American Journal of Law & Medicine

HMO and insurance insolvency: the benefits and detriments of a federal system.

I. INTRODUCTION

A. The National Character of the Health Maintenance Organization Industry

and the Need for Reform

Accompanying its expansive growth over the last fifteen years,(1) the health

maintenance organization (HMO) industry transformed from collections of HMOs in

local markets into an increasingly national system under the control of

centralized corporations.(2) During that time, HMOs established national chains

in an effort to capture market share,(3) The move toward nationalization of the

HMO industry suggests the need for a critical analysis of the current HMO

regulatory structure to determine whether it effectively safeguards the proper

functioning of HMOs.(4) As national and regional HMOs compete among themselves

and with local HMOs,(5) the need for unified, consistent financial protections

with respect to HMOs and similar entities becomes acute.(6) Competition from

national HMOs creates increased financial risk for the smaller HMOs whose

regional markets were previously insulated from broad-based competition.(7) The

need for preventative rules to offset this added risk, as well as a means by

which to adjudicate consistently cases of HMO and insurance insolvency, became

sufficiently acute that in March 1993 the U.S. House of Representatives sought

to regulate federally the solvency of insurance companies by proposing a

Federal Insurance Solvency Commission.(8) In addition, to deal effectively with

these problems, various industry participants and regulatory entities currently

seek other remedies and attempt action of varying degrees.

This Note examines the need for insurance insolvency reform using the HMO

structure as an example of why such reforms are necessary. With an eye on

ensuring continuity and adequacy of care for consumers, this Note uses the HMO

example to examine the current regulatory system and suggests remedies that

could protect HMOs and insurance companies from insolvency. Part I of this Note

examines the nature of HMOs and their "fit" with the current structures of

insurance insolvency. Part II considers the current state scheme of insolvency

regulation as it relates to HMOs. Part III analyzes the substantive merits of

four regulatory structures, including a federal insurance solvency commission,

and suggests which of these structures best promotes insurance and protects

consumers from HMO insolvency. The goals of the insolvency

proceeding -- irrespective of which regulatory structure best implements

them -- should be to maximize: (1) reorganization value of the HMO; (2)

reorganization or liquidation value for creditors; and (3) claim or contract

value for the customer. The final issue, derived from Part III and discussed in

Part IV, is which of these several options best integrates and achieves these

goals.

The "dual quality" of the HMO entity renders it a good candidate for

demonstrating problems inherent to the current insurance insolvency system.(9)

HMOs take responsibility both for providing care (via contractual relationships

with providers)(10) and for assuming -- or capitating -- the actuarial risk of

loss (as do many insurance companies). HMOs straddle the line between

independent providers and traditional indemnity insurance plans, the former

responsible for providing the health care service, the latter responsible for

assuming actuarial risk. The insolvency rules applicable to each should apply

to HMOs because they possess both functions.

In fact, most courts hold that traditional state rules for indemnity

insurance insolvency apply to HMOs despite their unique status.(11) Thus,

comments about the shortcomings of the current HMO insolvency structure can be

applied to the traditional insurance insolvency rules so that a unified system

could apply to both. Ideally, such a structure would provide a single means by

which to regulate both aspects of the dual quality. The attraction of a single

source of law both to provide an efficient system and to avoid the confusion

associated with different insolvency systems for different entities -- and

depending on increasingly arbitrary qualities -- yields efforts to achieve

broad-based rules with respect to insurance insolvency.

B. Competition and the Insolvency Problem

Statistics relating to health insurance insolvency reveal the recurring

nature of the problem. In recent years, managed care entities as a class and

HMOs specifically have faced varying types of solvency problems.(12) Although

some industry analysts expect the overall number of health insurance

insolvencies to decline, the record number of incidents of health insurance

insolvency in the early 1990s is expected to maintain a "historically high"

level.(13) In its insurance insolvency retrospective, A.M. Best Company (Best)

reported fifty-eight U.S. life or health insurance companies as financially

impaired in 1991.(14) These companies represented approximately two percent of

the total number of companies and comprised approximately three percent of the

insurance industry's total assets for that year.(15) In 1991, Best projected

that the rate of insurance insolvencies for that market segment over the next

two to three years would drop to approximately one percent of the total number

of companies.(16) Although suggesting the cycle of insurance insolvencies would

decline over the next several years, the study noted that "[h]ealth insurers,

which accounted for 47% of all impaired companies from 1976 to 1991, will

probably enter a down phase in the group health underwriting cycle in the near

future."(17) The study stressed that "this [trend] could produce more impaired

companies."(18)

The rise of managed care greatly exacerbated that trend because the

increasingly competitive health care marketplace constrains financial resources

along the vertical health care axis from provider to reinsurance entity.(19)

The proliferation of competitive managed care systems during the 1970s and

early 1980s created intense pressure in the health care industry and on the

overall profitability of HMOs.(20) This free market system increases insolvency

risk levels in the HMO and insurance field.(21) One report points out, even as

the Dow Jones industrials average broke through the six thousand mark for the

first time in history, that the HMO industry trailed in stock growth.(22) The

HMO entity arose rapidly during the managed care initiatives in the 1970s, and

the financial stability of HMOs did not consistently parallel the expansion in

number of HMOs and enrollees in such managed care programs.(23) Both in the

initial period of expansion and in the present restructuring,(24) the HMO

industry is beset by periodic insolvency crises.(25)

