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TABLE of CONTENTS

What

Private

Health

Coverage?

2. How is Private Health Coverage Delivered?

Types of Organizations that Provide Private Health Coverage 2

How

Does

Managed

Care

Fit

In?

What is a Preferred Provider Organization?

Risk Pooling, Underwriting, and Health Coverage

3. Regulation of Private Health Coverage

State Regulation of Health Insurance

Federal

Laws

Governing

Health

Insurance

ERISA

HIPAA

Other

Federal

Mandated

Benefits

Conclusion

This primer provides a basic overview of private coverage for health care. It

begins by describing what we mean by private health coverage, and continues with

discussions of the types of organizations that provide it, its key attributes, and how it is
regulated. The paper addresses private health coverage purchased by individuals and
employers; it does not address public benefit programs such as Medicare and Medicaid.

1. What is Private Health Coverage?

Private health coverage is a mechanism for people to (1) protect themselves

from the potentially extreme financial costs of medical care if they become severely ill,
and (2) ensure that they have access to health care when they need it.

Health care can be quite costly, and only the richest among us can afford to pay

the costs of treating a serious illness should it arise. Private health coverage products
pool the risk of high health care costs across a large number of people, permitting them
(or employers on their behalf) to pay a premium based on the average cost of medical

care for the group of people. This risk-spreading function helps make the cost of health
care reasonably affordable for most people.

In addition, having an “insurance card” enables patients to receive care in a

timely way by providing evidence to health care providers that the patient can afford
treatment. Providers generally know that when they treat people with health
coverage, they are likely to be paid for their services within a reasonable time.

Health coverage is provided by a wide array of public and private sources. Public

sources include Medicare, Medicaid, federal and state employee health plans, the

military, and the Veterans Administration.

Private health coverage is provided

primarily through benefit plans sponsored by

employers – about 162 million nonelderly people
are insured through employer-sponsored health
insurance.

People without access to employer-

sponsored insurance may obtain health insurance
on their own, usually through the individual health
insurance market, although in some instances

health insurance may be available to individuals

through professional associations or similar arrangements. About 12 million nonelderly
people buy health insurance directly at any given time.

Policy

: This is the contract

between the health insuring

organization and the

policyholder. The policyholder

may be an individual or an

organization, like an employer.

2. How is Private Health Coverage Delivered?

Types of Organizations that Provide Private Health Coverage

Private health coverage is provided primarily by two different types of entities:

state-licensed health insuring organizations and self-funded employee health benefit

plans.

State-Licensed Health Insuring Organizations

State-licensed health insuring organizations, as the name implies, are organized

and regulated under state law, although federal law adds additional standards and in
some cases supercedes state authority. There are three primary types of state-

licensed health insuring organizations:

Commercial health insurers.

Commercial health insurers (sometimes called

indemnity insurers) are generally organized as stock companies (owned by
stockholders) or as mutual insurance companies (owned by their policyholders).
A prominent example is Aetna, a stock company.

Blue Cross and Blue Shield Plans.

Historically, many of these plans were

organized as not-for-profit organizations under special state laws by state
hospital (Blue Cross) and state medical (Blue Shield) associations. These laws

differed significantly across states, sometimes imposing special obligations or
regulatory requirements on Blue Cross and Blue Shield plans (e.g., to insure all
applicants) and sometimes providing financial advantages such as favorable tax

status. Today, some Blue Cross and Blue Shield plans continue to operate under
special state laws; others are organized as commercial health insurers. Blue
Cross and Blue Shield plans operate and are regulated in a similar manner to
commercial insurers, although in a few states Blue Cross and Blue Shield plans

continue to have special requirements to accept applicants for health insurance
on a more lenient basis than is applied to other types of insurers.

Health Maintenance Organizations (HMOs).

HMOs usually are licensed

under special state laws that recognize that they tightly integrate health
insurance with the provision of health care. HMOs operate as insurers (meaning

they spread health care costs across the people enrolled in the HMO) and as
health care providers (meaning they directly provide or arrange for the necessary
health care for their enrollees). In many states, HMO regulation is shared by
agencies that oversee insurance and agencies that oversee heath care

providers.

iii

Prominent examples of state licensed HMOs include Kaiser

Permanente and Harvard Pilgrim.

