BILL ANALYSIS Ó
AB 1434
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Date of Hearing: April 27, 2015
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Philip Ting, Chair
AB 1434
(McCarty) - As Amended April 20, 2015
Majority vote. Fiscal committee.
SUBJECT: Health insurance: prohibition on health insurance
sales: health care service plans
SUMMARY: Deletes existing statutory language providing that any
person or entity subject to regulation under the Knox-Keene
Health Care Service Plan Act of 1975 (Knox-Keene) is not subject
to Insurance Code Section 742, which places specified coverage
providers under the jurisdiction of the Department of Insurance.
Specifically, this bill:
1)Repeals Health and Safety Code (H&SC) Section 1396.5. H&SC
Section 1396.5, in turn, provides that a nonprofit hospital
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corporation that substantially indemnified subscribers and
enrollees and was operating in 1965 under Insurance Code
Section 11490 et seq. and which is regulated under Knox-Keene
shall enjoy the privileges under the act that would have been
available to it had it been registered under the Knox-Mills
Health Plan Act (Knox-Mills) and applied for a license under
Knox-Keene in 1976.
2)Prohibits an entity licensed under Knox-Keene from offering,
marketing, or selling health insurance, as defined, including
a preferred provider organization (PPO) or arrangement
described in Insurance Code Section 10133, whether issued on a
group or individual basis, to an existing or new customer.
EXISTING LAW:
1)Imposes an annual 2.35% gross premiums tax on each insurer
doing business in California, as specified. (California
Constitution Article XIII, Section 28.)
2)Defines the term "health insurance", for purposes of the
Insurance Code, to mean an individual or group disability
insurance policy that provides coverage for hospital, medical,
or surgical benefits. (Insurance Code Section 106(b).)
3)Provides that any person who transacts disability insurance
without a valid and unrevoked certificate of authority from
the Insurance Commissioner is guilty of a misdemeanor, except
as specified.
4)Provides, under Knox-Keene, for the licensure and regulation
of health care service plans (HCSPs) by the Department of
Managed Health Care (DMHC).
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5)Defines a HCSP to include any person who undertakes to arrange
for the provision of health care services to subscribers or
enrollees, or to pay for or to reimburse any part of the cost
for those services, in return for a prepaid or periodic
charge. (H&SC Section 1345(f).)
6)Places under the jurisdiction of the Department of Insurance
any person or entity that provides coverage in this state for
medical, surgical, chiropractic, physical therapy, speech
pathology, audiology, professional mental health, dental,
hospital, or optometric services, whether this coverage is by
direct payment, reimbursement, or otherwise, and that enters
into an arrangement or contract with, or underwrites, a PPO or
specified arrangement. (Insurance Code Section 742(a).) Any
person or entity subject to regulation under Knox-Keene,
however, is not subject to this statutory provision.
(Insurance Code Section 742(b).)
7)Provides that a nonprofit hospital corporation that
substantially indemnified subscribers and enrollees and was
operating in 1965 under Insurance Code Section 11490 et seq.
and which is regulated under Knox-Keene shall enjoy the
privileges under the act that would have been available to it
had it been registered under Knox-Mills and applied for a
license under Knox-Keene in 1976. (H&SC Section 1396.5.)
FISCAL EFFECT: Unknown, but potentially significant revenue
implications to the extent this bill results in certain entities
becoming subject to the gross premiums tax on insurers.
COMMENTS:
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1)The author has provided the following statement in support of
this bill:
We need to close the loophole that allows any insurer to
move their health insurance products to the Department of
Managed Health Care to avoid the strong consumer protection
oversight of the Department of Insurance and avoid paying
premium taxes.
