronically ill individuals could obtain and afford coverage. The pools would also standardize benefits to prevent plans from cherry-picking healthy members through benefit design, and handle administrative tasks like enrollment coordination, plan negotiation and premium collection.

Requiring tax credit recipients to purchase through authorized pools was considered important to prevent lower-risk individuals from buying cheaper coverage outside the pool, which would drive up pool premiums through adverse selection.

Lessons from Previous Purchasing Pool Efforts

Voluntary purchasing pools had a mixed track record. Research using the 1997 Robert Wood Johnson Foundation Employer Survey found they had not expanded coverage or reduced premiums. Two statewide cooperatives in California, each covering about 150,000 workers, captured only 4 percent of their potential market. Broker resistance was one factor -- when Florida and California created cooperatives designed to bypass brokers and their commissions, the strategy backfired because brokers played an important role in helping small businesses navigate insurance purchases.

The availability of purchasing pools varied widely across communities. In one-third of HSC's 12 nationally representative study communities -- Greenville, Little Rock, Miami and Northern New Jersey -- market leaders could not identify any existing risk-pooling organization. Start-up funding would likely be necessary to ensure pools were available everywhere.

Outstanding Policy Questions

Linking tax credits to purchasing pools raised numerous design questions that needed resolution: how pools would be selected, what administration fees would be permitted, who would determine individual eligibility, who would handle grievances, how much flexibility pools would have in structuring benefits, and the extent of state and federal oversight. The viability of this approach depended on successfully resolving these issues while maintaining enough health plan participation to offer consumers meaningful choices.

Sources and Further Reading

This analysis was originally published as Issue Brief No. 36 by the Center for Studying Health System Change, drawing on HSC site visits to 12 communities and other research. HSC was funded principally by the Robert Wood Johnson Foundation.