It is becoming increasingly clear that the congressional
creation of a public health plan to "compete" with private health
insurance plans is a roadblock to serious, bipartisan reform of the
American health care system. Such a plan would likely result in the
massive erosion of private health insurance options for individuals
and families, restricting personal choice and competition.
All attempts at federal health reform inevitably end in a search
for a compromise that will be passed by the U.S. Senate. The
current efforts are no exception. Recently, Senator Kent Conrad
(D-ND) suggested that maybe some form of "consumer cooperative"
might be a politically acceptable alternative to the "competing
It is important to clarify exactly what is being proposed and
exactly how it would work.
A Familiar Concept. As Senator Conrad and others have
noted, cooperatives--often called "co-ops"-- have a long and rich
history. Farmers established co-ops in order to market and
distribute their produce, workers in some industries organized
financial co-ops called "credit unions," and when the term "co-op"
is used in New York City, the speaker most likely means an
apartment building collectively owned by its residents.
Defined by Merriam-Webster as "an enterprise or organization
owned and operated for the benefit of those using its services,"
the cooperative is also long-standing and widespread in the
insurance sector, where it is known as a "mutual" insurance
company. Thus, such large well-known companies as Mutual of Omaha
or Northwestern Mutual Life, are, in fact, cooperatives. There are
also successful, smaller niche-market mutual insurers, such as
Church Mutual, which offers lines of property, casualty, and
liability coverage for member religious institutions, or Jewelers
Mutual, which offers similar coverage lines for members engaged in
making or selling jewelry.
If Congress were to adopt such an approach, it would have to
ensure that the co-op was a genuine competitor in the insurance
market, not another government-sponsored enterprise (GSE) designed
to undercut choice and competition. Moreover, as with any other
entity in the marketplace, it would need to compete on a level
playing field with no special advantages, including special
taxpayer subsidies or government financial guarantees.
How Health Insurance Co-ops Might
In any field, there are two key features that distinguish
"co-ops" from alternative arrangements designed to perform the same
- Co-ops are "consumer-owned." This is also why co-ops are
often referred to--somewhat redundantly--as "consumer
cooperatives." One characteristic of a co-op is that its customers
are its owners, and its owners are its principal customers. For
example, a credit union operates like a bank, but offers banking
services only to its member-shareholders. Non-members cannot open a
savings or checking account or obtain a loan from a credit union.
In the case of a dairy cooperative, the purpose might seem to be
selling milk to the public, but what it really does is provide
marketing and distribution services for its members-- dairy
farmers--who are also its owners. After all, there are any number
of other arrangements and middlemen who could buy the milk from
farmers, and then package and distribute it to retail stores. The
difference with the cooperative is that the farmer-owners provide
that service to themselves through the co-op.
- Co-ops limit the ability of members to exercise their
ownership rights individually. A member of a co-op cannot,
individually, sell or transfer his or her ownership rights to a
non-member. Thus, while someone who owns a condominium can sell his
unit at any time to anyone, in a co-op building, the co-op board
must approve the sale. The reason is that in the co-op, the member
does not actually own the specific unit in which he lives. Rather,
he owns a share in the cooperative that owns the entire building.
In the same manner, a shareholder in a credit union has essentially
the same ownership and governance rights as the shareholder in a
stockholder-owned bank. But the shareholder in a credit union
cannot sell his shares to a non-member. The credit union can be
sold, say to a commercial bank, only as a whole and only by vote of
In the case of health insurance markets, there are two areas
where the co-op model could conceivably be applied.
The first is with respect to entities that might organize the
buying and selling of health insurance, such as employer purchasing
groups or state health insurance exchanges. The second is applying
the cooperative concept to one or more of the insurers selling
coverage in the market.
Neither of these concepts is novel. Existing and previous
multi-employer health insurance purchasing arrangements have
usually been established under the auspices of a business
association. The Cleveland Council of Smaller Enterprises and the
Lubbock Chamber of Commerce, to name two examples, currently
sponsor such arrangements. Doing the same through a
special-purpose, member-owned cooperative wouldn't be that
different. Similarly, when it comes to insurance companies, the
very definition of a "mutual" insurance company is an insurance
company that is organized as a cooperative with its policyholders
as the owners.
