May 5, 2006

May 5, 2006 | WebMemo on Health Care

Competition and Federalism: The Right Remedy for Excessive Health Insurance Regulation

The Senate will soon consider the "Health Insurance Marketplace Modernization and Affordability Act" (S. 1955), a proposal that is aimed at improving access to and reducing costs of health care coverage. The bill's proponents also believe that this measure would result in a reduction in health care costs for small businesses and their employees and contribute to a reduction in the number of the uninsured. A better policy, however, would promote open competition in the health care market. A robust national market can solve the problem of excessive state regulation and allow individuals and families to purchase more affordable health insurance across state lines.


Dysfunctional Markets

State health insurance markets are often dysfunctional, non-competitive, and dominated by a few large carriers. They offer standardized products that are increasingly unaffordable, and innovation in financing and delivery is officially discouraged. 


Federal and state policy contributes directly to the problem of dysfunctional markets. At the forefront is the federal tax treatment of health insurance. The federal tax code confines the availability of affordable health insurance to the employer-based market, undercuts the portability of coverage for individuals and families, and fuels health care inflation. It also directly discriminates against individuals who try to buy health insurance on the individual health insurance market. No comprehensive congressional tax reform legislation is pending that would address this failure of federal tax policy.    


State health insurance regulation is often excessive and undermines the availability of more flexible and affordable options for coverage, particularly for small businesses and their employees. State regulation of health insurance includes authority over underwriting rules, the conditions for sale and access, such as rules requiring guaranteed issue of coverage, and the authority to impose specific benefit mandates that insurers must offer as a condition for selling health insurance in the state.


First Principles and Federalism

The Constitution authorizes a federal system of national and state governments. The national government makes laws and imposes rules that deal with the general concerns of the Republic, and state governments make laws that address the particular concerns of its citizens. Both the national government and the state governments are each equal and independent within their own spheres of jurisdiction. 


The federal tax treatment of health insurance is a direct Congressional concern, and Congress, exercising its authority over the federal tax code, should remedy its deficiencies. Health insurance market laws are clearly matters of state concern, except if the commerce for those products crosses state lines. Thus, the real issue before Congress is the question of a national health insurance market. In other words, what steps, if any, should Congress take to set rules governing the sale of health insurance across state lines?


Given the diversity of cost and coverage options around the United States, the best and simplest answer to geographically concentrated regulatory excess is open competition. Open competition would allow citizens to shop around for the best coverage and enable individuals and families to get the best value on the basis of price, quality, and benefits.


In the absence of reform of the federal tax code, the best way for Congress to compensate for the disadvantages of dysfunctional state insurance markets is to use its constitutional authority to regulate interstate commerce. Congress should create a new openness for health insurance markets, allow individuals and families to buy health coverage across state lines, and promote a national market for health insurance. Thus far, the best available vehicle for such a policy is the "Health Care Choice Act" (S. 1015), sponsored by Senator Jim DeMint (R-SC). This legislation would preserve the primacy of the states in regulating health insurance while giving individual access to coverage available in other states. Such an approach would also encourage states to develop a more consumer-friendly regulatory structure for the purchase of health insurance.


What S. 1955 Does

The Senate legislation amends the Employment Retirement and Income Security Act of 1974 (ERISA). ERISA governs the self-insured health plans usually offered by large employers. Under the federal law, these self-insured health plans are exempt from state regulation, including state health insurance premium taxes and state benefit mandates. S. 1955 would add a new category of federally regulated health insurance plans for associations of small businesses and create a process for the federal preemption of state insurance laws.


Under the legislation, three separate initiatives combine to change the regulation of health insurance at the federal and state level. Specifically, the proposal would 1) allow small businesses to purchase health insurance coverage through an a federally qualified association; 2) enable insurers to sell health insurance plans that meet a model state rating and benefit standards for health insurance; and 3) harmonize and standardize the state regulation aspects of health insurance in both the individual and small group markets.   


  • The Establishment of Small Business Health Plans (SBHPs). This proposal is based on the Association Health Plan (AHPs) concept and would enable small businesses to purchase health insurance coverage through a bona fide association. The health care coverage offered through these associations would be based on the benefit standards set forth in the new state regulatory reform provisions established in the bill. Advocates of this approach argue that allowing small businesses to pool together through an association would expand the risk pool, reduce administrative burdens of purchasing health insurance, and enable small businesses to avoid costly state regulation. 

These objectives are worthy, and proponents point to the efficiencies of large employer health plans to illustrate its benefits. Basing pooling exclusively on employment, however, has its shortcomings. Under an employer-based model, when employees leave a job, they risk severing the doctor-patient relationship, episodes of un-insurance, and the disruption of their continuity of care. Worse, the lack of portability and individual choice in health insurance coverage is simply reinforced by insisting on health care coverage dependent on the place of work. Moreover, it further segments the health insurance market by creating a new federal pooling arrangement solely for the small business sector. 


If the Senate is determined to approve federally regulated association plans for small businesses, senators must extend the same option to individual-based associations, such as religious, civic and community organizations. Such organizations tend to hold longer-lasting relationships with individuals and better reflect personal preferences than employers. Expanding the scope of federal associations to individuals, while not necessarily the ideal approach, would at least resolve many of the obstacles created by employer-based coverage and would promote personal choice and individual ownership.

