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States shuttering Obamacare exchanges, but should they?

About $5 billion or so in federal money has been spent on building Obamacare exchanges run by individual states—but opinion is split on whether many of those marketplaces have a future, or if they represent enough of an attractive alternative to HealthCare.gov to continue operating and possibly encouraging other states to join them.

Last month, a major Supreme Court decision gave new fuel to that debate. The high court said that subsidies that help most Obamacare customers pay for their health insurance could be issued everywhere in the United States—including for coverage sold on the federal exchange HealthCare.gov—and not just to people who buy plans from state-run marketplaces. The decision means that states can, if they want, abandon their Obamacare marketplaces and let HealthCare.gov enroll their residents, and still guarantee eligible residents receive financial assistance.

Beforehand, several HealthCare.gov states were taking steps to create their own exchange in the event the court had ruled the other way.

Larry Levitt, senior vice president at the Kaiser Family Foundation, said the King v. Burwell decision gives the remaining 13 states that operate their own exchanges along with the District of Columbia a chance to evaluate the costs and other burdens of doing so. He predicts many then will opt for the HealthCare.gov.

A marketplace guide works on the Healthcare.gov federal enrollment website.
Andrew Harrer | Bloomberg | Getty Images
A marketplace guide works on the Healthcare.gov federal enrollment website.
"I think Amazon is the analogy. Amazon is the engine for many online stores.... In this case, there's just no reason for many states to operate their own health-care exchange." -Larry Levitt, Senior vice president, Kaiser Family Foundation

"When the law was first being implemented, there was enormous symbolic significance attached to states starting up their own exchanges," Levitt said. "It was a sign of momentum and that the law was working. And for a number of blue state governors, it seemed attractive politically to get behind Obamacare."

"Now that the law's in place, and the Supreme Court has said that subsidies are available in all states, there's really much less imperative for states to be running these things," he said. "I think the court's decision is very liberating for the states."

Operating an exchange is "a really big hassle and it's really expensive," Levitt said. "And, particularly the smaller states have a tough time financing their operations to scale."

In five years, Levitt said, "I wouldn't be surprised if half of the state exchanges are no longer operating," or at least no longer handling eligibility and enrollment functions for their residents.

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Asked if he could envision just one or two state exchanges, Levitt said, "That would surprise me, but it wouldn't shock me."

Either way, he expects the main survivors to be large states, such as California and New York, whose exchanges have economies of scale that aren't available to smaller states.

"HealthCare.gov is not perfect, but it's getting better, and it'll continue to improve," Levitt said. "I think Amazon is the analogy. Amazon is the engine for many online stores, and there's really just not a reason for every mom-and-pop e-commerce operation to build their own shopping website. In this case, there's just no reason for many states to operate their own health-care exchange."

Like 'dominoes' falling

There is a precedent for Obamacare-friendly states throwing in the towel on their own exchanges and letting HealthCare.gov handle enrollment.

Oregon's marketplace did so after a 2014 performance that was regarded as among the worst of the Obamacare marketplaces. Nevada also had the federal exchange take over enrollment duties in 2015. Right before the Supreme Court ruled in June, Hawaii decided to scrap its exchange because of lack of adequate operating funding from the state, even after spending more than $200 million in federal funds to construct the site.

Obamacare critic Phil Kerpen, president of the free-market advocacy group American Commitment, said he expects that most, if not all of the state exchanges will follow suit now that federal funding for them has run out and they face annual operating costs of tens of millions of dollars.

"I think it's just a matter of time," Kerpen said. "The economics don't work ... the ongoing maintenance costs are going to be very high."

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"I think what's going to happen is all the states will fall like dominoes. Maybe not California, because they've got scale," said Kerpen. Covered California, with more than 1.3 million plan selections this year, is the largest state-run exchange.

"I wouldn't say within one year, but within five," said Kerpen, of his prediction that most state exchanges would close up shop, although he conceded that New York might join California as a survivor.

"I really think there's no benefit to the state exchanges versus federal at this point," Kerpen said.

Big sunk costs

"This is actually not a simple website that's easy to put together," Kerpen said. "This is a pretty complex IT system."

