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By Frances Simmons
American Bar Association - Tort Trial and Insurance Practice Section
2009-10 Law Student Writing Competition
Third Prize Winner
HR 3962: A Hurdle to Risk Spreading
Introduction
On November 7th, 2009, the House of Representatives passed the Affordable Health Care for
America Act. This act, also known as HR 3962, includes the most significant and comprehensive changes
to the way health care is delivered in this country since the creation of Medicare in 1965. While the
purported intent of HR 3962’s sweeping language is to enhance the ability of United States citizens to
obtain affordable health insurance, the provisions create barriers to an important tool insurance companies
use to decrease cost: risk spreading.
HR 3962 constitutes an exponential expansion of federal government control of health insurance
entities. Its provisions prevent health insurance companies from (1) identifying high-risk individuals, (2)
charging high-risk individuals higher premiums, and (3) applying cost spreading to insureds. In addition, it
does not create enough of an incentive for low risk individuals to obtain health insurance.
This paper first provides a background on the state of health insurance in the United States
followed by a basic review of barriers to risk spreading. The paper then examines specific HR 3962
provisions, and then presents a discussion of their practical effects and implications for the healthcare
insurance industry.
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Status of Health Care Insurance
Depending on the source, almost 18% of non-Medicare eligible adults lack health insurance in the
United States.1 The problem with this number is that there is no indication as to what prevents this
population for obtaining health insurance from the private market. 2 While pundits claim that the
prohibitively high health insurance premiums are the cause, there is evidence that suggests this is not the
case. Michael Chernew states, “[a]lthough the overwhelming majority of individuals participate in their
employer's plan, there appears to be a subset who do not, even at prices heavily distorted by the employer. 3
He speculates that, for this population, a further subsidy would not increase participation in employer
provided plans.4
What can explain this? It is possible that the issue is individual demand for health insurance. Amy
B. Monahan suggests that demand may vary based on perceived risk. 5 For example, young adults are more
likely to be uninsured than older adults.6
HR 3962 attempts to increase the number of individuals who are covered by health insurance in
numerous ways. The primary provisions involve (1) changing the tax treatment of health insurance
premiums, (2) requiring all individuals to purchase health insurance coverage, (3) requiring all employers
to offer health insurance coverage to their workers, and (4) reducing health insurance companies’ ability to
use pre-existing condition clauses. As drafted, HR 3962 will adversely affect health insurance companies’
ability to constrain cost through risk spreading by the phenomenons moral hazard and adverse selection.
1
Paul Fronstin, Sources of Health Insurance and Characteristics of the Uninsured: Analysis of the March
2007 Current Population Survey, EBRI Issue Brief, No. 310 at 4 (Washington, Employee Benefit Research
Institute, Oct. 2007), available at http://www.ebri.org/pdf/briefspdf/EBRI IB 10a-20071.pdf.
2
M. Kate Bundorf et al., Health Risk, Income, and the Purchase of Private Health Insurance (Nat'l Bureau
of Econ. Res., Working Paper No. 11677, 2005).
3
See, e.g., Michael Chernew et al., The Demand for Health Insurance Coverage by Low-Income Workers:
Can Reduced Premiums Achieve Full Coverage?, 32 Health Services Res. 453, 464 (1997)
4
Id; See also Jonathan Gruber & Ebonya Washington, Subsidies to Employee Health Insurance Premiums
and the Health Insurance Market (Nat'l Bureau of Econ. Res., Working Paper No. 9567, 2008), available at
http://www.nber.org/papers/w9567.
5
See, Amy B. Monahan, Health Insurance Risk Pooling and Social Solidarity: A Response to Professor
David Hyman, 14 Conn. Ins. L.J. 325, 329.
6
See, Paul Fronstin, Sources of Health Insurance and Characteristics of the Uninsured: Analysis of the
March 2007 Current Population Survey, EBRI Issue Brief, No. 310 at 15 (Washington, Employee Benefit
Research Institute, Oct. 2007), available at http://www.ebri.org/pdf/briefspdf/EBRI IB 10a-20071.pdf.
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Hurdles to Risk Spreading
Moral Hazard
The first hurdle to risk spreading is moral hazard. Moral hazard is the “theoretical tendency for
insurance to reduce incentives to protect against loss (ex ante moral hazard) or to minimize the cost of loss
(ex post moral hazard).”7 The greater the control the insured has over the loss, the greater the moral hazard.