2)This bill is co-sponsored by Insurance Commissioner Dave
Jones, who notes the following:
Existing law allows Anthem Blue Cross and Blue Shield of
California to choose the regulator with which to file their
PPO products. These companies were granted special
separate exceptions which allowed them to sell regulated
PPO business under Department of Managed Health Care (DMHC)
licenses. This special exception allowed these two
companies to "regulator shop," thereby creating an uneven
playing field among PPOs as they compete in the
marketplace. Blue Shield had its 2014 products disapproved
by the Department of Insurance for non-compliance with the
Affordable Care Act and non-compliance with the network
adequacy law and rather than amend those filings in order
to comply with the law, they instead filed these products
with DMHC. Anthem is similarly moving their PPO products
to regulation under DMHC.
These special exceptions in law that allow these companies
to regulator shop also prevent Anthem Blue Cross and Blue
Shield from paying their fair share of taxes. Companies
that file their PPO policies with DMHC pay corporate income
tax on their net income instead of the gross premium tax of
2.35% on all premiums received that all insurers pay under
the state's Constitution. Filing non-HMO products under
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DMHC results in a significant loss of revenue to the
General Fund. This loophole has resulted in the General
Fund forgoing more than $1 billion from 2004-2011. As Blue
Shield and Blue Cross move their PPO products to DMHC, the
loss has increased from $150 million in 2011 to $220
million in 2014 and to over $300 million if the rest of the
covered lives move this year.
3)Opponents contend that this bill "seeks to strip the DMHC of
[its] regulatory authority over PPO products in California and
drive up health care costs by adding additional tax burdens on
health plans." Specifically, opponents note:
Prior to the ACA, significantly different products could be
filed at CDI [than] were filed at [the] Department of
Managed Health Care (DMHC). However, the ACA now requires
all product offerings, regardless of regulator, to have the
same benefit structure, making [filing] products with two
regulators redundant and inefficient. Further, the
consolidation of our products under the DMHC ensures better
consumer protections, including a ban on balance billing in
certain circumstances, than afforded by the CA Department
of Insurance (CDI). Finally, despite what is said by the
proponents of AB 1434, the DMHC has a well-established
record of regulating health plans and in particular [PPOs].
In fact, it wasn't until the late 80's that the Insurance
Code had to be amended to allow for [PPOs] to exist at CDI.
It's nonsensical that the legislature would arbitrarily
move products between regulators without real justification
at this time.
4)Committee Staff Comments
a) The bifurcated regulation of health care in California :
California has two separate regulators of health care
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coverage: the DMHC and the Department of Insurance.
i) The DMHC : The DMHC, within the Health and Human
Services Agency, regulates the managed health care
industry, a form of health care coverage used by nearly
22 million people in California. The DMHC oversees
full-service health plans, including all California
health maintenance organizations<1> (HMOs) and some PPOs,
as well as specialized plans such as dental and vision.
Specifically, the DMHC notes that Knox-Keene vests it
with the exclusive authority to regulate and license
HCSPs, including Anthem Blue Cross (Blue Cross) and Blue
Shield of California (Blue Shield). Overall, the DMHC
regulates more than 90% of the commercial health care
marketplace in California.
ii) The Department of Insurance : The Department of
Insurance was created in 1868 as part of a national
system of state-based insurance regulation. According to
the Department of Insurance, all of its functions,
including overseeing insurer solvency, licensing agents
and brokers, conducting market conduct reviews, resolving
consumer complaints, and investigating and prosecuting
insurance fraud, are designed to protect consumers.
Among its many duties, the Department of Insurance
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<1> An HMO is a kind of health insurance that has a list of
providers, such as doctors, medical groups, hospitals, and labs.
A patient must receive all of his or her health care services
from the providers on this list, also called a "network".
Usually, a patient with an HMO will have a primary care doctor
responsible for managing the patient's care. If the patient
needs to see a specialist, get tests, or be hospitalized, this
primary care doctor will request authorization and the medical
group must approve the service. Patients generally pay a fee or
"co-pay" for each service and may also be subject to a yearly
deductible (i.e., an amount the patient must pay each year
before the HMO pays for any services).
