Introduction

The House of Representatives will soon consider a major package of health care bills. The package, if enacted, would significantly improve the functioning of America's health insurance markets and establish a solid foundation for further transformation of America's health care system.

 

Americans are deeply concerned about rising health care costs and the rising number of Americans who do not have health insurance, have trouble keeping it, or are unable to find affordable health care. Policymakers at the federal and state levels are concerned about how to make existing health insurance markets work better and reduce barriers to access to coverage and care while enabling those who are chronically ill to secure the care and coverage they need at affordable prices. The House package directly addresses these concerns.

 

The House health care package contains three major proposals, all of which are based on previously introduced House bills. The first would establish association health plans (AHPs) and is based on legislation sponsored by Rep. Sam Johnson (H.R. 525). The second would foster interstate commerce in health insurance, enabling individuals and families to buy health insurance across state lines; this is based on legislation sponsored by Rep. John Shadegg (H.R. 2355). The third would extend federal funding for health insurance pooling demonstrations and programs, including high-risk pools, and is also based on legislation sponsored by Rep. Shadegg (HR. 3204).

 

One omission in the House's approach, however, is particularly conspicuous: The proposals do not address the tax treatment of health insurance, which undermines portability of coverage, distorts the insurance markets, and unfairly favors upper-income workers. Still, these House proposals are a major step in the right direction.

 

House Proposal No. 1: Association Health Plans

Representative Sam Johnson (R-TX) has introduced H.R. 525, the Small Business Health Fairness Act of 2005, to create association health plans. AHPs would enable small businesses to band together through trade associations to purchase coverage for their employees. These arrangements to self-insure would be regulated by the Employee Retirement Income Security Act of 1974 (ERISA) and therefore would be exempt from state health insurance mandates and regulations. According to Rep. Johnson, "AHPs will significantly expand access to health coverage for uninsured Americans" by giving small businesses improved bargaining power and relief from costly state regulations. [1]

 

Analysis: AHPs would give small businesses an alternative means to offer health care coverage to their employees. While pooling together would bring small businesses some cost savings, there are a variety of reasons why small businesses may not be the best or most efficient venue for delivering coverage, such as their high worker turnover rates and disproportionate share of part-time and seasonal workers. Furthermore, under this approach, workers would still be at the mercy of their employers for benefit and coverage decisions. The lack of individual ownership, lack of personal choice, and lack of true portability are all obstacles to moving toward a more robust consumer-based health care system.

 

Making the Proposal Better: Policymakers should expand the concept of association health plans beyond the workplace to membership organizations.

 

Groups such as civic and charitable groups, unions, fraternal and ethnic organizations, churches, and religious and faith-based organizations should all be encouraged to offer coverage to their members. Harnessing the financing of health care to the delivery of health care by religious institutions holds enormous potential for transforming the health insurance market.[2] This would provide individuals with an alternative to the traditional employer-based system that draws on longer-lasting relationships that reflect individual preferences and values. Expanded AHPs would give individuals the freedom to choose the style and type of coverage arrangement that best suits their and their families' needs and would allow individuals to own and keep their coverage when they switch jobs or change their work status.

 

House Proposal No. 2: An Interstate Market for Health Insurance

Today, each state regulates individual and com­mercial group health insurance plans. The reach and scope of health insurance regulations vary from state to state and range from the imposition of rules governing solvency and marketing to benefit mandates and rate regulations.

 

States can impose all manner of regulations on health insurance: "guaranteed issue" of insurance to individuals, meaning that an insurance company may not turn a person down for coverage on the basis of health status; limits on pre-existing condition restrictions; parity for mental health insurance benefits, whether for all or some of the benefits that are offered for non-mental health services; reporting requirements on enrollment and on quality, service, or patient satisfaction; and "patients' bill of rights" requirements, including the right to sue for the denial of reimbursement or an expedited grievance process for the denial of reimbursement for certain medical procedures or benefits. States can also impose premium taxes on health insurance in the individual and commercial or small group markets.

 

Exempt from state regulation are the health insurance arrangements of large and mid-size companies that are self-insured. These arrangements are governed by U.S. Department of Labor regulations issued under ERISA. Federally regulated insurance plans are exempt from state benefit mandates and premium taxes.