Put simply, it is an information problem. Insurance companies could eliminate moral hazard “if they could
determine what people would do to be careful in the absence of insurance and then require people to take
the same level of care with insurance.”8 Unfortunately, it is not practical for insurers to set up a system to
determine whether their insureds were taking an adequate level of care.
Insurers utilize three strategies to address moral hazard: (1) Insurers provide a financial incentive
for insureds to invest in some form of durable protection; (2) insurers create a “community of fate” with the
policyholder, so that the policyholder feels some of the pain of the loss through deductibles and co-
payments; (3) insurers design insurance contracts so that risks that pose a very high degree of moral hazard
are not covered or are covered less completely.9
(1) Financial Incentive
Insurers restrict the amount of coverage an individual can take by requiring a deductible on
insured policies. It is thought this can encourage investment in protective measures and often improves
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both individual and social welfare.
(2) Community of Fate
Costs are incurred on the insured when insurers assert control. Carol Heirner coined the phrase
“community of fate” which occurs when the asserted control is so expensive that even the most risk averse
insured prefers some coinsurance rather than pay the price of full insurance. 11
(3) Limited Coverage
As a practice, risks that carry a high moral hazard tendency are not insurable at all. Medical
underwriting excludes specific individuals or groups for non-fortuitous risks.12 Lesser risks are covered less
7
Tom Baker, Insurance, Law, and Society: Beyond Risk Spreading (2008).
8
Id.
9
See, id.
10
Alexander Muermann et al., Self-Protection and Insurance with Interdependencies (NBER Working
Paper No. 12827, 2008), available at http://www.nber.org/papers/w12827
11
Carol Heimer, Reactive Risk and Rational Action: Managing Moral Hazard, Insurance Contracts (1989).
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completely.13 Insureds are classified and segregated into groups by type and amount of risk they represent
in actuarially fair insurance policies. 14 Each policy contains different coverage, exclusions, and premiums.
In health insurance, insurers utilize these tools to market policies segmented into categories with
distinct products and pricing. Insureds pay for their most likely health problems. Other risks are aligned by
actuarial fairness to premium rates with the risk profile of the individual or group.15 Cost sharing devices,
like co-pays and deductibles, discourage unnecessary medical care and make the insureds insure their own
losses.16 Coverage limits and caps on claims, like annual or lifetime limits on the amount of coverage,
provide a ceiling on the risk insurers face.17
Adverse Selection
The second hurdle to risk spreading is adverse selection. Adverse selection refers to the theoretical
tendency for high-risk people to be more interested in insurance than low-risk people. This tendency,
propitious selection, results in the average risk level of people who chose to purchase insurance being
higher than the average level of risk of the population as a whole. 18 Propitious selection comes about in two
ways. First, people who buy insurance may be on average more risk averse than people who do not.
Second, higher levels of risk aversion are correlated with more safety-oriented behavior.
Like moral hazard, this is an information problem. Addressing adverse selection requires insurers
to be able to identify and act on the risk status of potential insureds. Insurers use risk-shielding tools to
avoid propitious selection pre and post enrollment in their plans.
Pre Enrollment risk shielding tools
The initial strategy for insurers to limiting risk is to bar, prevent, or constrain enrollment. Insurers
use gate-keeping tools to weed out undesirable risks: (1) barring enrollment by refusing to issue a product;
12
See Milliman, Individual Medical Underwriting Guidelines, and Small Group Medical Underwriting
Guidelines (updated periodically).
13
Tom Baker, Containing the Promise of Insurance: Adverse Selection and Risk Classification, 9 Conn.
Ins. L.J. 371, 374 (2002/2003).
14
Robert H. Jerry II, Understanding Insurance Law (2d ed. 1996); Malcolm Clarke, Policies and
Perceptions of Insurance, 256-57 (1997).
15
John C. Goodman, National Center for Policy Analysis, Characteristics of an Ideal Health Care System,
Policy Report No. 242 (April 2002), available at http://www.ncpa.org/pub/st/st242/.
16
Id.
17
Wendy Mariner, Social Solidarity and Personal Responsibility in Health Reform, 14 Conn. Ins. L.J. 199,
207 (2008).
18
Tom Baker, Insurance, Law, and Society: Beyond Risk Spreading (2008).
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(2) medical underwriting to classify and adjust premiums; (3) the use of pre-existing condition exclusions
and waiting periods; and (4) coverage rescissions and cancellations.