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regulates certain health insurance products. The
Department of Insurance is run by the Insurance
Commissioner, an elected constitutional officer.
b) Distinguishing between HCSPs and insurance : The DMHC
notes that, as early as the 1940s, HCSPs had evolved as a
legally distinct form of health care delivery. To this
end, the DMHC points to a 1946 California Supreme Court
decision holding that an arrangement to provide health care
services for dues-paying members did not constitute
"insurance" and was not regulated under the Insurance Code
because its principal object and purpose was service rather
than indemnity. (Cal. Physicians' Serv. v. Garrison (1946)
28 Cal.2d 790, 809.)
Between 1965 and 1976, private prepaid HCSPs were regulated
under a set of Government Code provisions known as
Knox-Mills. This act "was designed to regulate plans other
than those operated by licensed insurance carriers".
(Roseville Cmty. Hosp. v. State of California (1977) 74
Cal.App.3d 583, 585.) The rapid expansion in the ensuing
years of HCSPs gave rise to the passage of Knox-Keene in
1975.
Knox-Keene, in turn, appears to recognize this distinction
between "insurance" and HCSPs. Fox example, Knox-Keene
provides that a person licensed under its provisions need
not be licensed under the Insurance Code to operate a HCSP
unless the plan is operated by an insurer. (H&SC Section
1349.) Conversely, Knox-Keene specifies that if the DMHC
determines that an entity "purporting to be" a HCSP exempt
from Insurance Code Section 740 is not, in fact, a HCSP,
the DMHC shall inform the Department of Insurance of that
finding. (H&SC Section 1346.5.)
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c) The distinction between insurance and HCSPs begins to
blur : Originally, Knox-Keene's definition of a "HCSP"
excluded plans that "substantially indemnified subscribers
for the cost of provided services." (Former H&SC Section
1345(f).) In 1980, however, the Legislature removed the
indemnity exclusion from the definition of a HCSP. The
DMHC notes that this paved the way for Knox-Keene-licensed
PPOs<2> such as Blue Cross and Blue Shield, as well as
other products with indemnity features.
At the same time, Blue Cross contends that traditional
insurers offering disability insurance products also
evolved, and sought expanded authority to write products
beyond the scope of traditional indemnity products.
Specifically, Blue Cross notes:
In response to this need, the Legislature adopted
amendments to Insurance Code section 10133, which, over
time, allowed insurers to directly reimburse health care
providers, and to offer "alternative rates of payment" to
providers (enabling insurers to compete with HCSPs
offering contracted provider networks). That is,
insurers moved away from the traditional indemnity model
and began exhibiting attributes of HCSPs.
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<2> A PPO, in turn, allows individuals to see providers without
prior approval from their health plan or medical group.
Patients in a PPO get most of their health care from a network
of doctors and other providers. Patients can choose to go
outside of the network for some care and pay a higher cost. In
addition, the patient will usually pay a yearly deductible
before the PPO starts to pay some or all of the patient's bills.
A patient will usually pay a "co-insurance", or percentage of
the bill, when the patient receives a covered service. The PPO
pays the remainder.
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Thus, Blue Cross contends that the original distinction
based on the manner in which care is delivered (i.e.,
directly or through "indemnity") has been replaced by a
focus on the adequacy of care as the "central defining
characteristic of HCSPs relative to insurers writing health
insurance . . . . "
d) What does this bill seek to do ? Insurance Code Section
742 specifies that any entity providing health coverage
that enters into an arrangement with, or underwrites, a PPO
is subject to the jurisdiction of the Department of
Insurance. Insurance Code Section 742(b), however,
provides that any entity regulated under Knox-Keene is not
subject to this general rule. This bill would, among other
things, delete subdivision (b) of Insurance Code Section
742 with the ostensible purpose of placing all PPOs,
including Blue Cross and Blue Shield, under the regulatory
jurisdiction of the Department of Insurance.
e) What does all this have to do with taxes ? The author
notes that this bill "would eliminate the loophole that
allows only Blue Shield and [Blue Cross] to shop regulators
for their PPO products." Specifically, the author's office
notes:
In two separate actions, Blue Shield and [Blue Cross]
were granted exceptions to sell regulated PPO products
under the [DMHC]. All other health insurers' PPO
products are regulated by the California Department of
Insurance and do not have the option to shop regulators.