 

The House health care bill would allow individuals and families to purchase health insurance that is offered in other states. Based on the Health Care Choice Act of 2005 (H.R. 2355), sponsored by Rep. John Shadegg (R-AZ), the House legislation would allow insurance companies to sell their products across state lines, under specified conditions, without generally being subject to the mandates and regulations of other states.

 

The bill specifies that health insurers selling policies across state lines must be licensed in a "primary state" where the insurance is sold and must meet the regular state laws and requirements that govern health insurance, including benefit requirements and marketing standards, of that primary state.

 

Insurance regulators from "secondary states" in which these policies are sold could not impose their states' mandates or regulations on the policies. However, secondary states would still be able to require carriers to participate in their market-wide programs, such as solvency guarantee funds, high-risk pools, and other reinsurance or risk-transfer mechanisms, on a non-discriminatory basis. The secondary states could also apply premium taxes and assessments to make up the losses of market-wide pools, again provided that the payment structure does not discriminate between in-state and out-of-state plans.

 

States could also require that any broker or agent of out-of-state policies be licensed in-state so long as this requirement is applied on a non-discriminatory basis. The House bill also provides that consumers will retain recourse to their states' rules against insurance fraud and abuse.

 

This proposal would broaden the health insurance market and bring more competition to the marketing and purchasing of health insurance for millions of Americans. Those seeking more affordable coverage would not have to wait months or years for their state legislature or the relevant state agencies or commissions to approve such products; instead, they could take advantage of other states' markets immediately.

 

Writing recently in the Harvard Business Review, economists Michael Porter and Elizabeth Teisberg note that competition in health care today, particularly among plans and providers, is largely "local," but in a reformed health care system, competition would be regional and national.[3] In Porter and Tesiberg's vision of a reformed health care system, competition and choice would be unrestricted, information would be widely accessible to consumers, pricing would be transparent, billing would be simplified, insurance would be adequate and non-discriminatory, and there would be less litigation.[4] Enactment of the interstate commerce health insurance provisions of the House bill would be a step toward the realization of that vision.

 

Analysis: The cost of health insurance coverage varies widely among states. In an April 2004 study by Ehealthinsurance.com, an Internet provider of insurance quotes, researchers analyzed more than 60,000 policies sold in 42 states and the District of Columbia and found that individual premium costs ranged from a high of $4,044 per year in New Jersey to a low of $1,188 in Iowa and Wyoming.[5] Health care costs in a state are driven by a variety of factors, including cost increases resulting from increased reliance on newer and more effective prescription drugs, increased reliance on new medical technology, and increased utilization of medical services by an aging population, along with growth in the prevalence of chronic disease. The impact of these factors can vary from state to state. Nonetheless, excessive state regulatory policies add to the burden of heath care costs and price individuals and employers out of the insurance market.

 

Health insurance is one of the most highly regulated sectors of the American economy. Regulation imposes additional and often substantial costs. In a num­ber of states, costly regulations-such as benefit mandates and the imposition of rigid insurance rules-raise health care costs and discourage health plan participation. Interstate competition could encourage the development of a competitive national market for health insurance and, with it, serious regulatory review and reform.

 

In a groundbreaking cost-benefit analysis of 47 types of health care regulation, Professor Christopher Conover of the Terry Sanford Institute of Public Policy at Duke University found that the net cost of health care regulation amounts to $169.1 billion annually.[6] While the federal government is responsible for imposing some health insurance rules and mandates, the largest portion of these regulations comes from the states. A preliminary analysis of state health insurance regulation in the individual insurance market conducted by Professor Michael New of the University of Alabama for the Heritage Center for Data Analysis (CDA) estimates that guaranteed issue regulations increase monthly premiums by $160.56; community rating underwriting rules increase monthly premiums by $20.25; rules requiring direct access to medical specialists increase monthly premiums by $9.71; and mandatory assignment rules requiring insurers to make direct payment to non-participating providers increase monthly premiums by $7.91.[7]

 

Beyond state health insurance rules, another recurrent issue is the cost of state benefit mandates. According to the Council for Affordable Health Insurance (CAHI), there are 1,824 state regulations that mandate certain benefits nationwide.[8] The impact of mandates varies significantly by state. As the CAHI analysis notes, Minnesota and Maryland lead the nation in state mandates, with 62 and 58 mandates, respectively, while Alabama and Washington, D.C., have relatively few such mandates, with 18 and 16, respectively.[9] In Maryland, state benefit mandates account for approximately 15 percent of health insurance premiums.[10] Some states have begun to remove or reduce benefit mandates, and more and more state officials are working to make coverage more affordable by changing insurance rules or allowing insurers to offer less comprehensive health benefit packages. The House interstate commerce proposal would accelerate these changes.