1) Barring enrollment by refusing to issue a product
An individual’s health status alone may bar health insurance outright. This principle is primarily
used in the individual market and not group plans. For example, a person with a history of a congenital
defect of the kidney may be barred from enrollment.
2) Medical underwriting to classify risks and adjust premiums
As discussed above, insurers may use medical underwriting to classify and segregate individuals
into groups based on potential future use of care. These classifications permit allocation of premiums based
on the financial risk the individual posses to the insurer. An individual whose characteristics (both health
status and personal characteristics that predict health status and insurance use) pose higher financial risks
thus would be expected to pay a higher premium, and in some cases sufficiently high enough to render
coverage unaffordable.19
3) The use of pre-existing condition exclusions and waiting periods
Instead of barring enrollment, an insurer may allow enrollment, but will impose exclusions for
pre-existing conditions or waiting periods. The insurers assumption of risk is reduced by applying
restrictions on enrollment rather than completely barring individual enrollment.
4) Coverage rescissions and cancellations
In the case of an individual that is allowed to enroll, an insurer may rescind coverage of a benefit
or revoke coverage when an individual’s usage of care exceeds anticipated norms or when the insurer
suspects fraud at the point of enrollment. 20 In the case of rescissions, not only is coverage of the pre-
existing condition revoked, all claims leading up to rescission are no longer the responsibility of the
insurer.
Post-Enrollment Techniques
19
Sara Rosenbaum, Legal Solutions in Health Reform: Insurance Discrimination on the Basis of Health
Status: An Overview of Discrimination Practices, Federal Law, and Federal Reform Options, 37 J.L. Med.
& Ethics 103, 106 (2009)
20
See, id at 107.
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Once enrollment occurs, insurers strategies to limit risk shifts to management of risks associated
with coverage and utilization of health care. Insurers use case management and utilization tools to limit
risks: (1) limiting the scope of coverage; (2) high cost sharing; (3) utilization management techniques and
constraining challenges to coverage denials; and (4) constraining the size and operation of provider
networks and provider payment.
1) Limits on the amount, duration, or scope of coverage
Insurers place limits on the amount, duration, and scope of coverage to minimize the financial
risks of health coverage. Classes of benefits offered, how covered benefit classes are defined, and the
conditioning of coverage on certain requirements defines the scope of coverage provided.21 In addition, the
medical necessity standard defines treatments as necessary only when the treatment restores the individual
to previous functioning level. This can, in some cases, bar coverage of treatments that maintain function or
prevent the loss of function.22
2) Cost sharing
Insurers utilize cost-sharing techniques like deductibles, copayments, and coinsurance. In-network
and out-of-network tiering creates an incentive for insureds to use care economically by steering them to
providers that have a track record of efficient use. In addition, imposition of annual and lifetime limits on
care overall or by condition shifts the burden of coverage back on the insured.
3) Utilization management and procedures for challenging coverage denials
Insurers limit their risks by implementing utilization review processes. Insurance contracts are
drafted to retain discretion over the approval of coverage or limitation of coverage. 23 Courts and the federal
government have extended this power to allow insurers to define the appeals process.24 The ultimate burden
of proof lies with the insured.
21
See, Sara Rosenbaum, Legal Solutions in Health Reform: Insurance Discrimination on the Basis of
Health Status: An Overview of Discrimination Practices, Federal Law, and Federal Reform Options, 37 J.L.
Med. & Ethics 103, 107 (2009)
22
See, Id.
23
Firestone Tire and Rubber Co. v. Bruch, 489 U.S. 101 (1989) (applying lesser standard of review for
challenges to plan denial of coverage if the plan gives the administrator or fiduciary discretionary authority
to construe the terms of the plan).
24
Metropolitan Life Ins. Co. v. Glenn, 128 S.Ct. 2343, 2347 (2008); Regulations published by the
Department of Labor in 2000 limit the discretion of plan administrators to design the appeals process in the
case of appeals involving the denial of claims for health benefits. 29 C.F.R. ß 2560.503-1(h) (2008).
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4) Network size, composition, and payment
Insurers will use the above tools to control the size of their provider networks and their
compositions. Altering network size and composition, in turn, will affect utilization. For example, high-risk
individuals will be deterred from enrolling in plans that limit coverage, decreasing the number and
concentration of high-risk individuals in a network. In addition, insurers can shield risk by constraining
payments. This is accomplished by restricting the scope of covered procedures within a covered benefit
class and by reimbursing at lower rates for covered benefits.