  • State Regulatory Reform. Title II of the legislation consists of two parts. The first part creates the Model Small Group Rating Rules (MSRR), a model originally developed by the National Association of Insurance Commissioners in 1993 to create a single national set of rating rules for plans sold to small businesses. The basic idea behind these rules, some variant of which many states adopted during the 1990s, is that similarly situated employer groups should be charged essentially the same premium for coverage. So, insurers are permitted to adjust premiums for relevant differences among employer groups, such as the size of the group, location of the business, or industry classification, but are limited in the degree to which some rating factors may be applied. Under these provisions of the bill, in a state that does not adopt the Model Small Group Rating Rules, insurers can elect to sell small group insurance plans to businesses based on the new federal standard and exempt themselves from the "non-adopting" state rating rules.
    The second part of Title II creates the Benefit Choice Standard option whereby an insurer could sell policies that do not include one or more coverage requirements mandated by that state in any given state. However, the insurer would also have to offer an Enhanced Option, alternative plan with coverage and benefits equal to or better than those in a plan offered to state employees in one of the five most populous states, descriptions of which the Secretary of HHS would publish annually in the Federal Register. The basic objective of these provisions is to give insurers flexibility with respect to state mandated benefit laws. As with the new rating standard, if a state does not adopt the Benefit Choice Standard, an insurer can elect to exempt themselves from the state benefit laws and sell a Benefit Choice Standard policy, provided they also offer the Enhanced Option.   

These provisions have some potential downsides. First, these provisions are based on adding more layers of regulation to the system, further blurring and complicating the lines of regulatory authority over health insurance. Second, it offers relief only to those insurers that offer the comprehensive alternative. This could be problematic for those insurers that do not to sell products that meet the comprehensive standard. Plans that exclude controversial procedures, such as abortion or contraception, might be excluded from offering a new Benefit Choice Standard simply because they have moral objections to the Enhanced package. Third, the approach most likely will lead to a de-facto standardized federal system. The structure encourages states to simply conform to the federal standards. "Non-adopting" states will find it difficult to maintain a stable market and to resist pressure to conform to the federal standard for the sake of simplicity. 


Finally, it may discourage or preclude states from considering regulatory reforms beyond the new federal standard, such as doing away with the distinctions between the individual and small group markets. The reality is that while employer group insurance does offer some benefits to larger employers and their workers, it simply doesn't make much sense for small business or their employees. Massachusetts recently passed a comprehensive health care reform package that has made numerous changes to their insurance market, most notably the creation of a new marketplace for purchasing health insurance, called the Connector. Under the Massachusetts law, the Connector will replace that state's current non-group health insurance market, and a commission is to report back to the legislature on the feasibility of doing the same with the Massachusetts small group market. Similarly, legislation introduced in the 2006 session of the Maryland general assembly would also combine that state's non-group and small-group markets into a new, statewide health insurance exchange.

The concept behind the Massachusetts legislation and the Maryland proposal is to consolidate a state's currently fragmented health insurance markets into a single system offering simple, uniform regulation and personal, portable coverage. However, the Federal regulatory preemptions in S.1955 might not only disrupt the new state regulatory structure proposed in these initiatives, but could also create a disincentive for any other state to consider comprehensive health reform along the same lines.

  • Health Insurance Harmonization. Title III of the legislation provides for the federal "harmonization" of state health insurance laws. The bill would establish a new federal panel, the Health Insurance Consensus Standards Board and Advisory Panel. The Board would make recommendations to the HHS Secretary on how to "harmonize" the insurance rules of the states in four areas: Insurance filing and rate filing rules, market conduct review, prompt payment of claims, and the internal review of disputed claims.

After receipt of the Board's recommendations, the Secretary of HHS would certify the recommended harmonization of the state standards. The Secretary, in consultation with the National Association of Insurance Commissioners, the Board and Advisory Panel, would  submit on-going reports to Congress on the impact of the harmonized standards on access, costs and marketing of health insurance, and can update the standards through the rulemaking process. Again, states could decide to adopt the new standards voluntarily, but for those that do not, insurers could elect to use the new "harmonized" standards set forth under this section.       


Certainly, there is value in trying to simplify the administrative process for insurers. The establishment of a federal commission that has full authority to set those standards, without congressional approval, however, is a concern. Furthermore, there is the worry that the establishment of such a standardizing commission's role and scope could eventually be expanded.  

National Competition: A Better Solution

Senators should not reinforce the current health insurance regulatory design by even a limited standardization of health insurance regulation at the federal level. A robust national market can solve the problem of excessive state regulation while allowing individuals and families to purchase more affordable health insurance across state lines. The "Health Care Choice Act" (S. 1015), sponsored by Senator Jim DeMint (R-SC), would allow sales of health insurance products across state lines.


In pursuing the option of open competition, senators would preserve the legitimate authority of the states to regulate health insurance, while giving individuals the freedom to choose the regulatory environment that most meets their needs. Furthermore, it would spur competition among the states to experiment and adjust their health insurance regulation to make it more affordable and accessible for all consumers. Such an approach is not only consistent with federalism, but advances a patient-centered, consumer-directed model for health insurance.


Nina Owcharenko is a Senior Policy Analyst in, Edmund Haislmaier is a Research Fellow in, and Robert E. Moffit, Ph.D., is Director of, the Center for Health Policy Studies at The Heritage Foundation.

About the Author

Nina Owcharenko Director, Center for Health Policy Studies and Preston A. Wells, Jr. Fellow
Center for Health Policy Studies

Edmund F. Haislmaier Senior Research Fellow, Health Policy Studies
Center for Health Policy Studies

Robert E. Moffit, Ph.D. Senior Fellow
Center for Health Policy Studies