When a PPO product is regulated under the DMHC it is
taxed more favorably than the PPO products of all other
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insurers. Rather than paying a gross premium tax like
all other insurers, PPO products regulated under the DMHC
pay a corporate income tax. This change in tax liability
caused by the regulator shopping loophole results in
significant loss of revenue and creates an unfair playing
field amongst health insurers.
f) California's gross premiums tax : Insurance companies in
California are subject to a gross premiums tax equal to
2.35% of all premiums written. The gross premiums tax is
imposed by Article XIII, Section 28, of the California
Constitution. Section 28(a), in turn, defines an insurer
to include "insurance companies or associations and
reciprocal or interinsurance exchanges together with their
corporate or other attorneys in fact considered as a single
unit, and the State Compensation Insurance Fund."
For most types of insurers, this tax is in lieu of all
other taxes except property taxes and vehicle license fees.
Thus, insurers do not pay tax on other forms of income,
such as investment income, or income earned from other
trades or businesses. Most other states also have a
state-level gross premiums tax.
The special tax treatment of insurance companies is
primarily grounded in the economics of the insurance
industry. Most businesses calculate their income by
subtracting costs incurred in the production of a good or
service from the revenues received from sales. Insurance
Companies, by contrast, collect their revenues "up front",
and subsequently make payments to policyholders based on
contingent events that may occur months or years later.
Thus, it can be challenging to match up revenues to related
expenses. For this reason, a gross premiums tax was
adopted. As the Legislative Analyst's Office (LAO) has
noted:
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In an income tax framework, insurers ideally would be
allowed to deduct the current value of all future
obligations (claims) covered by the insurance policies
they have written when calculating their taxable income
for a given year. Because the actual amount of these
obligations is uncertain, as are the amount of investment
earnings on accumulated premiums received during the
intervening period, an accurate determination of the
theoretically appropriate amount of taxable income proves
very difficult to achieve in practice.
The LAO also notes that the gross premiums tax appears, in
most years, to raise more revenue than would be raised by
applying the Corporation Tax Law to insurers' net income.
As noted above, the author asserts that a health benefit
company's taxation depends on whether its plans are
regulated by the DMHC or the Department of Insurance. The
author is not alone in this contention. The DMHC
essentially asserts that because the constitutional
definition of "insurer" is "vague", its interpretation
should depend upon the comprehensive statutory scheme the
Legislature has adopted for regulating health care
coverage. The DMHC asserts that this regulatory scheme
firmly establishes that HCSPs, including those that sell
PPO products, are not insurers for purposes of the gross
premiums tax.
g) I'll see you in court : This very issue, however, is
currently the subject of ongoing litigation pending before
the California Court of Appeal. Specifically, on July 3,
2013, Michael D. Myers filed a taxpayer action alleging
that the Insurance Commissioner, the State Board of
Equalization, and the State Controller have all failed to
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perform their duties under California law to assess and
collect the gross premiums tax from Blue Shield and Blue
Cross. Blue Shield and Blue Cross, in turn, filed
demurrers asserting, among other things, that neither
entity is an "insurer" subject to the gross premiums
tax.<3> The trial court sustained the demurrers pointing
to the case of Silvers v. State Board of Equalization
(2010) 188 Cal.App.4th 1215 for the proposition that the
term "insurer" in Section 28 of Article XIII of the
California Constitution means an entity licensed by the
Insurance Commissioner. Moreover, the trial court noted
that it was undisputed that neither Blue Shield nor Blue
Cross is licensed by the Insurance Commissioner.