These pre and post enrollment tools aid insurers in spreading the financial risk between
themselves and their insureds. Pre enrollment tools help to reduce propitious selection. Post enrollment
tools help to reduce moral hazard and limit financial losses due to over utilization of care.
Brief Overview of HR 3962
HR 3962 amends existing federal laws (HIPAA, ERISA etc) and imposes new restrictions on the
business of insurance. Contained in the bill are mandates that all health insurers accept all applicants, that
insurers limit the use of pre-existing exclusions, that policies cannot be rescinded or cancelled, and that
insurers no longer increase premiums for the more risky individuals. In addition, individuals will be taxed
for not obtaining health insurance, but the mandate has a big loophole. These provisions, as written, will
decrease insurers’ ability to shield them from and to spread risk.
Key Provisions
Rate Controls
Sec. 104. Sunshine on price gouging by health insurance issuers. Under §104, insurers lose the ability to
raise premiums without prior approval. Insurers must submit to a yearly review of their premiums. 25 In
order to increase premiums, the insurer must “submit a justification” for the increase “prior to
implementation of the increase” to the Secretary of Health and Human Services. 26
Sec. 213. Insurance rating rules.
Section 213 places restrictions on what classifications qualify for different premium rates. The
25
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §104.
26
Id.
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premium rate charged for plan coverage cannot vary except by age, premium rating areas, and family
enrollment.27 Each of the categories will be designed and specified by the Health Choices Commissioner
(created by §224).
Pre and Post Enrollment Controls
Sec. 103. Ending health insurance rescission abuse.
Under § 103, insurers lose the authority to determine when coverage can be rescinded. Insurers
must prove by “clear and convincing evidence” that there was fraud on the part of the insured. 28 That
evidence must be presented to an independent third party.29 In addition, a waiting period is imposed on the
insurer before the rescission can occur and coverage must stay in effect until the independent third party
determines rescission is appropriate.30
Sec. 212. Guaranteed Issue and Renewal for Insured Plans and Prohibiting Rescissions.
Section 212 requires insurers to accept for enrollment every individual who applies for enrollment
during the period in which the individual first becomes eligible to enroll under the terms of a group or
individual health plan. Additionally, insurers may not place any coverage restrictions on the individual. In
addition, no coverage can be rescinded except as provided for under section 103. 31
Sec. 106. Limitations on preexisting condition exclusions in group health plans in advance of applicability
of new prohibition of preexisting condition exclusions.
Under §106, the insurer look back period and duration of limitation periods are decreased. This
provision, in conjunction with §211, reduces the look back period for pre-existing conditions from 6
months to 30 days and reduces the limitation in coverage of pre-existing conditions from 12 months to 3
months.32
Sect. 211. Prohibiting Pre-existing Condition Exclusions.
Section 211 replaces section 106 once the grace period for adhering to the new standard of a
27
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §213(a)(1)-(3).
28
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §103(b)(1)-(2).
29
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §103(b)(1)-(2).
30
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §103(c)(1)(b).
31
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §212 (citing §2711 of the Public Health
Services Act).
32
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §106(a)(1)-(2).
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qualified health benefits plan ends.33 Section 211 guarantees coverage to all individuals despite pre-existing
conditions within 5 years of enactment.34 This section prohibits an insurer from imposing any pre-existing
condition exclusion or any limitations or conditions on coverage under the plan with respect to an
individual’s “health status, medical condition, claims experience, receipt of health care, medical history,
genetic information, evidence of insurability, disability, or source of injury.”35
Sec. 109. Elimination of lifetime limits.
Under §109, lifetime limits on covered benefits are eliminated. All plans, whether covered by
ERISA, HIPAA, or state laws, “may not impose an aggregate dollar lifetime limit with respect to benefits
payable under the plan or coverage.” 36
Sec. 222. Essential Benefits Package Defined.
Section 222 places restriction requirements on cost sharing. No cost sharing is allowed for
preventive items and services recommended by the “Task Force on Clinical Preventive Services.”37 Cost
sharing is capped at an annual rate of $5000 for individuals and $10000 for families with adjustments at the
discretion of the Secretary of Health and Human Services.38
Individual Mandate
Sec. 501. Tax on individuals without acceptable health care coverage.
Section 501 alters the Internal Revenue Code to include a tax on individuals who fail to obtain
health care coverage. If an individual fails to maintain health care coverage during a taxable year, a tax
equal to 2.5 percent of the individual’s modified adjusted gross income is imposed.39 This tax is capped at
the national average premium for that taxable year. 40
Potential Risk Spreading Challenges for Health Insurance Entities
33
Five years after enactment, most health care plans must conform to QHBPs requirements in order to
operate within the United States.
