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Constitutional Limits on Insurance Regulation

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The following is part of a longer paper addressing legal and policy issues raised by health insurance exchanges, which will be presented at the O’Neill Center’s Legal Issues in Health Reform symposium on Monday, October 26.

The health reform legislation pending in Congress would dramatically expand federal regulation of health insurance. Indeed, in most states it would significantly expand the scope of health insurance regulation generally. What constitutional constraints cabin this expansion of authority?

The Fifth Amendment of the Constitution provides that no one shall be “deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.” The right to contract for the sale of insurance is a liberty or property interest protected by the Due Process Clause and arguably a private property interest protected by the Takings Clause.

Insurance regulations have often faced constitutional challenges. They have generally been challenged as denying substantive due process or as violating the takings clause. Government regulation of economic conduct, including insurance regulation, is acceptable under the Due Process and Equal Protection clauses as long as it bears a rational relationship to a legitimate government interest. A challenge to a regulatory law brought under the Takings clause–which bars the government from taking private property for public use without just compensation–can only succeed if the law goes “too far” in the severity of its impact. The Supreme Court has applied a three-part test on an ad hoc basis to determine whether a regulatory taking has occurred. It considers the diminution in value of the property imposed by the regulation, the extent to which the regulation interferes with the owner’s investment-backed expectations, and the character of the government action.

The government’s power to regulate insurance is far-reaching. Insurance has long been a heavily regulated industry, and constitutional challenges to requirements imposed by health reform legislation or by a health insurance exchange through regulation or negotiation are unlikely to succeed unless the requirements are wholly irrational or confiscatory. In its many decisions reviewing insurance regulation, the Supreme Court has consistently permitted government broad regulatory powers. Half a century ago the Supreme Court stated “What was [said in an earlier case] about the police power-that it ‘extends to all the great public needs’ and may be utilized in aid of what the legislative judgment deems necessary to the public welfare, is peculiarly apt when the business of insurance is involved-a business to which the government has long had a ‘special relation.’” (California State Auto Ass’n Inter-Ins. Bureau v. Maloney (1941)). That case upheld a California statute that allocated high-risk insureds among auto insurers through an assigned risk scheme. The Court summarily disposed of the appeal, citing twenty-one cases in which the Court had earlier rejected due process challenges against various state insurance regulations, including rate-setting schemes. The Court has not since deviated from this course.

Provisions in the bills pending in Congress requiring insurers to cover particular benefits or to standardize benefits are very unlikely to be invalidated. Courts have repeatedly rejected constitutional challenges to state insurance mandates including statutes requiring insurers to provide maternity coverage and coverage for mental disorders. In the one actual reported case involving an insurance purchasing exchange, a federal court in Kentucky rejected a Due Process and Commerce Clause challenge brought by an insurer against a statutory requirement that insurers offer only standard plans approved by a health policy board.

Courts are also unlikely to invalidate risk-pooling or reallocation requirements such as those found in each of the current bills. Indeed, the regulation upheld in the Supreme Court case cited above imposed a risk reallocation scheme. In a case involving New York’s attempt to create a risk-pooling mechanism the court observed that an insurer has no “constitutionally protected interest in maintaining a healthier than average risk pool.” (Colonial Life Ins. Co. v.Curiale (1994)) Federal and state courts have repeatedly upheld various schemes for reallocating and assigning risk among insurers.

It is also unlikely that the courts would strike down legislation that would limit the number of insurers allowed to participate in health insurance exchanges. In analogous areas, courts have upheld the constitutionality of certificate of need programs, which prohibit private health care providers from entering markets or expanding their market participation without permission from the state. The courts would probably also uphold legislation prohibiting insurers that sold within the exchange from selling policies outside of it. Analogous Medicare amendments that prohibited physicians from selling their services to Medicare beneficiaries outside of the Medicare program unless the physician left the Medicare program for two years have been upheld.

The authority of the government to regulate insurance, however, is not unbounded. A number of cases have successfully challenged particularly severe forms of insurance regulation under the Takings Clause. To this point, takings challenges have been brought against state rather than federal insurance regulation, although the Takings Clause applies equally to both the federal and state governments. Successful challenges have been brought, for example, against 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. The success of these challenges is to some extent specific to particular jurisdictions; laws similar to those successfully challenged in one jurisdiction have sometimes survived similar constitutional challenges in other jurisdictions.

In general, however, the courts have come to recognize that insurers have been treated by government like public utilities, and like public utilities insurers are ultimately entitled to rates that are not confiscatory and provide a “fair and reasonable return” It is not enough that a rate barely protects the insurer from insolvency; it must in fact permit a reasonable return on investments. But diminution in value of an insurer is not confiscation, indeed some courts have articulated the constitutional standard as protecting against “deep financial hardship.” The Constitution does not require any particular form of rate regulation, only a rate that is not confiscatory. Moreover, a reasonable rate of return is not guaranteed for each individual policy, but rather to the range of policies issued by the insurer. Indeed, insurance rates are not necessarily constitutionally inadequate simply because aggregate rates are not sufficient to guarantee a profit to all companies engaged in a particular business. Finally, the Constitution does not necessarily guarantee a return to businesses that are not “well and economically operated,” indeed it does not protect industries that are not conducted efficiently. Health insurers who do not bargain vigorously with providers to bring down health care costs or control their own administrative costs cannot depend on the Constitution to assure them a continued profit.

Congress should not encounter serious constitutional barriers in imposing coverage mandates on insurers or implementing programs to reallocate risks among insurers. The exchanges are likely to be permitted to negotiate rates (permitted by the House but not the Senate bills) with insurers as long as insurers are not forced to accept rates that do not permit a reasonable return on their investment. Total exclusion from the market of insurers who are not able to negotiate rates that do permit a reasonable return on their investment or of insurers because there are enough insurers in the market may, however, prove problematic.

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  • Confiscatory Insurance Regulation: Yet Another Constitutional Attack, Rebutted « Legal Issues in Health Reform says:

    […] Confiscatory Insurance Regulation: Yet Another Constitutional Attack, Rebutted The formidable Richard Epstein has launched the latest attack on the constitutionality of health care reform.  He argues that minimum medical loss ratios coupled with tougher insurance standards are “confiscatory” rate regulation that vioate the Takings Clause or substantive due process.   As with other right-wing constitutional attacks, he suggests this conclusion is firmly based in existing law (claiming “little doubt”).  Conservative bloggers hail his analysis as demonstrating that reform is “blatantly unconstitutional.”  But Epstein is well known for arguing, far outside the legal mainstream, that much of modern government is unconstitutional on much the same grounds.  Thus, we need to look closer to distinguish a libertarian view of what constitutional law should be from a convincing view of what it actually is. Consider, for instance, the following (in addition to points Tim Jost makes here  and here): […]

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