American Journal of Law & Medicine

The role of state regulation in consumer-driven health care.


In December of 2003 the Medicare Modernization Act EMMA) added section 223 to the Internal Revenue Code, creating a federal tax subsidy for money contributed to (and earnings accumulated on) health savings accounts, or HSAs. (1) Though public attention was largely focused at that time on the provisions of the MMA creating the new Medicare prescription drug benefit, the MMA was also a major victory for advocates of "consumer-driven health care" who believe that HSAs have the potential to control the cost and improve the quality of health care in the United States, and perhaps even to increase health care access. (2)

Consumer-driven health care advocates believe that the key reason health care costs are out of control in the United States is that most Americans are too generously insured. (3) They believe the solution is to increase consumer sensitivity to cost and effectiveness by making people spend their own money for health care. (4) People should make health care purchasing decisions just as they make purchasing decisions for everything else: by evaluating the costs and benefits of health care and balancing their preferences for it with their preferences for other goods and services. If consumers are forced to do so, providers and professionals will lower their prices to compete seriously for the consumer dollar. On the other hand, consumers will buy only the services they really need (or want, or can afford) and thereby reduce utilization to the correct level. (5) Consumers will also be more sensitive to the effectiveness of health care, since they are now spending their hard-earned dollars to buy it. Finally, as costs come down health care will become more affordable to those who currently consume too little of it. (6)

Consumer-driven health care advocates believe that imposing higher deductibles is the most effective way to turn patients into consumers. (7) They argue that individuals should be encouraged to buy high-deductible health plans (HDHPs) to cover medical catastrophes, and spend their own money to cover routine medical care. (8) They encourage the establishment of HSAs to help assure that money is available to cover routine costs and to equalize the tax treatment of insured and out-of-pocket medical spending. (9) The MMA does this by offering three tax benefits: tax deductions for funds that HSA holders contribute to their HSAs (regardless of whether the account holder files an itemized return), exclusion from income and payroll taxation for funds employers contribute to HSAs for their employees, and freedom from taxation for accumulated earnings of HSAs. (10) The HSA must, however, be coupled with a HDHP, which must have a deductible of $1,000-$5,000 a year for a single individual, or $2,000-$10,000 a year for family coverage. (11) The tax subsidies for contributions to the HSA, moreover, only apply to amounts limited to the lesser of the deductible of the insurance plan or $2250 for individual coverage and $4500 for family coverage (indexed for inflation), though people over 55 are allowed to make additional "catch-up" contributions. (12)

Money contributed to a HSA is not subject to income tax if it is spent on "qualified medical expenses" (13) but is subject to both income tax and to a 10% excise tax if it is used for other purposes. (14) "Qualified medical expenses" are broadly defined, however, to include many things traditional health insurance does not cover such as nonprescription drugs, transportation or lodging while away from home to receive medical care, or long term care insurance premiums. (15) If HSA funds are not spent for health care, they can be withdrawn for any purpose once the account holder dies, becomes disabled, or reaches the age of 65. (16)

The consumer-driven health care vision and strategy is very controversial. Many health care policy experts believe that HSAs will do little to control health care costs or improve quality, and are likely to diminish access to health care by further fragmenting the insurance market. (17) The purpose of this article, however, is not to join this debate. Rather, our aim is to explore the regulatory issues that HSAs and HDHPs raise. Consumer-driven health care in general, and HSAs in particular, are major federal health policy initiatives, yet they raise a host of regulatory and health policy considerations that traditionally have been the province of the states. Therefore, understanding the interplay of federal and state oversight in this field is critical. For instance, some consumer-driven advocates complain that "state laws are getting in the way" of HSAs, (18) yet the sale of these products is increasing rapidly, (19) perhaps so rapidly that the states will not be able to fully think through the issues they raise before they capture a significant market share. There are legitimate concerns that state and federal regulatory policies may not be well-coordinated in this quickly developing new approach to health care finance and delivery.

To explore these issues, we begin by considering broadly the federalism issues raised by health insurance generally. We then focus more particularly on how these issues play out in the context of HSAs and HDHPs. We base our analysis in large part on twenty-two interviews we conducted in the spring of 2005 with a total of thirty-two regulators, insurance company and trade association representatives, independent experts, and HSA advocacy groups.


Throughout the last half-century, both the federal and state governments have played a major role in regulating health insurance in the United States. Their respective jurisdictions have evolved over time, and a variety of approaches to sharing and allocating authority have emerged. (20) A dominant theme--arguably the dominant theme has been federal deference to state regulation. From the Supreme Court's 1868 decision in Paul v. Virginia that "[i]ssuing a policy of insurance is not a transaction in commerce," (21) until the 1940s, insurance regulation was regarded as exclusively a state concern. In 1944 the Supreme Court reversed its position in United States v. South-Eastern Underwriters Association, (22) recognizing that insurance did involve interstate commerce. The following year, however, the McCarran-Ferguson Act (23) rearticulated the position that insurance regulation is principally the domain of the states, and that Congress preempts state regulation only if it clearly and considerately expresses an intent to do so.