34
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §202(b)(1)(A).
35
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §211.
36
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §109(a)(1), (b)(1), (c)(1).
37
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §222(c)(1)(A).
38
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §103(c)(2)(A)(B).
39
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §501(a).
40
Id.
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HR 3962 hobbles insurers from utilizing methods to reduce moral hazard and adverse selection,
affecting their ability to spread risk and reduce costs. The bill’s provisions affect the risk spreading tools
through premium rate controls, restrictions on pre and post enrollment controls, and individual mandates.
Rate Controls
The drafters of HR 3962 intended for the rate control provision coupled with the guaranteed issue
provision to expand access to health care coverage by restricting insurers’ ability to utilize risk
classification and medical underwriting. Yet, these requirements, when implemented in state markets, have
had a destabilizing effect on health care plans. 41
HR 3962 switches an insurers rating model from “experience rating” to “community rating.”
Under traditional “experience rating,” insurers charge different premiums to groups of individuals based on
how much care that group utilizes.42 Under “community rating,” regulations limit how much insurers may
take into account factors like a group’s status, age, and past care utilization levels. 43 “Pure” community
rating models require insurers to spread the costs of coverage evenly across all groups. 44 Under this
scheme, all individuals pay the same premium, regardless of what grouping they may have been placed in
or past level of care utilization. For this reason, healthier groups end up paying higher premiums and
subsidizing less healthy groups. In addition, the “premiums of low risks exceed their actuarially fair level,
while those of high risk are lower than their fair actuarially fair level. 45 Market equilibrium may not be
sustainable under this arrangement.
Section 213 prohibits insurers from taking into account an individual’s health history or present
health status as a factor in deciding whether to allow enrollment in their plans. A consequence of this
mandate is that the low risk individuals, the young and the healthy, will have the same premiums as those
that are high risk, the old and the infirmed. As constructed, the mandate prevents insurers from offering
41
Alan C. Monheit and et al., Community Rating And Sustainable Individual Health Insurance Markets In
New Jersey, Health Affairs, 23, no. 4 (2004): 167-175, available at http://content.healthaffairs.org/cgi/
content/full/23/4/167#R4.
42
The Maze: Rate Regulation in Arizona, available at http://www.slhi.org/publications/policy_primers/
pdfs/pp-2003-11.pdf.
43
Id.
44
Id.
45
M. Rothschild and J. Stiglitz, Equilibrium in Competitive Insurance Markets: An Essay on the
Economics of Imperfect Information, Quarterly Journal of Economics 90, no. 4 (1976): 630–649; and T.
Buchmueller and J. DiNardo, "Did Community Rating Induce an Adverse Selection Death Spiral?
Evidence from New York, Pennsylvania, and Connecticut," American Economic Review 92, no. 1 (2002):
280–293.
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lower premiums to individuals that preserve and protect their health.
Section 213 does modify the community rating. It allows insurers to account for three rating
factors: age, location, and family composition. This modification does nothing to lessen the impact on the
insurers and healthy individuals. Healthy insureds of a given age group still subsidize the claims of sick
individuals by being forced to pay the same premiums. In addition, if the rates are the same for the healthy
and the sick, there lacks a financial incentive not to utilize the policy as much as possible.
Most troubling of all, states that have enacted similar mandates tend to have both problems: higher
premiums and overutilization. In 1993, New Jersey implemented the Individual Health Coverage Program
(IHCP). IHCP implemented similar provisions proposed in HR 3962:
1. Guaranteed issue of policies to any New Jersey resident without
access to group health insurance.
2. Guaranteed renewal to any person covered by an individual policy.
3. Limits preexisting-condition exclusions to 1 year.
4. Portability of coverage is guaranteed if an enrollee switches from
one carrier to another. The preexisting condition exclusion cannot be
restarted if the enrollee has had a lapse in coverage of less than 32 days.
5. Standardization of policies that can be sold, with specified benefits
packages and cost-sharing arrangements. The actual design of the six
original standardized plans was intended to reduce adverse selection
among the types of policies that could be bought in the IHCP market.
