HEATHCARE SPECIAL: SCHIP Enriches the Insurance Industry

 George Bush justified his October 3 veto of a bill to reauthorize and expand the State Children’s Health Insurance Program (SCHIP) with the argument that the bill would cause parents of several million middle-income kids to drop private health insurance coverage for those kids. SCHIP, which was established in 1997, “sits on the shoulders” of Medicaid, the nation’s health insurance program for some of the poor. Under SCHIP, the federal government gives money to the states to insure children who are too well off to qualify for their state’s Medicaid program, but who are not well off enough to afford private health insurance. Nearly all states have set their upper-income limit for SCHIP at two to three times the poverty level—or between $41,000 and $62,000 for a family of four. Only New Jersey, which has an income limit of 350 percent of poverty, permits SCHIP money to subsidize kids above three times the poverty level. 

Politicians and pundits on the left and right focused their debate on whether Bush’s allegations that SCHIP would “crowd out” private coverage were true. For several months prior to Bush’s veto of the Children’s Health Insurance Program Reauthorization Act (CHIPRA) of 2007, as the SCHIP reauthorization bill is formally known, Americans were treated to a discussion of whether CHIPRA would really let families making as much as four times the federal poverty level (about $83,000 for a family of four) participate in SCHIP and whether the number of kids who would drop their private-sector coverage to enroll in SCHIP would be half a million or 3 million or something in between. 

For the record: CHIPRA would not set upper income limits, but it would make it difficult for states to use SCHIP funds for kids above three times the poverty level; and some “crowding out” would occur (the Congressional Budget Office estimated that two million of the six million kids who would be added to SCHIP rolls by CHIPRA would otherwise have purchased private coverage). 

This debate about “crowding out” and income ceilings totally ignored the endorsement of CHIPRA by America’s Health Insurance Plans (AHIP), the cloying name of the trade group that represents America’s health insurance industry. AHIP did not conceal its endorsement of SCHIP. For example, Karen Ignagni, AHIP’s president and CEO, urged Americans to lobby for the bill during her September 27 appearance on the “Oprah Winfrey Show” with Michael Moore. If AHIP was all for CHIPRA, how could Bush, his Republican allies in Congress, and all the Republican presidential candidates claim CHIPRA was guilty of “crowd out” and that the alleged damage to the health insurance industry would hasten the arrival of “socialized medicine?” Why would AHIP endorse CHIPRA if it would rob AHIP members of income? 

There are two answers. First, AHIP members would not lose money. They would probably have gained money because most states have privatized the insurance function of their SCHIP programs (not the actual delivery of health care, which always has been delivered by privately owned clinics and hospitals). To express this another way, most states have decided to hand over their federal SCHIP money (and matching state funds) to insurance companies rather than bypass insurers and purchase medical services directly from the doctors and hospitals that treat SCHIP kids. 

According to the Kaiser Family Foundation, “About three out of four children enrolled in Medicaid and SCHIP are enrolled in private managed care plans.” According to a paper in the August 2007 edition of Health Affairs Web Exclusives by George Washington University professor Sara Rosenbaum, “virtually all state Medicaid programs and 27 SCHIP programs enrolled most or all [eligible] children” with insurance companies by 2002. 

These figures suggest that somewhere between half to three-fourths of the six million kids who would be added to SCHIP rolls by CHIPRA, or 3 to 4.5 million kids would wind up being insured by insurance companies. If the Congressional Budget Office is correct in its estimate that CHIPRA would cause two million of those six million kids to drop private coverage, that means the effect of CHIPRA would be a net gain of one to two and a half million new customers for the insurance industry. In short, the “crowd out” effect of CHIPRA (a loss of 2 million kids) would have been more than offset by the addition of 3 to 4.5 million kids through privatized SCHIP programs. 

