BILL ANALYSIS Ó AB 1434 Page A 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 AB 1434 Page B 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). AB 1434 Page C 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: AB 1434 Page D 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 AB 1434 Page E 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 AB 1434 Page F 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 ------------------------- <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). AB 1434 Page G 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.) AB 1434 Page H 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. ------------------------ <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. AB 1434 Page I 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 AB 1434 Page J 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: AB 1434 Page K 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 AB 1434 Page L 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 ------------------------- <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. AB 1434 Page M 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 AB 1434 Page N 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 AB 1434 Page O 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 AB 1434 Page P 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 AB 1434 Page Q 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 AB 1434 Page R 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