The real risk of HMO insolvency lies with the subscriber located at the

bottom of the web of contractual relationships that constitute the managed care

entity.(26) The financial regulation of the insurance industry directly affects

the structure of the health care industry in the United States and is crucial

to its stability.(27) The structure of the industry and the regulatory

architecture determines the extent of the solvency of insurance companies and

HMOs. The effects of HMO insolvency impact HMOs' general efficiency and affect

not only the quality but also the availability of care HMOs can provide their

members.(28) The need for protection of the health care consumer lies at the

heart of the need for protections against HMO insolvency. As the object of the

health care industry, a system that does not function efficiently does not

effectively satisfy the consumer's need for care. A system that does not

function at all, as can happen in an insolvency situation, affects the consumer

all the more. The ultimate risk to the consumer lies in an inability to recover

the cost of health care provided or to receive credit for prepaid fees.(29)

Protections against these risks must take the form of prospective and

retrospective insolvency guidelines and structures for HMOs.

II. HMOS AND THE AMBIGUITY OF THE CURRENT SYSTEM

A. State Regulation

States regulate insurance companies through their respective insurance

departments.(30) State insurance departments also initiate and conduct state

insolvency proceedings when necessary.(31) Before insolvency proceedings are

necessary, several alternatives are available.(32) Bearing responsibility for

regulating insurance solvency, the states monitor insurance companies to ensure

their ability to maintain financial health.(33) Monitoring procedures include

analyzing financial reports as well as conducting on-site reviews of

state-licensed insurance companies.(34) The insurance regulator may seek orders

to cease and desist any questionable underwriting and marketing activities.(35)

These activities create the bulk of the insurance insolvency problem because

existing regulatory measures fail to ensure compliance with the minimum

standards necessary to operate the insurance business.(36)

Further administrative actions by regulators include the issuance of

"mandatory orders relating to investments, assets, lending, borrowing and

reinsurance," each of which establishes certain limits on the companies'

activities, thus protecting the businesses and the customer.(37) States may

also institute administrative proceedings of supervision or conservation which

allow for a more active role for the state to operate the business.(38) At this

point, regulators and companies can seek mutually acceptable plans to remedy

the solvency problems before mandating court-supervised insolvency proceedings.

As a final option, once troubled HMOs meet certain conditions under state

law -- ranging from insolvency to violation of administrative orders regulating

financially impaired HMOs(39) -- the commissioner of insurance may institute

insolvency

proceedings in state court.(40) The insolvency proceedings may consist of either

rehabilitation or liquidation actions.(41) On instituting insolvency

proceedings, the regulator, acting as receiver, assumes substantial control

over the operations of the business and exercises wide discretion over the

proceedings.(42) The initiation of formal proceedings requires swift action to

notify the guaranty funds and the creditors of the insolvent company.(43)

Although many commentators consider the state systems as generally adequate

to handle single state insolvency crises, many commentators, legislators and

insurance regulators attack the current systems' ability to protect the

fluctuating insurance market as it becomes increasingly national and

international in scope and increasingly complex in the number and combination

of services provided.(44) On the regulatory front, state insurance regulators'

"hands are often tied by outdated laws, territorialism, lack of resources and a

fragmented structure that was not designed to cope with current problems,"(45)

effectively rendering "inadequate" states' administration of insolvency

regulation.(46)

The National Association of Insurance Commissioners (NAIC) moved to

impose further oversight on state procedures by instituting standards for

accreditation of individual state insurance departments and by setting minimum

capital requirements for insurance companies.(47) Moreover, the NAIC's attempt

to facilitate information between states is ineffective, leaving officials in

one state unaware of the solvency condition of the companies' branch offices in

another state.(48) The cost of insolvency proceedings results largely from the

failure to remove insolvent entities from the marketplace in a timely

manner.(49) The expense of the process and the time required for a proceeding

increase because state officials with differing needs, procedures and

experience levels are unable to share expertise among themselves due to lack of

communication and centralization.(50) The conflicting political pressures and

jurisdictional issues substantially impact the manner in which an insolvency

proceeding is carried out.(51) Further complications arise in the U.S. market

because "the United States is alone in liberally granting access to unlicensed

foreign companies" largely in the reinsurance sector.(52) The placement of a

substantial number of commercial policies abroad poses a problem for state

regulators trying to recover assets for policyholders' claims.(53) The general

inconsistency of the laws and procedures with respect to administration of the

insolvency system poses a significant problem for a multi-state insurance

company.(54) For example, the states employ varying guidelines and fiscal

standards in their management of the guaranty funds, which constitute the

source of payment of policyholder claims.(55) The end result of these problems

means "the goal of preventing insolvencies is `very unlikely to be achieved

through the present regulatory apparatus.'"(56)

B. Treatment Under the Bankruptcy Code

One obvious place to turn for a centralized remedy for the state insolvency

problems is the federal bankruptcy court. However, access to this remedy remains

largely unavailable to both insurance companies and HMOs.(57) Congress

established that under Bankruptcy Code [sections] 109(b)(2) "domestic insurance

companies" do not qualify for federal bankruptcy protection.(58) The

justifications for the exclusion of domestic insurance companies range from the

fact that state structures already exist,(59) to the public interest nature of

the companies that renders them more suitable to state regulation. …

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