Cooperative Purchasing Arrangements. The cooperative
approach is certainly one, but not the only, reasonable and
plausible model for health insurance purchasing groups or state
health insurance exchanges. Basically, those entities provide
standardized administrative and human resource services for
participating businesses. While the administrative tasks involved
in offering each employee the choice of, say, 15 different health
plans at an annual open enrollment season is beyond the
capabilities of the 10-employee auto repair business, it is quite
feasible to standardize those functions through a single entity for
not only that employer, but for hundreds of others as well.
Organizing such an entity as a cooperative owned by its customers
would be quite similar to the way agricultural cooperatives
In the case of a state health insurance exchange, a state
government could decide that it wants to give all businesses in the
state the option to offer health insurance coverage though an
arrangement under which each employee is free to choose the
coverage he or she prefers from a menu of competing plans. Of
course, making that work will require some kind of administrative
mechanism to handle tasks such as: employers electing to
participate; offering all the participating individuals a menu of
price and coverage information on the competing plans; the process
for workers making individual plan choices; and transferring
payments from different employers and workers to the various
insurers based on who picked which plan.
In the case of Massachusetts, which authorized this new kind of
health insurance coverage option as part of its 2006 reform law,
the state created an independent entity called the Commonwealth
Health Insurance Connector to perform those administrative tasks,
along with other responsibilities. In contrast, Utah enacted
reforms this year authorizing the creation of a similar coverage
option for employers and their workers, but the state is
implementing a decentralized design that will form contracts with
private vendors to provide the necessary administrative
These are by no means the only approaches. Yet another state
pursuing the same coverage option, could, for instance, charter a
member-owned cooperative entity to perform the necessary
administrative functions--in short, a co-op solution.
None of this requires federal action, nor does it seem to be
what Senator Conrad has suggested. Rather, and somewhat more
interestingly, the Senator appears to be suggesting that health
insurers who are organized as cooperatives and competing against
other types of insurers--on the same terms and under the same
rules--could be an alternative to the liberal proposal of a
government-sponsored "competing public plan."
Cooperative Health Insurers. In essence, what Senator
Conrad seems to be proposing is the authorization of health
insurers that are member-owned mutual insurance companies. That
suggestion is intriguing for two reasons--one political, and one
that relates to the market.
The political aspect is the possibility that the option to buy
health insurance from a member-owned mutual insurer could give
lawmakers a way to address voter interest in more options and more
consumer control when it comes to health insurance.
From the market perspective, the idea is intriguing because
while member-owned mutual insurers are a longstanding feature in
most other insurance markets, they are not found in today's health
insurance market. Instead, current health insurers are organized
either as stockholder-owned companies, or as non-profits (operated,
at least in part and at least in theory, charitably, and beyond
simply selling health insurance). Even the Group Health Cooperative
of Puget Sound, cited by Senator Conrad as an example of a
cooperative insurer, is actually organized as a non-profit, the
same as a charity, and is not, in fact, a mutual insurer. The one
difference between Group Health Cooperative and other non-profit
health insurers, such as Kaiser Permanente, is that Group Health
Cooperative includes in its bylaws provisions allowing
policyholders to apply to become members and then grants those
"members" voting rights on certain governance issues, such as the
election of directors. However, Group Health Cooperative's
policyholders do not have ownership rights in the company as in the
way the policyholder owners of, say, Northwestern Mutual Life.
Of course, while the idea of member-owned mutual health insurers
might be intriguing from both a political and market perspective,
as with so much in health policy, the devil is in the details.
A Level Playing Field. To begin, any health insurer that
is subject to any special government control or receives any type
of special government subsidy or financial guarantee would not be a
truly "private" entity, nor in most such designs would it be truly
"member-owned," regardless of what Congress chooses to call it. In
order to be a true "cooperative," or mutual insurer, the entity
would have to be subject to the same insurance regulations as other
health insurers, be independent and self-governing, and not benefit
from any direct taxpayer subsidies or financial guarantees. Of
course, like any other health insurer, they could still indirectly
benefit from, say, a government program that subsidizes low-income
individuals to help them buy coverage.
