American Journal of Law & Medicine

Constitutional Ratemaking and the Affordable Care Act: A New Source of Vulnerability


As this Article is being written, the Patient Protection and Affordable Care Act (ACA) is being besieged with two different types of challenges. The first is a Commerce Clause challenge to the individual mandate on the ground that, although the Commerce Clause allows the government to "regulate" the transactions into which people choose to enter, it does not allow the state to force people to enter into disadvantageous transactions against their own will. The second of these challenges deals with the imposition of the Medicaid expansion provisions requiring a state to forego all of its additional Medicaid support unless it is prepared to extend Medicaid coverage, partially at its own expense, to individuals whose income levels put them at 100% to 133% of the federal poverty level. The charge is that this requirement represents, through the use of inappropriate conditions, an impermissible compromise of state sovereignty by forcing states to make the choice of taking on the costs of new programs or losing their federal support for their present program.

In this Article, we suggest that the ACA should, and may well, be subject to a third constitutional challenge dealing with a portion of the statute that thus far has escaped systematic judicial scrutiny, but which is likely to loom far larger in importance if both parts of the ACA weather their constitutional assaults--or if the individual mandate is struck down, but the remainder of the ACA survives. We refer to the elaborate set of provisions that regulate health insurance providers in the private market, including their access to the health insurance exchanges, which lie at the core of the private market's operation under the new statute.

The reason that these provisions have thus far escaped judicial notice does not, we believe, have to do with the weakness of the underlying claims. Rather, we think that the real reason is that the conventional wisdom views these provisions--chiefly those dealing with the combination of guaranteed issue and renewal, pre-existing conditions, community rating, rate review, and the medical loss ratio (1)--as not amenable to a facial challenge. A facial challenge, in this view, only works if the statute produces an unconstitutional outcome, in all states of the world, for the parties in question. (2)

The normal approach is that such certainty is not attainable in the world of regulatory affairs. We dissent. In some ratemaking schemes, we think that it is possible to identify a system of restrictions so pervasive that this exacting condition is satisfied. Indeed one of us (Epstein) was for a time involved in the litigation over the Durbin Amendment, in which this attack failed. (3) Nonetheless, we think that a reframed argument can meet the objections lodged against it by showing how the inefficiencies of that scheme of rate caps necessarily reduces consumer welfare in all states of the world.4 In connection with the Durbin Amendment, the deadly combination came in two parts. First, a sharp cut in competitive rates that could be collected from retailers. Second, the nominal right to collect money from retail customers that under no circumstances could offset the losses from retailers and which in fact did not yield any new revenues at all.

The theory behind this approach is that the ratemaking cases under the United States Supreme Court tradition do not give the government the same degree of discretion in regulating a particular industry that has sunk costs as they do in allowing general price controls over the economy. The point is made very clear by contrasting two cases, both of which were decided in early 1944. United States v. Yakus (5) upheld a broad delegation of authority to the federal government to impose price controls on the overall economy based on historical costs, subject only to a very low level of judicial scrutiny, which has proved to be all but useless in practice. (6) Just months before, the same Supreme Court, speaking through Justice Douglas, upheld a standard that required federal and state regulators to make sure that the rate of return on an equity owner's invested capital was "sufficient to assure confidence in the financial integrity of the enterprise, so as to maintain its credit and to attract capital." (7) As Hope Natural Gas makes clear, the judicial examination of rate regulation does not turn on the steps that the government takes along the way in reaching its final ruling. Instead, it turns on the need for its bottom line to produce an "end result" that satisfies the substantive standard. (8) In effect, Hope Natural Gas takes the view that complex ratemaking determinations involve many contested findings, some of which can cut in favor of the regulated utility and some of which can cut against it. The "end result" standard in question forgives the individual errors in dealing with rate calculation on the ground that they will "cancel out" along the way. That determination, however, does not undermine the categorical nature of the final standard, such that, for example, any explicit effort to short-circuit that standard will result in constitutional invalidation. On this score, the key standard is rate of return, not the ability to avoid bankruptcy, which would give far more running room to state regulators. (9) In Hope Natural Gas, the rate determination came in the context of a challenge to an individual rate, set in a specific hearing. That is the standard that will surely apply to any challenge brought against the various provisions that regulate the health insurance market here.

In many cases, it is said that the high level of deference in ratemaking cases necessarily dooms this inquiry. We take a different view. There are, in fact, a number of important rate cases dealing with, for example, insurance and telecommunications, in which the government's aggressive imposition of rate controls attracted successful constitutional challenge once the courts rightly understood the detailed operation of the particular industry. (10) In our view, the multiple constraints that the ACA places on the operation of its voluntary exchanges--and on the operation of health insurance companies inside and outside of the exchanges--will sooner or later force the imposition of controls on rates and revenues that will, in combination, yield a confiscatory rate--if they have not done so already. In order to set the stage, Part II of this Article examines in some detail the key features of these provisions that lead to this judgment. Thereafter, Part III shall develop the constitutional arguments in greater detail.


