01.03.10

Confiscatory Insurance Regulation, Further Thoughts

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Mark’s response to Richard Epstein’s observations on the constitutionality of the Senate bill certainly does the job, but I will add a few notes. First, although Epstein’s article is much more attentive to the actual details of the law than is much of Epstein’s writing on health care topics, he is selectively attentive, as Mark notes. First, he ignores the effects of the individual mandate (perhaps assuming that he has already won the argument that it is unconstitutional). One of the greatest threats he sees to the insurance industry is that healthy people will opt out of the insurance market, leaving insurers with an unsustainable unhealthy pool. But that is precisely why the legislation has an individual mandate (and effectively, an employer mandate). The mandate, particularly under the enhanced penalties imposed under the manager’s amendment, should assure insurers a large pool of healthy enrollees. Second, he ignores the risk adjustment and reinsurance mechanisms built into the legislation, which will help out particular insurers who end up with an unprofitable risk pool. Third, he underestimates the effect of allowing an insurance market to exist outside of the exchange. In fact, insurance policies sold outside of the exchange face significantly less regulation than subsidized policies in the exchange and are likely to be very attractive to healthier and wealthier individuals and small groups than exchange policies. I expect a vigorous and profitable market to continue outside of the exchange (although I think the consequences of this for risk selection against the exchange are very problematic). Fourth, Epstein overestimates the continuing effect of state mandates on insurers under the new legislation. The states must fully finance any cost to subsidized enrollees of state mandates above the federal mandates. Given the current fiscal condition of the states, this is likely to lead to very rapid repeal of state mandates that go beyond the federal law. Fifth, although it is largely irrelevant to his argument, Epstein fails to note as have many other opponents of the legislation that the Senate bill does permit interstate sales of insurance (and the sale of multi-state policies), which, if it has the effect that Epstein and the Republicans in Congress predict, should make administrative rate controls unnecessary. Finally, as Mark points out, Epstein fails to take account of the fact that the legislation should dramatically reduce the administrative costs of insurers by eliminate health status underwriting, simplifying enrollment and collection of premiums through the exchange, and simplifying claims processing.

Epstein also does not seem to understand the current insurance market very well. First, insurers are in fact heavily regulated in most states far beyond the consumer protection and solvency requirements. Thirteen states already impose community rating in the small group market, thirty-nine impose limits on rating dispersion, all fifty already have guaranteed issue and renewal, and all fifty impose some limits on preexisting condition exclusions. In the individual market, thirty-one states limit preexisting condition exclusions, eight have community rating, and ten additional states limit rating dispersion. The federal requirements will add little new in a number of states. Second, a recent CRS report noted that only one of the thirteen major insurers it studied had an MLR of less than eighty percent. The definition of MLR the CRS used, moreover, did not exclude administrative costs related to quality improvement or taxes and fees, so the MLRs of these firms using the Senate bill definition would likely be significantly higher. Also, as Mark notes, MLR does not account for profits made from investment income, which in normal years are an important source of insurer profits, so a firm could make a profit even though it was required to pay rebates to its enrollees because of inadequate MLRs.

Finally, like Mark, I question Epstein’s constitutional analysis. Epstein is correct that the Constitution would probably prohibit confiscatory regulation of insurer rates, but he does not sufficiently attend to the long history of due process and takings challenges against insurance regulation in the federal and state courts. A half century ago the Supreme Court recognized a “special relation” between the government and insurance regulation, and the Court has upheld virtually all challenges brought by insurers against regulations. Only in egregious cases of overreaching, such as laws rolling back or freezing rates, requiring insurers to fund residual markets using profits from other states or lines of business, applying assessments retroactively on insurers that have left a market, and prohibiting insurers from exiting markets have state or federal courts found that constitutional limits have been exceeded. Courts have not found it necessary that every policy sold by an insurer make a profit or even that every insurer in a market make a profit.

We do not know yet the exact provisions the final bill will include or how it will be applied. It is possible that in rare circumstances an as applied challenge against particular decisions affecting insurers will succeed, particularly if the issue is litigated in some state courts that are more open to substantive due process challenges than are the federal courts. But a facial challenge the the provisions of the current law would certainly fail.

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[…] Issues in Health Reform « Public Health and Health Reform: A Preliminary Scorecard Confiscatory insurance regulation, further thoughts […]

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