If those conditions are not met, then any proposed "co-op plan"
simply becomes an unacceptable exercise in attempting to disguise
the true nature of a government-controlled or -funded "public
That said, assuming that those conditions apply, there does
exist room for good-faith efforts to try to make the option of
member-owned mutual insurance companies offering health care
coverage available to consumers.
So, the question then becomes, what, if anything, might Congress
do to make the mutual insurer option available in health insurance
markets? Given that mutual insurers already exist, and that they
are regulated like other insurers by state insurance departments,
there does not appear to be any need to modify existing laws in the
areas of either corporate form and governance or insurance
The one change that Congress might explore is the possibility of
granting an exemption from corporate income taxes to mutual
insurers offering health insurance. In other words, Congress could
consider authorizing non-profit mutual insurers.
Under current tax law, in order for a health plan to qualify as
"non-profit," it must meet the "community benefit" test along with
the requirement that "no part of its net earnings inures to the
benefit of any private shareholder or individual." Those are the same
tests applied in granting tax-exempt status to any other type of
charitable organization. However, those restrictions also
effectively make it impossible for a non-profit health insurer to
be a true policyholder-owned mutual insurer without losing its
tax-exempt status in the process.
Indeed, the structure of Group Health Cooperative of Puget Sound
seems to be about as far as a non-profit health insurer can go
under current law in providing for some limited "member governance"
of a non-profit organization without crossing the line into "member
ownership" and triggering the loss of its tax-exempt status.
That said, the tax code does provide precedents for Congress
granting tax-exempt status to certain truly member-owned
cooperative entities, such as "mutual or cooperative" telephone or
electric companies. The most directly relevant and comparable
precedent is the tax-exempt status explicitly granted to
member-owned credit unions.
Credit unions are able to retain their tax-exempt status by
distributing any "profits" or "surpluses" to their members in the
form of dividends, lower interest rates charged on loans, or
expenditures to improve the services offered to their members--and
may do so in any combination. Each credit union is also free to
make those decisions in accordance with the specific
self-governance provisions adopted in its articles of incorporation
or bylaws. So, one credit union might specify that whether to
distribute a surplus to its members in the form of increased
interest rates on deposits versus decreased interest rates on loans
requires a shareholder vote, while another credit union may
delegate such decisions to its board, and yet another credit union
might delegate those decisions to management.
How Tax Changes Can Make True Co-ops
It is possible for Congress to create a legal framework that
authorizes the creation of non-profit mutual insurers in the health
insurance sector. Furthermore, the explicit granting of tax-exempt
status to credit unions offers both a relevant precedent and a good
model for how that might be accomplished. However, the central
issue involves changes to tax law--not changes to insurance law or
incorporation law, both of which already contain long-standing,
well-established provisions governing mutual insurance
That said, the possibility of amending the tax code to allow for
non-profit mutual health insurers does raise a number of key
- Should a tax-exemption for mutual health insurers be
conditioned on meeting unique requirements with respect to how they
conduct their business?
The answer is no. In order to have a well-functioning insurance
market, all competitors must be subject to the same set of
insurance (i.e., business practice) regulations, regardless of any
other differences among them in tax status or corporate form.
Questions about what, if any, changes should be made to existing
insurance law, and whether those changes should be made at the
state or federal level, are entirely separate and independent
issues. Furthermore, if there are to be any such changes, they must
be applied equally to all competing plans. Judging by his public
comments, Senator Conrad seems to understand and accept this
principle; his colleagues should as well.
Would combining tax-exemption with
mutual status create an unacceptable, or even significant, market
imbalance between tax-exempt mutual insurers and for-profit
This is an important question and one likely to engender debate,
but there are some good reasons to think that the answer is no.
While some argue that the avoidance of corporate taxation gives
existing non-profit health insurers an inherent advantage over
for-profit competitors, what is often overlooked is that their
non-profit status also imposes countervailing competitive
disadvantages on those organizations. The most significant
disadvantage is lack of access to capital markets--which is
particularly relevant if the entities in question offer financial
services, such as insurance.
The cheapest and easiest way for a stock company to raise
capital is through stock offerings, either by public or private
placement. While issuing more stock initially dilutes the ownership
interest of existing shareholders, if the funds raised are put to
good use, the shareholders will benefit from subsequent growth in
the company's profits.