The ACA is a transformative statute that legislates in bold strokes. Taken together, the ACA's private insurance market provisions (11)--applicable to group plans and to health insurance issuers offering coverage in the individual and group markets--impose significant new coverage mandates that will increase the cost of providing health insurance coverage. At the same time, the ACA's private insurance market provisions will limit or prohibit the traditional insurance practices that enable insurers in other markets to price policies based on risk (either individual or group risk), and constrain premiums and rate increases. In addition, these provisions have two other features that increase their complexity and confusion. The first is that the government has extensive discretion in fleshing out by regulation the key provisions of Title I of the ACA. That situation is further compounded because the discretion extends not only to the articulation of the rules, but also to the granting of short-term waivers from the application of the rules that is in widespread use today, but subject to little or no published standards. (12) Second, the basic provisions envision a completed dance between the federal and state governments whereby both have an important say on how the rates are determined. Under this system, the initial examination of the factual record is made by the states (if the states have "effective rate review programs"), with federal oversight and required reporting to the Department of Health & Human Services (HHS) which issues the rate determination, or by HHS if the states do not have effective rate review programs. (13) The program necessarily requires close coordination between state and federal governments. The process is supposed to take place on an annual basis, but it seems unlikely that the review cycles can proceed on the rapid timetable needed to make all this work possible. The postponement of deadlines (which happened with the single debit interchange rate regulation published by the Federal Reserve Board (14)) is likely to become an integral part of the overall process.

The complexity of the regulatory framework is matched by the magnitude of the ACA's departure from the time-tested principles of insurance law. These principles start from two assumptions, both of which are violated by the ACA. The first assumption defends the principle of freedom of contract on matters of rates and coverage. The second holds that the greatest danger to an effective insurance market is the non-disclosure of key elements, going to the existence or magnitude of the risk, by the insured, not the insurer, who knows far less about the insured's risk, such as the condition of a vessel for which an application of marine insurance was pending. In line with these principles, traditional insurance law gave the insurer the ability to determine whether to accept or reject a designated risk, and to determine the premiums to be charged to an insured, the policy limits, and the terms and conditions on which to issue the policy. In sharp contrast to the ACA, extensive duties to disclose were imposed on the applicants or insureds because they alone possessed the relevant knowledge about the nature and scope of the risk that they were asking the insurer to assume. An applicant/insured was required to make full disclosure of health, health status, and health risks. The insurer would analyze the information and determine whether to accept or reject a given risk (i.e., to cover a given risk), along with risk-based premiums for coverage, the policy limits, and the terms and conditions upon which it issued the policy. The principles that started with individual policies carried over to group insurance, which presented special complications of its own, given the heterogeneity of its members. To the extent that these risks were evenly distributed over the insured population, they tended to cancel each other out. When that happened, the focus of the analysis shifted to the group as a whole, and so, for the most part, the personal characteristics of the beneficiaries were not considered individually.

In this traditional environment, regulation of insurance companies was directed to two different issues. The first aspect of insurance regulation was a general form of consumer protection, which required full disclosure of the terms and conditions of policies or plans, and reviews to ensure that the insurers carried out the terms of their contracts with customers. The insurer's own duty to disclose rates and terms did not negate the insured parties' equally critical duty to disclose information about material risks. The second aspect of insurance regulation addressed insurer solvency, imposing certain financial requirements on insurers, to ensure that the insurer receiving premiums to provide coverage would retain sufficient reserves to enable it to pay the valid policy claims. Competitive forces generally determined premiums. Most state and federal regulation directed insurers to file their policies in order to give fair notice of the rates in question to both state officials and the public at large. In some instances, as with assigned risk pools in automobile insurance, the states imposed rate regulation, creating severe dislocations in the underlying markets, owing to the elaborate cross-subsidies involved.

As we move to a specific discussion of the health insurance market provisions, it is important to note how such provisions apply with respect to plans and policies offered on the exchanges, as opposed to outside the exchanges, and how such provisions apply to pre-existing (or grandfathered) forms of coverage. The provisions discussed below specifically apply to plans and policies offered for sale in the private market. In general, they usually apply to plans and policies offered for sale on the exchanges in the same way. There are several notable exceptions: any large group plans that are offered on the exchanges, as permitted by state decision beginning in 2017, have to offer the essential health benefits package. (15) They must also provide their plans with actuarial values meeting the "metallic" levels. Any large group plans offered in the private market, however, do not have to meet these requirements. (16)

Under the ACA, only a subset of the health insurance market provisions apply to plans and policies that existed as of the adoption of the ACA ("grandfathered plans"). Accordingly, the ACA permits family members and new employees to be added to such plans or policies without the loss of grandfathered status. (17) In contrast, the provision requiring coverage of dependents up to twenty-six years of age applies to grandfathered plans, except that, for plan years before 2014, it only applies to group plans if the child is not eligible to enroll in eligible employer-sponsored coverage. (18) The prohibitions on pre-existing condition exclusions and excessive waiting periods apply only to those grandfathered plans that are group plans. (19) The provision barring rescission, except for misrepresentation or fraud, applies to grandfathered plans. (20) The bar on lifetime limits on essential health benefits applies to all grandfathered plans, while the bar on annual limits applies only to grandfathered plans that are group plans. (21) The medical loss ratio (MLR) provision applies to all grandfathered plans, as does the requirement for the development and distribution of the summary of benefits and coverage. (22) The implementing regulations adopted by HHS, the Department of Labor, and the Treasury Department (1) permit states to impose stricter requirements on grandfathered plans; and (2) apply separately to each benefit package available under a grandfathered health plan.

The status of grandfathered plans is not secure under the ACA. The following changes would cause a grandfathered plan to lose its grandfathered status under the regulations: (1) changes in the scope of benefits; (2) increases in percentage cost-sharing requirements; (3) increases in fixed-amount cost-sharing (other than copayments), except if limited to medical inflation plus fifteen percentage points; (4) increases in co-payments, except if limited to the above, or five dollars plus medical inflation; (5) decreases in the employer contribution rate of more than five percent below the March 2010 rate; (6) addition of an annual limit on the dollar value of benefits for a plan that did not impose overall annual or lifetime limits as of March 23, 2010; (7) addition of an annual limit for a plan that imposed only a lifetime limit, unless the annual limit is not less than the lifetime limit; or (8) any lowering of annual limits for plans that had an annual limit as of March 23, 2010. …

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