 

Perhaps the biggest issue of all is the question of the primacy of state regulation of health insurance. The House bill is carefully written to preserve the basic construct of state regulation of health insurance. In essence, the bill exerts the federal government's power to regulate interstate commerce in order to facilitate cross-border insurance sales, but without federalizing insurance regulation in the process.

 

There are only two federal standards in the bill. First, primary states must use a "risk-based capital formula" to set solvency and reserve requirements. Second, primary states must have an independent review process for disputed claims unless the insurance carrier in question already has an independent review mechanism that meets National Association of Insurance Commissioners standards.

 

The obvious concern even with a bill as narrowly crafted as this one is that it opens the door to further federal regulation of health insurance. However, in fairness, the trend toward greater federalization of health insurance has been well underway for decades, at least since the 1974 ERISA legislation. For example, the fed­eral government now exercises some regula­tory authority over health insurance plans through various provisions of the Health Insurance Portability and Accountability Act of 1996 (HIPAA).

 

Making the Proposal Better: The House bill would not only reward reform-minded states working to reduce unnecessary health care costs, but would also encour­age other states to adopt reforms to keep their own health insurance plans competitive.

 

More important, the House bill opens up the possibility of creating a truly national market for health insurance in which individuals and families from Key West to Seattle could enroll in large national health plans, just as federal workers and retirees do today in the Federal Employees Health Benefits Program (FEHBP), the consumer-driven program that covers millions of federal workers and retirees.

 

The creation of a national market would lead to the creation of large national pools. These have obvious benefits: They reduce the impact of adverse selection and lower administrative costs. Moreover, in a national market, individuals and families would have the opportunity to purchase health plans sponsored by organizations that share their values on sensitive matters relating to the provision of health care services, including ethical health plans, faith-based health plans, and plans sponsored by religious organizations and institutions. The potential to transform the character of the health insurance market by enabling ordinary Americans to secure health care in accordance with their ethical, moral, and religious convictions is enormous.

 

While greater federal regulation of health insurance would likely result under the House bill, the creation of a robust national health insurance market could significantly improve Americans' access to the affordable coverage that they want. The growth of interstate commerce in the health insurance market would also intensify competition and improve the range of choices available to millions of Americans.

 

House Proposal No. 3: High-Risk Pools

The State High Risk Pool Funding Extension Act of 2005 (H.R. 3204) would provide federal grants to help states set up health insurance high-risk pools. The legislation would extend and slightly modify a program authorized by Congress in the 2002 Trade Adjustment Assistance Reform Act (TAA).[11]

 

Analysis: State health insurance high-risk pools are designed to offer affordable coverage to individuals who would otherwise be denied coverage in the individual insurance system because of expensive medical conditions. Because the purpose of high-risk pools is to make coverage affordable for the "uninsurable," by design their costs exceed their premium income, and thus they incur operating losses. States cover those losses out of other revenue sources, most commonly assessments on health insurance policies sold in the state.[12]

 

In TAA, Congress authorized $20 million in "seed grant" money help states establish high-risk pools. Any state without a high-risk pool that enacted legislation to create one could apply for a grant of up to $1 million to help set up the pool. However, these grants expired on September 30, 2004. Because of the limited time that seed grant funding was available, only five states were able to take advantage of them, and those grants totaled only $4.2 million.[13]

 

Congress also authorized a further $80 million in grants to states with new or existing high-risk pools to help them defray operating losses in their pools. $40 million per year was appropriated for FY 2003 and FY 2004.