However, that option is not available to non-profits or mutual
companies because it is not possible under their ownership
structures. The same would hold true for a non-profit mutual
It was this inherent limitation on access to capital markets
that in the recent past led some mutual insurers who offer other
lines of coverage to convert themselves into for-profit,
stockholder-owned companies. That process is called
"demutualization." A prominent example was the demutualization of
the Prudential Life Insurance Company in 2001. A crucial aspect of
that demutualization process was that Prudential's policyholders'
existing ownership rights in the company were monetized in the form
of being converted into shares of stock in the new,
stockholder-owned incarnation of the company. Once that change took
effect, those policyholders were free to sell their stock on the
stock exchange or to enter into private transactions to sell or
give their shares to others.
The inherent limitation on access to capital markets also helps
to explain why for-profit, stockholder-owned health insurers have
successfully competed for years against their non-profit
However, this does raise the next important question that will
need to be addressed in the design.
What limits should be placed on the
ability of such tax-exempt mutual health insurers to retain
earnings on a tax-free basis in order to organically fund growth
through acquisitions or capacity build-outs?
Almost certainly, some allowance will need to be made in order
to give non-profit mutual companies the ability to accumulate some
discretionary capital for expansion purposes. However, if the
allowance is too generous, it could tip the competitive balance
described earlier decisively in favor of the non-profit mutual
companies vis-à-vis both their for-profit and traditional
A good solution would be to include in the provisions that grant
tax-exempt status to mutual health insurers some reasonable limits
on their ability to accumulate capital on a tax-free basis. For
example, the statute could specify that the organization could
accumulate capital tax-free in order to meet its working capital
needs (defined, say, as a maximum allowable percentage of the
premium income it received) and to fund reserves against claims as
required by insurer solvency laws.
Congress could then allow further tax-free accumulations up to a
set ratio of minimum reserve requirements. That way, the company
would not be penalized if it acted prudently by setting aside
larger reserves than the minimum required by law. Beyond that, any
further capital accumulation would be taxed annually at a low rate,
for example, 1 or 2 percent, applied to the total excess balance.
The idea is to allow the organization to accumulate reasonable
excess capital to fund future growth plans while simultaneously
giving it incentives to be practical and concrete about any such
plans and act on them expeditiously by imposing a "carrying charge"
on any excess funds it holds.
This approach is similar to existing requirements that a
charitable trust disburse a minimum percentage of its assets each
year, or that an IRA beneficiary over age 74 withdraw each year a
minimum percentage of the IRA balance and add that amount to his or
her taxable income. These kinds of provisions are designed to limit
the accumulation and preservation of tax-free income beyond the
amounts and timeframes that are reasonable for effecting the
purpose for which the assets or income was granted a
How could Congress ensure that
tax-exempt mutual health insurers do not deviate from their
Once again, there is a well-established tax law precedent that
can be applied to keep tax-exempt organizations properly focused.
Tax-exempt organizations are subject to the "unrelated business
income" (UBI) tax on any income they receive from operating
businesses that are not related to their tax-exempt purpose. Thus,
in authorizing tax-exempt mutual health insurers, Congress could
specify that offering major medical health insurance to its members
would be the only tax-exempt activity. Any other coverage offerings
or business activities would be subject to the UBI tax, though
Congress should consider whether UBI tax provisions need to be
further modified to ensure that income from other lines of coverage
is appropriately taxed. That way, if say, an existing non-profit
health insurer that also offers supplemental coverage, such as
Medigap or dental plans, decided to convert to mutual status, it
could still offer those other policies, but its income from them
would be subject to normal taxation.
Might there be some new benefits from
introducing this concept into the existing market?
Indeed, there would be some added benefits. A mutual health
insurer would be able to offer "policyholder-owned" as a clear,
easily understood differentiation in the marketplace and would
likely attract some segment of customers on the appeal of that
proposition alone. The practical significance is that those
policyholder-owners could ensure that any profits or surpluses are
returned to them in the form of either lower premiums or enhanced
coverage--just as credit unions distribute surpluses to their
members in the form or either higher interest rates paid on
deposits or lower interest rates charged on loans.