Federal deference to state law is also evident in the Employee Retirement Income Security Act of 1974 (ERISA). (24) In general ERISA, which was intended to bring national uniformity to employee pension and benefit law, preempts state laws that "relate to" an employee benefit plan. (25) At the same time, however, ERISA explicitly "saves" from preemption state laws that regulate insurance, (26) assuring that most issues affecting insured employee benefit plans are governed by state rather than federal law. Recent Supreme Court decisions interpreting ERISA have emphasized the expansive state regulatory authority over insured ERISA plans. (27)

ERISA's complex preemption provisions also demonstrate other Congressional approaches to health insurance regulation. The Supreme Court has interpreted ERISA's "deemer" clause, which provides that ERISA plans "shall not be deemed to be an insurance company or any other insurer," as preempting all state laws that relate to self-insured employee benefit plans. (28) ERISA also preempts ordinary contract law of the states that duplicate its exclusive remedies. (29) Section 502 of ERISA provides a cause of action exclusively in federal court and under federal law, "to recover benefits due ... under the terms of [the ERISA] plan, to enforce ... rights under the plan, or to clarify ... rights to future benefits under the terms of the plan," (30) and preempts all state law to the contrary. ERISA regulations issued by the Department of Labor further provide a detailed federal scheme for claims determination and internal review by ERISA plans. (31) In these respects, ERISA has replaced state insurance law with federal.

With regard to other issues, however, federal law simply preempts state law without replacing it with federal regulation, essentially leaving a regulatory vacuum. The most notable example is ERISA's approach to common law or statutory claims against managed care plans for extra-contractual damages. (32) Here ERISA preempts all state claims but offers no federal remedy. More broadly, self-insured ERISA plans are exempt from state regulation and only subject to limited federal regulation. (33) With respect to many issues where states see regulation as appropriate, self-insured plans are simply unregulated. Congress is currently considering legislation for preempting state regulation of association health plans that reflects this same approach. (34)

State law preemption with and without replacement federal regulation does not exhaust the possibilities for dividing federal/state authority in health insurance regulation. The Health Insurance Portability and Accountability Act (HIPAA) represents yet another approach. (35) Several provisions of HIPAA impose direct federal regulatory control over insurers themselves, but allow the states to supplement federal regulation as long as the state regulation is not less restrictive than the federal law. (36) HIPAA's provisions limiting preexisting conditions clauses, for example, establish a federal floor for regulation but allow the states to impose more restrictive requirements. (37) Several states have done so. (38) HIPAA's privacy requirements for health information also are subject to more restrictive state regulation. (39)

Finally, in at least one instance the federal government has attempted to encourage the states themselves to regulate insurance, imposing federal regulation only if the states fail to take up the challenge. HIPAA requires insurers that sell in the individual market to offer insurance to individuals who lose group insurance coverage unless the state in which they are doing business provides an alternative approach to insuring individuals. (40) Most states have taken an alternative approach by covering individuals through high-risk pools. (41)

Despite the variety of these approaches to federalism, the general trend is toward greater federal involvement in health insurance regulation. Health care finance and delivery raises issues of national importance that are frequently viewed as calling for uniform or consistent national solutions. Rarely are these issues considered purely local concerns, and only a minority of policy advocates see the virtue in pursuing a "laboratory" of state experimentation with widely different approaches or non-approaches to possible solutions. (42) Increasingly, there is a shared sense that the most effective path toward reform is through federal leadership and oversight. (43) This was the path taken for promoting HMOs, for ensuring portability and accessibility of group health insurance coverage, and for protecting medical privacy. At first glance, this also appears to be the path for consumer-driven health care.

Closer inspection reveals, however, that Congress has taken a quite different approach in the MMA. The remarkable aspect of the MMA's provisions regulating HSA/HDHPs is the indirection of its regulatory strategy. The MMA does not require anything of health insurers or the states; however, it also does not explicitly free insurers from any state requirements. Rather the MMA simply offers federal tax subsidies for contributions individuals or employers make to an HSA that is coupled with a HDHP, and for the earnings of those accounts. (44) The MMA does not require insurers to offer such policies. It does not compel states to require insurers to offer such policies. It does not even require the states to allow conforming high deductible insurance policies to be sold. It simply makes it clear that states that prohibit such policies will deprive their residents of access to a generous federal tax subsidy. The Department of the Treasury has issued a notice that allows states until the end of 2005 to eliminate state statutes that block such high-deductible policies. (45) The law does not compel the states to eliminate these barriers, however. Therefore, although HSAs are one of the major federal health policy initiatives of our time, states may completely block or fail to implement them if they desire.

The use of tax subsidies to effect health insurance regulation is not original to the MMA. Arguably the single most important federal intervention in the health insurance market is the government's provision of tax subsidies for employment-related health insurance found in the 1954 federal income tax amendments. (46) More recently, federal tax subsidies have also been extended to subsidize health care flexible spending accounts, the purchase of health insurance by the self-employed, and most recently health reimbursement accounts. (47) Tax incentives were also available for Archer Medical Savings Accounts (MSAs), which preceded the HSA. (48) However, with the exception of the MSA statute, which was adopted for a limited time and applied to only very limited circumstances, these tax subsidies are not linked to particular forms of insurance and do not affect state attempts to regulate insurance. The MMA represents, therefore, an innovative approach to federalism health policy: regulation (and deregulation) through tax subsidies rather than through preemption.

A key policy question, therefore, is how the states have responded and will respond to this federal invitation to allow an innovative form of insurance. Has the possibility of a tax subsidy for their residents been sufficient to entice the states to remove regulatory barriers to HSAs and high-deductible insurance policies? Alternatively, do the states have their own concerns about HSAs or HDHPs that have produced regulation limiting their availability? …

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