A second reason why AHIP endorsed CHIPRA is that AHIP has come to realize the health insurance industry will starve if state and federal governments cannot be persuaded to funnel more tax dollars to the industry. With the average cost of insuring an employee with dependents now over $12,000 a year, employers are fleeing the health insurance market in droves. AHIP has decided that it is better off suffering a little “crowd out” now in exchange for the assurance that the taxpayer will pay for coverage of six million more kids, all of whom are at risk of disappearing as private-pay customers over the next five years (the period over which CHIPRA would extend SCHIP). 

The media’s failure to report that the bulk of SCHIP funds would be handed over to the health insurance industry was very helpful to Bush and all those who screamed “crowd out” and “socialized medicine.” Conversely, the blackout of this fact was not helpful to the Democrats who promoted CHIPRA or to the handful of surprisingly vocal pro- CHIPRA Republicans like Senators Charles Grassley of Iowa, Orin Hatch of Utah, and California Governor Arnold Schwarzenegger. 

The most important reason for the blackout is the Democrats’ longstanding complicity in the privatization of Medicaid and, more recently, of SCHIP. If one party does not raise a fuss about an issue, the media tends to ignore that issue. Because Medicaid and SCHIP are federal programs administered by the states under federal law and regulations, the privatization of these programs required support within the White House, Congress, and all the states where privatization of these programs has occurred. Democrats at both the federal and state level have been as enthusiastic about the privatization of Medicaid and SCHIP as Republicans. 


Medicaid was gradually privatized beginning in the early 1980s while SCHIP was privatized relatively quickly in many states after its enactment in 1997. The privatization of Medicaid began in earnest under Ronald Reagan. Within weeks of taking office, Reagan’s Health Care Financing Administration (HCFA, the name at the time of the agency in charge of Medicaid and Medicare) announced in the Federal Register that it would entertain proposals from the states for privatization “demonstrations” that experimented with “health maintenance organizations” and other types of insurance companies that utilized managed-care cost control tactics. (Those tactics boil down to financial incentives to get doctors to deny services, second-guessing of doctors’ decisions by insurance company bureaucrats, and limited choice of doctors and hospitals.) By the mid-1980s, Reagan’s HCFA had granted permission to six states to begin privatization experiments with their Medicaid programs. A Democrat-controlled Congress stood by and did nothing to prevent these first steps to the widespread privatization of Medicaid and SCHIP. 

Democratic legislators and governors played critical roles in getting their states to permit privatization demonstrations. In Minnesota, for example, a legislature controlled by Democrats passed legislation endorsing Republican Governor Al Quie’s 1981 application to HCFA that proposed privatizing Minnesota’s Medicaid program beginning in three counties. Although Quie’s application promised to evaluate the privatization experiment rigorously, that never happened. When, in 1993, the Minnesota Medicaid agency finally got around to attempting to evaluate the behavior of the HMOs participating in the experiment, the HMOs refused to deliver the data the agency needed and, for good measure, sought to suppress an incomplete draft of the study, which showed the HMOs were delivering fewer preventive services than had been delivered by the “unmanaged” doctors under the old system. When this skullduggery was unearthed by the Minneapolis Star Tribune and exposed in a front-page story in 1994, the legislature, still controlled by Democrats, held no hearings. 

Minnesota Democrats went on to expand the Medicaid privatization “demonstration” statewide during the late 1990s. They also led the 1996 campaign to privatize a program for adults and children called MinnesotaCare, which had been created in 1992 for families too well off to qualify for Medicaid. A few years later they wholeheartedly agreed to funnel Minnesota’s SCHIP money into MinnesotaCare. 

The disastrous overnight privatization of Tennessee’s entire Medicaid program in 1994 is another example of Democratic complicity in the privatization scam. Even though Tennessee had almost no experience with managed care plans, liberal universal coverage advocates hailed them as the solution to the state’s rising Medicaid costs and Democratic Governor Ned McWherter shoved a privatization bill through the legislature. Then, when HCFA was slow to grant Tennessee permission to engage in what proved to be a doomed experiment, McWherter visited his good friend President Bill Clinton, who, as a former governor, sympathized with McWherter’s impatience with HCFA and put pressure on them to grant McWherter the permission he sought. Shortly thereafter HCFA granted McWherter permission to force all Medicaid-eligible Tennessee residents into a dozen managed care plans. 

