Closing the Healthcare Loopholes

With the election of Scott Brown to Congress, meaningful healthcare reform seems a lot less likely than it did a few months ago. The issue is so divisive that without a filibuster-proof super majority in the Senate, most political commentators just don’t think reform is possible at all. Yet, beneath the intractable debate between the parties over things like single-payer systems, public options and end-of-life counseling, there is actually a lot of common ground.

For example, not many in Washington would tell you that insurance companies should be able to deny coverage for preexisting conditions. Furthermore, all would agree that minimizing the costs of administering any sort of reform measure must be a priority given the already out of control national debt. There are also real implementation issues, as well as federalism and states-rights concerns associated with a large, national health insurance program.

The compelling thing about all this is that it is quite possible — with the closing of a minor loophole — to achieve real progress on many of the issues which Republicans and Democrats share common ground on.

So what’s this simple loophole? It’s called, “ERISA preemption.” Basically, ERISA is a federal law that was designed to regulate all employee benefits. Where there is a federal law that governs certain activities — in this case the administration of employee benefits — then any state law governing the same activity is “pre-empted” or superseded by the federal ERISA law. ERISA was never intended to regulate health insurance, and even contains explicit language which states that it is not to be read to cover healthcare plans.

OK, so then you’re probably wondering what the problem is and why this has anything to do with healthcare since, you know, it doesn’t cover health insurance plans. Well, the problem is that a lot of private healthcare coverage in the United States is not technically health insurance — it turns out that nearly half of all private, employer-provided health plans are now so-called “self-funded” plans. And the number of employers switching to “self-funded” plans continues to grow every year.

All insurance plans work by spreading risk. That means that we, the “policy holders,” all fear certain calamities — car accidents, floods, severe illness, etc. — that would create a financial hardship for us. We decided to pay a little bit now — this is called a “premium” — so that if a catastrophe should happen, we can draw on the pool of collected premiums from all policy holders in order to pay for the expenses we’ve incurred as a result of the calamity. This is the basic idea of risk spreading.

And health insurance works much the same way as other types of insurance. The only difference is that typically, in a traditional healthcare plan, an employer contracts with an insurance provider to deliver insurance coverage to its employees and the employer pays the premiums of its employees instead of the employees directly.

On the other hand, a self-funded plan is structurally different, but functionally the same. Instead of the premiums of its employees into an insurance providers general risk pool, the company takes that money and pays its employees’ insurance costs directly with it. In other words, it essentially forms its own risk pool. The employer then contracts with the same healthcare provider that it would have purchased insurance from to “administer” the self-funded risk pool. These plans operate the same way that a traditional healthcare plan would; the only difference is that the healthcare provider is no longer technically providing health insurance, they are just administering someone else’s plan.

Here is the problem with the current system: These “self-funded” plans are considered employee benefits and are not considered health insurance. That means that ERISA preempts any local regulation of these plans that might exist in areas where they are administered and would otherwise apply to the plans if they were considered to be health insurance. Instead, ERISA regulates these plans. Not surprisingly, as ERISA was never intended to cover health insurance, there is little to no language regulating “self-funded” plans in the statute. And thus these plans exist almost entirely unregulated.

Because of ERISA preemption, state regulation of health insurance is like nailing Jello to a wall. Prohibiting insurance providers from denying coverage for preexisting conditions or implementing other consumer protection laws has little if any effect other than driving more healthcare providers to encourage more employers to choose self-funded plans and use them as “administrators” rather than “providers” through pricing incentives.

Closing this loophole would allow states to regulate insurance providers in a way that they’ve been unable to in the past. State legislatures could then develop regulatory regimes tailored to the specific needs of the health insurance industry in their states. This would also allow the states to act as “laboratories” for developing novel, innovative health insurance regulation and would eliminate the need for an expansive national regulatory regime and be almost entirely deficit neutral.

Alas, an extremely strong insurance lobby and partisan rangling has kept a proposal to modify ERISA off the table.