6. Premiums must be community-rated for policies sold in the
individual market, that is, a carrier must offer each plan it sells to all
applicants at the same premium.46
Eight years after implementation, enrollment in the program dropped by more than half.47 At the same time,
premiums increased two and three fold over initial rates. 48 In addition, the age composition of the enrollees
46
Katherine Swartz and Deborah W. Garnick, Can Adverse Selection Be Avoided in a Market for
Individual Health Insurance?, Medical Care Research and Review, Vol. 56 No. 3, (September 1999) 373,
376.
47
Alan C. Monheit and et al., Community Rating And Sustainable Individual Health Insurance Markets In
New Jersey, Health Affairs, 23, no. 4 (2004): 167-175, available at http://content.healthaffairs.org/cgi/
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changed. The enrollee population shifted toward older and potentially higher-cost enrollees.49 Between
1996 and 2002, the percentage of new enrollees aged 45-64 increased by over 20 percent.50 During that
same time period, the percentage of enrollees that reported their health as fair to poor doubled. 51 According
to Alan C. Monheit, this “separating market equilibrium” can be sustained only if low risks find more
restrictive plans of value and remain in the market. 52 Without this retention, high-risk enrollees will
dominate a program profile and as premiums rise to cover the increase in costs, further defections of low-
risk enrollees will occur.
The HR 3962 mandates place hurdles in the purpose of insurance to spread risk among the healthy
and the sick. When similar mandates are in place, healthy individuals tend to wait until they are sick before
enrolling in a plan. Because of guaranteed enrollment, there is no need for an individual to purchase
insurance while healthy if insurers are required to enroll him when he applies and to charge him the same
rate as if he were well. The resulting effect is to spread coverage expenses among the sick and the less
sick. As a consequence, insurers will be required to raise their rates or if they cannot provide adequate
justification to the Secretary of Health and Human Services, to leave the market all together.
Pre and Post Enrollment Controls
Pre-existing conditions
Currently, group insurers can only use the past six months of an individual’s medical history to
find a pre-existing condition.53 In individual markets, the look-back period ranges from six months or
less.54 Group insurers may not exclude an individual’s pre-existing condition form coverage for more than
12 months after an enrollment date.55 In most states, individual insurers are not restricted from imposing
permanent pre-existing condition exclusions.56
content/full/23/4/167#R4.
48
Id.
49
Id.
50
Id.
51
Id.
52
Id.
53
Kaiser Family Foundation, State Health Facts, www.statehealthfacts.org/glossary.jsp
54
Id.
55
Id.
56
Id.
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Section 106 shortens the look back period and insurer can use during medical underwriting and
section 212 guarantees coverage to all individuals despite pre-existing conditions within 5 years of
enactment57. If insurers have to cover all individuals and their pre-existing conditions, there is no incentive
for a healthy individual to obtain insurance coverage before getting sick. Insurers would be left covering an
increased ratio of those who are sick defeating a major component of insurance, risk spreading. As a
consequence, insurers would have to increase premium rates. The increased rates, as described above,
would drive more healthy individuals out of the market, perpetuating the problem of adverse selection.
Insurance rescission
While pre-enrollment medical underwriting can catch most pre-existing conditions, some do slip
through the cracks. The option of insurance rescission, through post enrollment underwriting, performs the
task of reducing adverse selection after enrollment. Adverse selection increases costs to all enrollees in a
plan. Concentration of risks and cost create a disincentive for lower risk individuals to obtain coverage.
Surprisingly, 20% of the United States population accounts for 80% of all medical costs. 58 High-risk
individuals may have the incentive to hide information about his health or level of risk in order to obtain
coverage from an insurer who would not otherwise offer coverage. In some cases, an individual may
accidently fail to disclose information to a potential insurer (e.g.- childhood illnesses, minor illnesses or
conditions). Another reason could be that the individual was not aware of the condition before enrollment.
An insurer may initiate an investigation if a new enrollee files a claim for a serious or expensive
condition during the first year of coverage. If it is determined that the enrollee failed to disclose all
pertinent health information or that the medical condition was pre-existing, an insurer could address the
issue several ways: coverage cancellation, coverage rescission, retroactive coverage riders, pre-existing
condition exclusion or no change in coverage.59
57
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §202(b)(1)(A).
58
Kaiser Family Foundation calculations using data from U.S. Department of Health and Human Services,
Agency for Healthcare Research and Quality, Medical Expenditure Panel Survey (MEPS), 2006.
Calculations located in Kaiser Family Foundation, “Health Care Costs: A Primer,” March 2009.