The bipartisan support for the claim that the privatization of Medicaid and SCHIP would save money can only be explained as ideological. It was never based on scientific evidence. As late as 1993, which is to say, nearly a decade after Reagan unleashed the Medicaid privatization juggernaut, the U.S. General Accounting Office reported it could find no conclusive scientific evidence that managed care saved money. “The Physician Payment Review Commission [a commission that advised Congress on health policy] and the Congressional Budget Office have reported that the evidence on the effectiveness of managed care to control costs is inadequate and inconclusive,” said the GAO report. “Other analysts have concluded that…‘some very basic questions about managed care remain unanswered. We do not even know if managed care saves money.’” 

Bipartisan support for the myth that managed care would improve quality of care was not based on evidence either. A 1995 review of the scientific literature on the impact of managed care plans on Medicaid, commissioned by the Kaiser Family Foundation, stated: “There is little evidence…to suggest that managed care either increases or decreases the number of physician visits, or the use of preventive health services, or the use of inpatient hospital care” 

Today the jury is in. The evidence indicates managed care plans did not improve care or save money, either for employers or for Medicare, Medicaid, and other government programs that have experimented with privatization. In fact, the evidence indicates managed care has damaged quality and, for government programs, raised costs. 

One of the rare studies done to evaluate the claims made by Medicaid privatizers was conducted in California by Mark Duggan, an economics professor at the University of Maryland. Unlike many states, California’s Medicaid privatization “demonstration” had not yet gone statewide by the turn of the century. Medi-Cal, as California’s Medicaid program is called, was privatized in some counties, but remained unprivatized in others. In a paper published in 2002 entitled, “Does contracting out increase the efficiency of government programs? Evidence from Medicaid HMOs,” Duggan reported that Medi-Cal costs in the privatized counties were 20 percent higher than costs in the unprivatized counties where the old-fashioned Medi-Cal program continued to exist; that is, where the California Medicaid agency paid doctors and hospitals directly for services rendered to Medicaid beneficiaries rather than funnel tax dollars through managed care plans. “The results presented in this paper demonstrate that the increased reliance on HMOs led to a substantial increase in government spending and suggest that health outcomes for the poor did not improve significantly,” Duggan concluded. “It therefore appears that requiring millions of California’s Medicaid recipients to switch out of the [traditional Medicaid system] and enroll in HMOs did not lead to an improvement in the efficiency of this government program.” 

Duggan’s finding of 20 percent higher costs in privatized counties is consistent with evidence indicating that the typical health insurance company allocates 20 percent of its revenues to administrative (or overhead) costs. Under the unprivatized Medicaid program, a state Medicaid agency would allocate about 5 cents of every tax dollar it received to its own overhead costs and pay out 95 cents to doctors and hospitals and other providers of medical services to Medicaid enrollees. 

After privatization, however, the Medicaid agency hands that 95 cents not to providers, but to a managed care plan, which in turn scrapes another 20 cents off of that and hands the remaining 75 cents to providers. This simple arithmetic raises an obvious question: How does privatization save money if it requires allocating another 20 percent to administrative costs? 

The answer is it doesn’t. The states that have privatized their Medicaid programs have, over the years, raised their expenditures 15 to 20 percent above what they would have been under the traditional direct-purchasing Medicaid model. They did that in order to get their local managed care plans to agree to participate in the privatized version. Of course, that was not what was supposed to happen. Privatization was supposed to lead to improved health in Medicaid recipients and the elimination of unnecessary services. These changes were, in turn, supposed to lead to lower costs. But the privatizers got away with it because support for privatization was bipartisan and faith-based, not evidence-based. 