For anyone who complains that existing for-profit and non-profit
insurers are too self-interested, make too high a profit, or spend
too much on administrative overhead, the option of obtaining
coverage through a non-profit mutual insurer offers a practical and
personal solution. With policyholder-owners controlling the
company, the incentives will be to find ways to lower costs while
also expanding coverage and benefits. Furthermore, those
policyholder-owners are not likely to favor cost control strategies
that mainly rely on denying claims or limiting access to providers.
What they will want to see is that their premiums are kept in
check, but that they can still receive timely access to quality
care. Thus, the managers they hire to run their company will need
to work with--not against-- health care providers to find ways to
deliver better value to their company's policyholder-owners. That
result would be a very positive, pro-consumer development and any
demonstrated successes of cooperative mutual health insurers would
also generate indirect pressure on competing insurers with
different corporate structures (whether for-profit or non-profit)
to adopt more "consumer-friendly" business practices.
Should existing health insurers be
permitted to convert to the new non-profit mutual structure?
There are some good arguments in favor of an answer of yes.
First, capital considerations, provider-contracting considerations,
and capacity build-out considerations all mean that conversions by
existing insurers will be, by far, the fastest way for the new
model to enter the market-- in terms of scale as well as geographic
coverage. In contrast, start-ups inherently face a long, slow path
to achieving any significant scale or geographic dispersion.
Indeed, building sales channels, constructing back-office billing
and claims-processing operations, negotiating provider contracts,
marketing a new company with new products, and so on, all require
significant time, even with adequate start-up capital.
The second point is given that the most promising path would be
conversion to mutual status by existing insurers, the insurers most
likely to pursue that conversion path are the existing non-profit
In the case of for-profit carriers, the major obstacle to
conversion would not be the mutual aspect (that is, moving from
stockholder-owned to policyholder-owned), but the significant
change in corporate culture entailed in moving from for-profit to
In contrast, in the case of existing non-profit insurers, the
conversion would mainly involve a change in governance, with little
initial change to existing business models or corporate culture,
though the ownership change would likely produce the positive
effect of an increasingly policyholder-focused corporate
Furthermore, such conversions might well be attractive to
existing non-profit health insurers for another reason: It would
allow them to retain their non-profit status by meeting the "member
benefit" test applied to credit unions instead of having to meet
the "community benefit" test applied to charities. Given the
increasing difficulty that non-profit health insurers face at both
the federal and state levels in defending their current business
practices under the "community benefit" test, they might find this
new option quite attractive. Indeed, one implicit effect of federal
or state lawmakers enacting health reform measures designed to
cover the uninsured will be the further erosion of the few
remaining justifications offered by non-profit health insurers for
preserving their tax-exempt status as "charities" that provide
While existing non-profit health
insurers might be able to convert to cooperative mutual status,
would not federal government "start-up" funding be necessary to
create new ones in states where people believe there is a need for
more health insurance competition?
The answer is no. Furthermore, there are very good reasons for
Congress to avoid including any federal government "start-up"
funding in a proposal to create cooperative, non-profit mutual
health insurers. First, even start-up funding by the federal
government would inevitably entail some level of federal government
control--on the grounds that federal officials need to be
"stewards" of the taxpayers' "investments." This is precisely what
has occurred with the federal government's recent bailouts of the
banking and auto industries. Second, once federal lawmakers have
"invested" taxpayer dollars in a business, they have a natural
incentive to ensure that their investment succeeds.
But a truly free market offers both the opportunity to succeed
and the opportunity to fail. Thus, even if lawmakers could devise
some kind of "arms-length" structure for providing start-up capital
(a questionable "if"), the temptation would be for Congress to
treat the recipient organizations as "too important to
fail"--leading to later, further interventions on their behalf.
Indeed, the health care delivery system is already distorted by
these kinds of policies, most notably federal, state, and local
regulations and subsidies designed to protect or prop up hospitals
that are deemed too important to their communities to be allowed to
fail--despite inefficiencies or substandard care.