 

H.R. 3204 would extend these two grant programs. It would authorize $15 million for seed grants for FY 2005. Because less than $5 million of the $20 million originally authorized for seed grants in TAA was actually spent, this is essentially an extension of the time for states to apply for the original TAA seed grant money. In addition, the legislation would authorize a further $50 million per year in operational subsidy grants for state high-risk pools for FY 2005 through FY 2009, for a total of $250 million.

 

The legislation would also modify the definition of a high-risk pool to give states more flexibility and modify the payment formula for the operational subsidy grants.

 

H.R. 3204 is a valuable extension of a modest, but important, health care safety-net program. However, it could still be improved in several respects.

 

Making the Proposal Better: First, the funding for seed grants for states to establish high-risk pools should be extended beyond just one fiscal year. Seventeen states still do not have such pools in place. States, especially those with part-time legislatures, often need more than one year to design and enact such programs. Indeed, had the original TAA seed grant funding been available for more than just two years, it is likely that more states would have established high-risk pools by now.

 

Second, the proposed increase in funding for the operational losses of high-risk pools is worrying. The danger is that the states will be encouraged to seek further extensions and greater subsidies as a way to shift health care costs to the federal government.

 

The purpose of risk-spreading mechanisms like high-risk pools and reinsurance pools is to ensure that the cost of covering the small minority of "uninsurable" individuals is spread evenly among all carriers and policyholders in a state-not simply shifted to the federal government. Such programs should properly operate as "closed systems" and not rely on subsidies from external sources. The more equitable approach, though certainly a politically contentious one, would be for Congress to allow states to assess self-insured health plans based on the number of covered lives in their state on the same terms that commercial insurers use to cover pool losses. That way the costs of covering "uninsurable" individuals would be distributed evenly across the whole population of a state.

 

The Missing Piece: Health Care Tax Credits

While the House proposals, focused primarily on health insurance reform, would improve the functioning of existing health insurance markets, their potential impact in expanding access and controlling costs is limited without corresponding changes in federal and state tax policy. The House bill contains no provisions that address this area of concern.

 

The American health care system and health insurance markets in particular are shaped and driven by the federal and state tax treatment of health insurance. Under Section 106 of the Internal Revenue Code, employee compensation in the form of health benefits is excluded from taxation if, and only if, employees get their health insurance through their place of work. Under today's employer-based health insurance system, that tax exclusion is unlimited. Similar tax policies govern employer-based insurance in the states. Together, federal and state tax breaks for health insurance amount to more than $210 billion annually.[14] This is the most significant variable in the health policy equation.

 

The current tax policy undermines portability of health insurance and simultaneously hides and fuels health care cost increases. Moreover, the current tax policy is profoundly regressive: Its benefits are inequitably distributed to upper-income individuals-those who least need help from the federal government. That is why President Bush has proposed a limited tax credit program for individuals and families who do not or cannot get health insurance through their place of work.[15]

 

A Better Idea: A national system of individual health care tax credits would be an even better policy. It would bring all Americans tax relief for the purchase of health insurance regardless of where they work, and Congress could target greater assistance to lower-income families or families with higher health care costs. In any case, a health care tax credit system would foster personal ownership and control of health plans and increase the market competition that the House health care bills seek to advance.

 

Conclusion

If Congress wants to reform the health care system, it must reform health insurance markets. But it cannot and will not fully reform health insurance markets unless it addresses the federal tax treatment of health insurance. Reform of the federal tax code is the single most important component of comprehensive health care reform.

 

The House bills focus on insurance market changes, not federal tax policy. Their omission of individual health care tax credits is thus a significant shortcoming.

 

Whether taken individually or as a whole, the House's legislative proposals are insufficient to address all of the major problems of the health care system. Nonetheless, these proposals are largely sound and can be easily improved, broadening their reach and impact and enabling free-market forces to work even more efficiently to provide medical coverage and access to care. This is particularly true of legislation to enable individuals and families to purchase more affordable coverage across state lines. Overall, these proposals would improve the current system for millions of Americans and allow the health insurance markets to function much better than they do today.

 

Edmund F. Haislmaier is Research Fellow in Health Policy Studies in, Robert E. Moffit, Ph.D., is Director of, and Nina Owcharenko is Senior Policy Analyst in, The Center for Health Policy Studies at The Heritage Foundation. Research Assistant Derek Hunter contributed to this piece.