59
Robert Wood Johnson Foundation, Post Claims Underwriting and Rescission Practices: A Primer, 2009,
1-7, at 4, available at (last visited
November 18, 2009).
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Section 103 addresses coverage rescission. Coverage rescission is the retroactive cancellation of
health coverage. Not only is the individual’s coverage cancelled, the insurer is no longer responsible for
any previously submitted claims. Usually an insurer rescinds a policy if it determines that the enrollee
committed fraud, knowingly lied about or attempted to conceal a pre-existing medical condition in order to
qualify for coverage. Rescission for fraud is designed to protect both insurers and enrollees. Insurers are
shielded from individuals who “intentionally misrepresent their medical history and heath status in order to
obtain health insurance.”60 This tool creates an incentive for an individual not to wait until he is in need of
coverage before he obtains it, which, in its absence, would drive up cost for all enrollees. Insureds are
protected from losing coverage that they obtained in good faith. While there has been some evidence of
coverage rescission misuse, this tool acts as a deterrent to potential enrollees from being dishonest on their
applications.61
Coupled with pre-existing condition restrictions and guaranteed enrollment, insurers lose the
ability to avoid adverse selection. HR 3962 places blinder on insurers, effectively eliminating the role of
medical underwriting. Individuals will have the incentive to wait until they are sick before obtaining
coverage, undermining a basic principle of insurance: risk spreading. A concentration of risks has the
potential of creating higher costs for all individuals enrolled in healthcare plans.
Cost-Sharing
Insurers utilize cost-sharing techniques like deductibles, copayments, and coinsurance. Individuals
must have their own resources to pay for their most likely health problems. This serves two purposes. First,
it discourages unnecessary medical care.62 Second, it engages the insured in “insuring” his losses.63
Coverage limits, which limit the number and amount of covered services, also discourage unnecessary
60
Robert Wood Johnson Foundation, Post Claims Underwriting and Rescission Practices: A Primer;
Findings from Texas in Individual Health Insurance Market, 2009, 1-14, at 5, available at
(last visited November 18, 2009).
61
See for example, California Department of Managed Health Care News Release, “Department of
Managed Health Care Fines Blue Cross of California for Illegally Rescinding Health Insurance
Policieshttp://www.hmohelp.ca.gov/library/reports/news/prbccpcusurvey.pdf.
62
John C. Goodman, National Center for Policy Analysis, Characteristics of an Ideal Health Care System,
Policy Report No. 242 (April 2002), available at http://www.ncpa.org/pub/st/st242/.
63
Id.
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medical care.64 In addition, imposition of annual and lifetime limits on care overall or by condition shifts
the burden of coverage back on the insured and provides a ceiling on insurers’ risk. The “community of
fate” decreases utilization of care and decreases costs.
Section 109 eliminates annual and lifetime limits on medical coverage. Section 222 places a cap
on out-of-pocket expenses insureds pay per year. This cap applies to preventative services and care that a
third party panel decides is a necessary benefit. As posited by Wendy Mariner, “if services to prevent
illness and promote health and fitness become a mandated part of health insurance coverage, the role of
insurance may be converted from risk spreading into financing personal services.”65 She finds the use of
insurance to promote public policy “challenges the nature of commercial insurance.” 66 Preventive care is
predictable and under the control of the insured, therefore it is not normally an insurable risk.67 When an
insured elects to obtain these services, the insurer pays them for. Mariner believes that, since insurers can
predict the cost of this type of coverage without assuming risk, coverage contracts are removed from the
realm of insurance.68 Insurance payments would “function like assets of the insured to pay for a defined set
of services, resulting in a service contract rather than an insurance policy. 69
Under this setup, difficulties arise in placing boundaries on the demand for services or their costs.
Pushing expensive illnesses to later ages creates an incentive to push younger (i.e. healthier) individuals
into the risk pool to spread costs of the old.
Individual Mandates
64
See Tom Baker, Containing the Promise of Insurance: Adverse Selection and Risk Selection, 9 Conn.
Ins. L. J. 371 (2002/2003).
65
Wendy K. Mariner, Article: Social Solidarity and Personal Responsibility in Health Reform, 14 Conn.
Ins. L.J., 199, at 228 (Spring 2008).
66
Id at 210.
67
See, e.g., SCA Servs. Inc. v. Transportation Ins. Co., 419 Mass. 528, 532, 646 N.E.2d 394, 397 (1995)
(explaining that a risk that the insured knows is likely to happen "ceases to be contingent and becomes a
probable or known loss").