More important, with the right policies, federal start-up
funding would not be needed at all. There is currently more than
enough private, philanthropic funding available to provide start-up
grants for new cooperative insurers. A newly released report by
Grantmakers in Health, for example, "identified 197 health
foundations created in the wake of transactions involving the sale,
merger, or transfer of assets of nonprofit health organizations,"
mostly hospitals and insurers. In March, 155 of those
organizations responded to a GIH survey: Of those, 146 reported the
value of their assets as of December 2008. The assets reported by
those 146 foundations ranged from "approximately $2.4 million to
Indeed, those 146 health care foundations collectively hold more
than $18.3 billion in assets. Not counted are the further 51
conversion foundations that either did not respond to the GIH
survey or did not provide asset figures. In addition, there are
numerous other foundations, both large and small, with a special
focus on health care charitable giving that were not included in
the GIH survey because their endowments were derived from sources
other than the conversion of a previously non-profit health care
organization. The Robert Wood Johnson Foundation, originally
endowed by its namesake who created the Johnson & Johnson
company, has long been a major funder of health care causes and
lists in its 2008 annual report assets of $7.3 billion and
disbursements of over $523 million in grants.
Thus, there are likely tens of billions of dollars of health
care philanthropy available to meet the start-up capital needs of
new, cooperative health insurers. All that Congress needs to do to
unlock that potential funding is to amend non-profit tax law to
allow those foundations to make the necessary grants. The reason a
tax-policy clarification is required is that current law prohibits
those foundations from distributing their funds for the benefit of
private shareholders or individuals--which could be interpreted as
applying to grants made to member-owned cooperative health
Of course, it would also be possible for state governments to
provide start-up funding for new health insurance cooperatives
through special purpose bond issues. While that does entail risks
similar to the ones that would accompany federal start-up funding,
those risks would be limited to only the state in question. In any
event, given the substantial amount of available private
philanthropic funding, state lawmakers should only consider such
state funding as a fallback.
Finally, Congress could provide for proper oversight for the
start-up of new cooperative mutual health insurers by asking the
National Association of Insurance Commissioners (NAIC) to develop
model rules for special supervision of start-up companies by state
insurance departments. The model would specify standards and
procedures to be applied by a state insurance department during the
start-up phase of a new entity. Specifically, the state insurance
department would ensure that initial capitalization funding was
properly accounted for and that the entity was executing an
appropriate plan to become a licensed insurer under the laws of the
state, and to obtain tax-exempt status under federal law. Once the
organization met all licensure standards and became a licensed
insurer, the special rules and oversight would end. From that point
on, the company would be subject to normal state insurance laws and
regulations (both in that state and in any other in which it seeks
to do business), the same as any other insurer.
Furthermore, it would only be necessary for one state to adopt
these rules. Once that happened, new cooperatives could be
incorporated in that state. Then, once a cooperative attained
licensure in that state, it could apply for licensure in any other
state under the existing laws of the states in which it seeks to do
The concept of a health insurance co-operative, if structured as
a non-profit mutual insurer, is an intriguing one. However, the
design issues that will need to be addressed are ones of tax
policy--not of health care policy or insurance regulation.
Most important, the entire basis for lawmakers even pursuing
further discussions of the cooperative insurer concept must rest on
a firm agreement that the objective is to give consumers more
options and control within the context of a "level playing
field"--with all insurers subject to the same market rules.
Simply calling some form of government-sponsored enterprise a
"cooperative" is worse than false advertising. Not only would a
health insurance GSE tilt the market playing field and open the
door to political manipulations--both of which would ultimately
harm consumers--it would also create unjustifiable and unaffordable
taxpayer exposure to financial risk.
As an object lesson, Congress need look no further than the
experience of the mortgage market -- at the GSEs Fannie Mae and
Freddie Mac that it created. Decades of market distortions
generated by their implicit government backing, compounded by the
effects of repeated political meddling by Congress, put those GSEs
at the very epicenter of the mortgage market collapse that
triggered the current financial crisis and recession. Furthermore,
that GSE approach has now saddled American taxpayers with hundreds
of billions of dollars in liabilities for just Fannie and Freddie
alone--not counting the additional costs of the follow-on effects
that their market-distorting practices produced in the rest of the
Furthermore, subsidizing private cooperatives in health care
directly, as the federal government has done with rural electric
cooperatives since their inception in the 1930s, would create
similar unjustifiable distortions and taxpayer risks.
In short, the idea of cooperative health insurers merits further
discussion only if it is based on expanding consumer choice in a
market that provides a true "level playing field."
F. Haislmaier is Senior Research Fellow in the Center for
Health Policy Studies at The Heritage Foundation.