Kerpen noted that the experience of the exchange run by Massachusetts, whose "Romneycare" version of health-care reform was a key precursor to Obamacare, proves the difficulty of states in running their own marketplace. A number of small states struggled with enrollment, particularly in the first year, despite each spending hundreds of millions of dollars to build their online insurance markets.

In Massachusetts, a marketplace than cost more than $180 million to build had such a disastrous first year that more than 300,000 people had to be placed temporarily in a form of Medicaid because the exchange could not handle their enrollments.

Vermont, another small state that wholeheartedly embraced health-care reform, has seen its exchange struggle despite having spent $200 million on its exchange.

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Maryland's exchange also performed very badly in its first year. On Tuesday, the state and the federal government announced they would receive a $45 million settlement from the exchange's lead contractor, Noridian Healthcare Solutions. But that is just 60 percent of what Noridian was paid for the botched job.

Earlier this week, a story on Reason.com reported that the Government Accountability Office, in a draft report, had found that many state-run exchanges "have yet to complete work on critical functionality," including verifying that their customers are eligible for the subsidies they are getting, paying insurers and reporting required information to the Internal Revenue Service.

The GAO draft report found that only Vermont was now set up "to send data to the IRS," while 10 other states had partially completed such work, and two states—Minnesota and Hawaii—had performed no such test on that function, according to the story. And none of the exchanges with the exception of Kentucky's had finished building the IT functions that verified applicants' identity citizenship status and eligibility for subsidies, the story said.

A GAO spokesman, asked for comment by CNBC, said the report is "still in draft form and subject to changes."

A $10 million question

Despite problems at state exchanges identified by the GAO and others, some experts think there is good reason to believe they are here to stay.

Dan Mendelson, president of the Avalere Health consultancy, expects the number of such exchanges will remain "roughly stable."

"In five years, I would expect there will be like 15 well-integrated state exchanges," Mendelson said.

"Think about it from an 'eyeballs' perspective. You have control over the eyeballs, and that is of value." -Dan Mendelson, president, Avalere Health

"My view is that the larger states who have their own exchanges should be functioning well," Mendelson said. But smaller states also will stick around if they have "an exchange that is operating well and everything is going swimmingly and the [insurance] plans are used to it," he said.

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Athough Mendelson agrees that HealthCare.gov is "not a bad alternative" if a state exchange is concerned about costs, he pointed out that "it's not as if it's free" to transition to the federal exchange. One estimate is that each state would have to pay up $10 million to transition HealthCare.gov.

States also have an interest in running their own marketplaces because they can tailor the "interfaces and languages" that customers can select, and also can use their exchanges to connect people to other state-run programs, Mendelson said.

Mendelson said, "Think about it from an 'eyeballs' perspective. You have control over the eyeballs, and that is of value."

'1332' equals dozen new exchanges?

The head of a major online insurance brokerage said he expects that is a key reason most existing state exchanges will survive, and will persuade some other states to join them.

"I think it will stay at 14 for another year, give or take the loss or gain of another two or three," said Chini Krishnan, CEO of GetInsured.com, when asked about how many state exchanges would be around in coming years. "Then it will gradually go into the mid-20s."

By running their own exchanges, states can offer their users "a cohesive state experience in terms" of enrolling for Obamacare private plans, or for Medicaid and CHIP, the government-run health coverage programs for the poor and for children, respectively, Krishnan said.

He also said state exchanges will also get a boost as states explore a largely unknown but potentially significant aspect of the Affordable Care Act known as Section 1332, which state-run insurance marketplaces can help leverage.

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Beginning in 2017, Section 1332 will give states the ability to ask the federal government to waive many parts of Obamacare and allow them to to change the way health insurance and health care is delivered to their residents.

"The opportunity for states to transform the ACA within their borders is breathtaking," Stuart Butler wrote in a JAMA Forum article about Section 1332. "It's little wonder that a former top aide to the late Sen. Edward Kennedy describes Section 1332 as "state innovation on steroids."

An article in the journal Health Affairs last winter noted that federal funding for "alternate coverage reform" proposed by individual states "could reach into the hundreds of millions or even billions of dollars" per state if they seek waivers under Section 1332.

Krishnan told CNBC that "there are at least five states that are actively looking at 1332."

"That will potentially bring back momentum to state-based exchanges," he said.