Mr. Myers has appealed the trial court judgment. The
California Court of Appeal is now being asked to decide,
among other things, whether a licensed HCSP in the business
of writing HCSP products including PPO products, is subject
to the gross premiums tax applicable to insurers.
h) The parties make their arguments :
i) Blue Cross : Blue Cross is a licensed HCSP regulated
by the DMHC under Knox-Keene. Blue Cross asserts that it
is in the business of arranging health care services for
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<3> In its demurrer to the Myers complaint, Blue Cross also
asserted that the action impermissibly sought to re-litigate a
case it had already litigated and won. Specifically, Blue Cross
pointed to a 2004 case in which the Foundation for Taxpayer and
Consumer Rights (FTCR) asked the court to compel the collection
of the gross premiums tax from Blue Cross. FTCR had argued that
Blue Cross must be considered and taxed as an "insurer" since a
substantial portion of its plans were PPO products in the nature
of insurance. The trial court ruled against FTCR as a matter of
law, holding that Blue Cross, as a HCSP, was not an insurer
subject to the gross premiums tax.
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its members. Blue Cross notes that it arranges health
care services, in part, by offering PPO products that are
authorized HCSP products regulated by the DMHC. Blue
Cross asserts that these PPO products are not insurance.
To this end, Blue Cross maintains that it is neither an
insurer nor an insurance company and that the Insurance
Commissioner is without jurisdiction to regulate it.
Thus, Blue Cross asserts that it is not subject to the
gross premiums tax, which applies to an "insurer" in lieu
of all other state taxes save real property and motor
vehicle taxes.
ii) The Insurance Commissioner : The Insurance
Commissioner argues that the Myers trial court erred in
mechanically concluding that because Blue Shield and Blue
Cross are denominated as HCSPs under Knox-Keene, and are
regulated by the DMHC, they are exempt from the gross
premiums tax. Specifically, the Insurance Commissioner
contends that the true test for determining whether Blue
Shield and Blue Cross are subject to the gross premiums
tax is not how they are labeled or who regulates them,
but whether they are engaged in the business of
"insurance." To this end, the Insurance Commissioner
points to the case of Metropolitan Life Insurance Co. v.
State Board of Equalization (1982) 32 Cal.3d 649,
656-657, wherein the court noted:
In attempting to fulfill the purpose of the gross
premiums tax, it is preferable to look beyond the
formal labels the parties have affixed to their
transactions and seek, rather, to discern the true
economic substance of the [ ] arrangement.
The Insurance Commissioner contends that Blue Shield and
Blue Cross's DMHC-regulated products are subject to the
gross premiums tax, and that legislative changes
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permitting Blue Shield and Blue Cross to sell indemnity
products under DMHC jurisdiction did not change the
character of those products from "insurance" to something
else. Indeed, the Insurance Commissioner points to the
broad statutory definition of insurance, unchanged since
the late 19th century: "Insurance is a contract whereby
one undertakes to indemnify another against loss, damage,
or liability arising from a contingent or unknown event."
(Insurance Code Section 22.)
i) The Managed Care Organization (MCO) Tax : According to
Health Access California, the federal Centers for Medicare
and Medicaid Services "have instructed California that it
must reconfigure the current MCO tax so that it applies to
a 'broad base' of managed care organizations rather than
only to Medi-Cal managed care plans as it currently does."
Blue Cross also argues that this bill disregards the
Governor's budget proposal to bring the existing MCO tax,
which helps fund the Medi-Cal program, into compliance with
federal law. Specifically, Blue Cross notes:
The Governor's MCO tax proposal would expand the tax to
all lives covered at DMHC, ensuring the continued
generation of $1.9B in state taxes and federal matching
funds. If you remove the PPO lives from DMHC[,] the
revenues from the MCO tax would decrease by millions of
dollars . . . .