68
Wendy K. Mariner, Article: Social Solidarity and Personal Responsibility in Health Reform, 14 Conn.
Ins. L.J., 199, at 228 (Spring 2008).
69
Id.
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82 percent of the population of the United States currently has health insurance.70 Of the
remainder, only one percent of those under the age of 65 are uninsurable. The majority of the uninsured
lack health insurance not because they cannot afford it.71 This population has come to the conclusion that
the price of coverage is higher than the benefits they would receive. 72 An individual is less likely to obtain
health insurance if he is healthy and determines that he will not incur medical costs in excess of coverage
premiums. Part of the cause of this phenomenon is government insurance regulation that requires
individuals of all risk types to enter insurance pools at the same rate. This results in higher premiums for
the healthy to cover the cost of the other end of the spectrum. In the end, premiums rise as a result of the
healthy dropping their coverage.
As discussed above, Section 501 alters the Internal Revenue Code to include a tax on individuals
who fail to obtain health care coverage. If an individual fails to maintain health care coverage during a
taxable year, a tax equal to 2.5 percent of the individual’s modified adjusted gross income. 73 This tax is
capped at the national average premium for that taxable year. 74
Massachusetts enforces its mandate through a similar mechanism of fines based on a portion of the
cheapest health insurance plan being offered.75 A problem has emerged from this arrangement. When it is
cheaper to pay the fine than purchasing health insurance, healthy individuals will have the incentive to just
pay the fine. In 2009, the average cost of premiums for individual coverage is $402 per month or $4824 per
year for an employer provided plan.76 In order to drive the healthy and uninsured into health care plans, the
tax would have to exceed the cost of insurance. Unfortunately, the provision imposed a cap on the tax that
can be assessed.
If insurers must cover individuals and their pre-existing conditions, as mandated in sections 106
and 211, there would be nothing to prevent these individuals from refraining from getting coverage until
70
Paul Fronstin, Sources of Health Insurance and Characteristics of the Uninsured: Analysis of the March
2007 Current Population Survey, EBRI Issue Brief, No. 310 at 4 (Washington, Employee Benefit Research
Institute, Oct. 2007), available at http://www.ebri.org/pdf/briefspdf/EBRI IB 10a-20071.pdf.
71
Paul Fronstin, Sources of Health Insurance and Characteristics of the Uninsured: Analysis of the March
2007 Current Population Survey, EBRI Issue Brief, No. 310 at 4 (Washington, Employee Benefit Research
Institute, Oct. 2007), available at http://www.ebri.org/pdf/briefspdf/EBRI IB 10a-20071.pdf.
72
Id.
73
Affordable Health Care for America Act, H.R. 3962, 111th Cong. §501(a).
74
Id.
75
Jeffrey Krasner, Penalties to Rise for Shunning Insurance, BOSTON GLOBE, Jan. 1 2008, at A1.
76
Gary Claxton et al., Employer Health Benefits: Annual Report, Kaiser Family Foundation/Health &
Research Educational Trust, 2009.
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they are sick. Insurers would be stuck covering those who are sick. As a consequence, risk spreading would
eventually be defeated. An insurer’s only option to cover its costs would be to increase premiums,
perpetuating the problem of adverse selection by driving out the healthy.
Conclusion
While HR 3962 aspires to “provide affordable, quality health care for all Americans and reduce
the growth in health care spending,” the result will be the opposite. It hobbles insurers from utilizing tools
that reduce adverse selection and moral hazard, affecting their ability to spread risk and reduce costs. When
combined, the guaranteed issue, the elimination of annual and lifetime coverage caps, and community-
rating mandates eliminate the financial consequences to individuals related to their lifestyle choices, for
good or ill. Individuals have no financial incentives to get regular screening exams, to eat a healthy diet, to
exercise regularly, or to avoid unhealthy or dangerous activities. Consequently, those who voluntarily
choose healthy lifestyles are forced to subsidize the higher health care costs of those who do not.
In response, healthy individuals would have the incentive to drop out of the insurance pool and
forego coverage until they become ill. The mandatory coverage provision does not create enough of an
incentive for healthy individual to stay in the insurance pool. The tax cannot be over the price of the
average premium offered in the United States. Since premiums would be community-rated and higher than
the actuarially fair value for a healthy individual, it would be cheaper to pay the fine than to obtain
coverage.
In conclusion, HR 3962 will have a detrimental affect on commercial health insurance: higher
concentration of risk, smaller insurance pools, and increased premiums.