Selling insurance across state lines

Spengler: There's something very important I forgot to tell you.
Venkman: What?
Spengler: Don't cross state lines.
Venkman: Why?
Spengler: It would be bad.
Venkman: I'm a little fuzzy on the whole "good/bad" thing here. What do you mean, "bad"?
Spengler: Try to imagine all life as you know it stopping instantaneously and every molecule in your body exploding at the speed of light.
Stantz: Total protonic reversal!

--The Ghostbusters, discussing health care reform proposals

Another wonky--but accessible!--post. I want to walk through one of the key alternative Republican ideas for reforming the health care system. At its heart lies one of the recurring Republican economic panaceas: deregulation. The idea I'm talking about was mentioned by Rep. Charles Boustany in the lackluster Republican response to Obama's speech to Congress last Wednesday night: "Let's also talk about letting families and businesses buy insurance across state lines."

Sometimes it is erroneously claimed that some oppressive federal law is keeping health insurance companies from selling their product across state lines. The reality is that a 64-year-old federal law called the McCarran-Ferguson Act essentially declared that, unless the federal government opts to step in, regulating the insurance industry is a state prerogative. The reason you can't buy insurance from another state is that your state doesn't allow it--in other words, it's not so much that you can't buy it but that an out-of-state insurance company can't sell it to you. States require insurers to be licensed in their state and to comply with various benefit mandate, community rating, and guaranteed issue regulations in their state.

A state could choose to allow its citizen to buy insurance policies that are sold in (and regulated by) other states. Bills allowing the purchase of out-of-state health insurance have been proposed over the past few years in Colorado, Pennsylvania, and Vermont (though they didn't pass). Rhode Island actually passed a bill last year that directs state officials to examine the feasibility of allowing insurers licensed in Massachusetts and Connecticut to do business in Rhode Island.

What advocates of across-state-lines insurance selling are calling for is a new federal law that essentially forces states--against their will--to allow the laws of other states to extend into their state. The exemplary legislation for this kind of proposal has been introduced by Arizona Republican Congressman John Shadegg in the last few Congresses; in the current Congress, it's called H.R. 3217, the Health Care Choice Act of 2009. Essentially, it allows health insurance companies operating under the laws of a "primary state" to sell insurance policies to people in "secondary states." The laws of the secondary state don't apply to the policy because only the primary state from which an insurance policy originates can regulate it. So let's suppose I live in Ohio and I find an insurance policy that a company based in, say, South Dakota is offering. Right now I can't buy that insurance because the South Dakota-based company isn't licensed in Ohio and likely isn't in compliance with Ohio insurance regulations. But if H.R. 3217 passed, that South Dakota-based insurance could be sold to an Ohioan, slithering into the state surrounded by a cocoon of South Dakota state law protecting it from Ohio's regulators. A hint of the potential problems with this sort of idea can be gleaned from the notice that H.R. 3217 would require the insurance company to provide me:

This policy is issued by [name of insurance company] and is governed by the laws and regulations of the State of South Dakota, and it has met all the laws of that State as determined by that State’s Department of Insurance. This policy may be less expensive than others because it is not subject to all of the insurance laws and regulations of the State of Ohio, including coverage of some services or benefits mandated by the law of the State of Ohio. Additionally, this policy is not subject to all of the consumer protection laws or restrictions on rate changes of the State of Ohio. As with all insurance products, before purchasing this policy, you should carefully review the policy and determine what health care services the policy covers and what benefits it provides, including any exclusions, limitations, or conditions for such services or benefits.

To really dig down int the dangers of this proposal, let me share the Parable of the Credit Card Industry. Once upon a time, banks faced the same quandary that health insurance companies face today. States could protect their residents with anti-usuary laws that limited the interest rates that banks could charge on credit cards. But in 1978 a Supreme Court decision, Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp, ruled that nationally-chartered banks were subject only to the anti-usury laws of the state in which they were chartered. Thus an anti-usury law in Ohio couldn't necessarily protect an Ohioan from outrageous credit card interest rates if the bank that issued the credit card was based in another state. Rather, that Ohioan would be at the mercy of the laws of that other state.

The result of this decision was exactly what one might expect. Certain states, looking to attract banks to relocate to them, repealed their anti-usury laws altogether. Thus states like South Dakota (now you know why I used South Dakota as an example) and Delaware that fostered a loose or nonexistent regulatory atmosphere became hubs for the credit card industry. Here's a typical example: not long after Marquette, Citibank charted a subsidiary in South Dakota through which to issue its credit cards. I won't go into the abuses of the credit card industry here but I'll note that Marquette is guilty of enabling those abuses. The moral is that deregulatory steps that prevent states from protecting their residents and effectively level the regulatory playing field at the lowest common denominator have enormous destructive potential.

What does this suggest about allowing health insurance companies to sell policies across state lines? It indicates that states would have an incentive to relax regulations to attract insurance companies and insurers, in turn, would have an incentive to relocate to the state with the most lax laws. But consumer protections exist, as the name would suggest, to protect consumers and abruptly shedding them is dangerous. The dirty little secret about a health insurance pool is that the healthy people subsidize the less healthy people; if a healthy person gets ill or injured, they in turn are subsidized. This, of course, is why the health reform proposals being offered by the Democrats right now (H.R. 3200 and the like) all contain an individual mandate: if we want to make it so that "uninsurable" people with pre-existing conditions or whatever can obtain health insurance, we have to mandate that healthy people enter the insurance pools and pick up some of the tab, too.

If an insurer locates itself in a state that lets it deny coverage to anyone it wants, it can construct a pool of the healthiest, cheapest individuals. Healthy people like it because the plan offers them cheaper premiums, the insurance company likes it because it's profitable (fewer payments for health benefits translates into larger profits). But if these sorts of plans pluck healthy people out of insurance pools all around the country, all of the other insurance pools suffer as they are left less healthy and more expensive. The rising costs of these pools in turn encourage the healthy people who are still in them to shop around for one of the cheaper "healthy people only!" plans and you get what's called a death spiral. It's not implausible to speculate that in many cases the insurance system will simply become unsustainable--numerous states currently operate small high-risk insurance pools for the "uninsurable" and these operate at a loss. Why would a private insurance company try this, particularly if it can relocate to a place with nonexistent consumer protection regulations? When all is said and done we likely end up with fewer insured people and, for many people, higher premiums. Total protonic reversal.

The vaunted benefits of the increased competition associated with this sort of deregulation flow to a specific segment of the population: healthy and easily insurable folks. These people do indeed stand to see cheaper premiums as insurance companies fall all over themselves attempting to attract their business. But everyone else stands to lose, perhaps substantially. Ultimately the issue is that profit maximization and the expansion of health insurance coverage are not compatible in the absence of consumer protections preventing insurers from simply slamming their doors in the face of less profitable prospective customers. The race to the regulatory bottom that bills like H.R. 3217 would trigger is propelled by competitive pressures. That should serve to remind us that, in the face of perverse incentives, competition in an unregulated free market isn't always the solution to every problem. So Egon was right--don't cross the streams state lines.