Blue Shield appears to share this assessment, noting that,
"AB 1434 shifts all PPOs to the [Department of Insurance],
subjecting the products to the gross premiums tax, which
goes to the General Fund, precluding the application of the
MCO tax." Blue Shield further contends that this shift
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would dramatically shrink the revenues that could otherwise
be raised by the MCO tax, which, in turn, would lead to
cuts to the Medi-Cal program.
j) Wading into uncharted territory : As noted above, the
proper taxation of Blue Cross and Blue Shield is the
subject of ongoing litigation. If the Court of Appeal
determines that Blue Cross and Blue Shield, as HCSPs
regulated by the DMHC, are not subject to the gross
premiums tax because of their regulatory status, this bill
could result in significant changes to the manner in which
these entities are taxed. Specifically, under such a court
ruling, transferring these entities or products to the
jurisdiction of the Department of Insurance would result in
these entities or products becoming newly subject to the
gross premiums tax and, as such, not subject to corporate
taxation or a theoretical expansion of the MCO.
Conversely, the Court of Appeal could determine that the
taxation of a HCSP should depend on the nature of its
business activities and not the regulatory entity
overseeing those activities. In such a case, the Court
might determine that Blue Cross and Blue Shield are subject
to the gross premiums tax, irrespective of the regulatory
framework involved. Given the complexity of all these
issues, the Committee may wish to consider whether it might
be preferable to await further guidance from the judicial
branch.
aa) A reduction in consumer protections ? The Affordable
Care Act (ACA) ensures that health plans offered in the
individual and small group markets offer a comprehensive
package of services, known as "essential health benefits."
Essential health benefits must include items and services
within at least the following 10 categories: ambulatory
patient services; emergency services; hospitalization;
maternity and newborn care; mental health and substance use
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disorder services, including behavioral health treatment;
prescription drugs; rehabilitative services; laboratory
services; preventative and wellness services; and pediatric
services.
Knox-Keene, in turn, generally requires a HCSP contract to
provide subscribers and enrollees all of the basic health
care services included in H&SC Section 1345(b). (H&SC
Section 1367(i).) H&SC Section 1345(b) defines "basic
health care services" to include, among other things,
physician services, hospital inpatient services, diagnostic
laboratory services, home health services, preventative
health services, and hospice care.
Organizations like Consumers Union note that the ACA's
"essential health benefits" mandate applies irrespective of
the overseeing regulatory entity (i.e., the DMHC or the
Department of Insurance). Consumers Union is quick to
point out, however, that the ACA's benefit mandate does not
apply to large group plans and that "large group plans
regulated by CDI do not have to offer a standard package of
benefits." Thus, critics of this bill contend that moving
certain health plans from the DMHC to the Department of
Insurance would erode certain consumer protections. As the
Western Center on Law and Poverty notes:
While individual and small group plans - regulated by
either DMHC or CDI - must cover Essential Health Benefits
per federal and state law, the same does not apply to
large group plans, making the Knox-Keene Act requirement
of providing basic health care services a critical
baseline for consumers in those plans.
Consumers Union also notes that plans regulated by the DMHC
are prohibited from "balance-billing" consumers for
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high-cost emergency services performed by out-of-network
physicians, while the Insurance Code, which governs plans
regulated by the Department of Insurance, permits
balance-billing for emergency room services.
The DMHC also notes that Knox-Keene's statutory grievance
and appeal processes allow consumers to seek DMHC review of
any HCSP denial or modification of a service, while the
Insurance Code provides consumers with only the opportunity
to request review of medical decisions.
REGISTERED SUPPORT / OPPOSITION:
Support
California Medical Association (Co-Sponsor)
Insurance Commissioner Dave Jones (Co-Sponsor)
Congress of California Seniors
Consumer Federation of California
Opposition
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Anthem Blue Cross
California Association of Health Plans
California Chamber of Commerce
California Taxpayers Association
Consumers Union
Delta Dental
Health Access California
Western Center on Law and Poverty
Western Health Advantage
Analysis Prepared by:M. David Ruff / REV. & TAX. / (916)
319-2098