By the late 1990s when the states had to decide how to spend their SCHIP money, privatization mythology was well established and billions of SCHIP dollars were dumped into the giant river of Medicaid money already flowing down the cavernous maw of the health insurance industry. 

Thus, it came to pass that in 2007 a U.S. president and his Republican allies could oppose a largely privatized CHIPRA —one that would deliver more tax-financed customers to the insurance industry than it would lose due to “crowd out” —on the ludicrous premise that CHIPRA would lead to “government-run health care” and “socialized medicine.” On October 3, the day he vetoed CHIPRA, Bush said with a straight face, “I believe in private medicine, not the federal government running the health-care system.” Rep. Todd Akin (R-MO) was even sillier; he announced he voted against the bill because it would lead to “Hillary socialized medicine.” 

Single-payer advocates can make a strong argument for the opposite position—that CHIPRA should be opposed because it is so beneficial to the insurance industry. A national single-payer system has many powerful opponents, but no opponent is more powerful and more committed to defeating single-payer than the U.S. health insurance industry. Single-payer advocates must take the long view. To get a single-payer system, we will have to defeat the insurance industry. It will help our cause if we support legislation that weakens the insurance industry. It will hurt our cause if we support legislation that strengthens the insurance industry (or delays the industry’s demise). CHIPRA strengthens the insurance industry. 


In his debate with AHIP’s Karen Ignagni on “Oprah” last September, Michael Moore made a statement to Ignagni that most Americans would agree with. “I don’t want, frankly, any of my tax dollars going to any subsidized program that goes through your private insurance companies when my tax dollars increase your profits,” he said. This declaration drew vigorous applause from the audience. But odds are extremely high that not a soul in that room, including Moore, knew that CHIPRA would bring about precisely the result Moore said he opposed. 

There are reasons to be guardedly optimistic that Democrats (and maybe even a few Republicans) will some day take an interest in this scam. For one thing, Democrats have taken a strong stand against privatization scams involving Halliburton and Custer Battles in Iraq. For another, Democrats are finally taking interest in a problem very similar to the Medicaid privatization problem—the overpayment of HMOs to induce them to participate in Medicare, the nation’s program for the elderly and disabled. Like the Medicaid privatization scam, the Medicare privatization scam has been perpetuated for decades with bipartisan support. But in early 2007, a few leading congressional Democrats, including Rep. Pete Stark of California, declared their opposition to the overpayments to Medicare HMOs. 

It is not clear why those Democrats waited until 2007 to find their backbone on the Medicare HMO overpayment issue, but it’s a good bet the belated opposition to overpayments by the influential American Medical Association (the trade group representing doctors) had something to do with it. The AMA has, at long last, awakened to the fact that the huge overpayments to Medicare HMOs means there is less money available to pay doctors who treat Medicare beneficiaries. If the AMA can see its way clear to opposing the overpayments that induce HMOs to participate in Medicare, perhaps it’s just a matter of time before the AMA reaches the same conclusion about the overpayments that make it feasible for the same HMOs to participate in Medicaid and SCHIP. 

Single-payer advocates need not wait for Congress to act. They should demand that their state legislatures and governors kick managed care plans out of their Medicaid and SCHIP programs. Legislation to do that, SF 1897/HF 2000, was introduced in the Minnesota legislature last March. A good place to start this debate would be to demand hearings by state legislatures on whether the privatization “demonstration” projects were ever evaluated to determine the impact of privatization on cost and quality. 

On October 18, the House of Representatives sustained Bush’s veto of CHIPRA. It’s hard to know how to feel. On the one hand, it is infuriating to live in a country as rich as America is and watch the president deny health insurance to millions of kids. On the other, it is infuriating to watch politicians enrich the insurance industry under the pretext that that is the only way to insure six million more kids. We deserve better choices than this. 


Kip Sullivan is the health system analyst for the Greater Minnesota Health Care Coalition and a member of Physicians for a National Health Program. He is the author of The Health Care Mess: How We Got Into It and How We’ll Get Out of It (AuthorHouse, 2006).