Although states tend to separately license each of these types of entities, it is

quite common for several different health insuring organizations to operate together

under a common corporate identity. For example, an HMO may have one or more
subsidiaries that are separately licensed as commercial health insurers, and may offer
its group customers coverage packages that permit members to choose between the
different types of coverage.

Self-Funded Employee Health Benefit Plans

Self-funded employee health benefit plans operate under federal law and are

health benefit arrangements sponsored by employers, employee organizations, or a
combination of the two. Under a self-funded arrangement, the plan sponsor retains the

responsibility to pay directly for health care services of the plan’s participants. In most
cases, the sponsors of self-funded health plans contract with one or more third parties
to administer the plans. These contracts are sometimes with entities that specialize in
administering benefit plans, called third-party administrators. In other cases, sponsors

contract with health insurers or HMOs for administrative services. The administering
entity usually will manage the health benefits in the same way as a health insurer or
HMO, but will pay for the cost of medical care with funds provided by the sponsor (i.e.,

no premium is paid).

How Does Managed Care Fit In?

Under managed care, health coverage providers seek to influence the treatment

decisions of health care providers through a variety of techniques, including financial
incentives, development of treatment protocols, prior authorization of certain services,

and dissemination of information on provider practice relative to norms or best
practices.

As managed care has become increasingly prevalent, the distinctions between

different types of heath coverage providers are shrinking. Commercial health insurers
now offer coverage through networks of providers and may establish financial
incentives similar to those traditionally used by HMOs. At the same time, HMOs have

developed products, called point-of-service products, that permit covered people to
elect to receive care outside of the HMO network, typically with higher cost sharing.
Although it remains true that HMOs generally are the most tightly managed

arrangements and most tightly integrate insurance and the delivery of care, virtually all
private health coverage now involves some aspect of managed care.

What is a Preferred Provider Organization?

It is common for people to believe that they are covered by a preferred provider

organization (PPO), but these entities generally do not actually provide health coverage.

Rather, PPOs are networks composed of physicians and other health care providers that

agree to provide services at discounted rates and/or pursuant to certain utilization
protocols to people enrolled in health coverage offered by a health coverage provider.

Typically enrollees in such an arrangement are given financial incentives – such as
lower copayments -- to use network providers.

In some cases, PPOs are freestanding networks of health care providers that

contract with a number of different health coverage providers to act as the health
coverage provider’s network in a particular area. In other cases, a health coverage
provider may establish its own PPO network of health care providers in a particular

area. Although some states have raised concerns about the level of insurance risk
assumed by PPOs under some of their arrangements with health coverage entities,
PPOs generally are not treated as health coverage providers in most states.

Risk Pooling, Underwriting, and Health Coverage

As discussed above, health coverage providers pool the health care risks of a

group of people in order to make the individual costs predictable and manageable. For
health coverage arrangements to perform well, the risk pooling should result in
expected costs for the pool that are reasonably predictable for the insurer and relatively

stable overtime (e.g., the average level of health risk in the pool should not vary
dramatically from time to time, although costs will rise with overall changes in price and
utilization).

To accomplish this, health coverage providers strive to maintain risk pools of

people whose health, on average, is the same as that of the general population. Said
another way, health coverage providers take steps to avoid attracting a

disproportionate share of people in poor health into their risk pools, which often is
referred to as adverse selection. For obvious reasons, people who know that they are
in poor health will be more likely to seek health insurance than people who are

healthier. If a risk pool attracts a disproportionate share of people in poor health, the
average cost of people in the pool will rise, and people in better health will be less
willing to join the pool (or will leave and seek out a pool that has a lower average cost).
A pool that is subject to significant adverse selection will continue to lose its healthier

risks, causing its average costs to continually rise. This is referred to as a “death
spiral.”

In practice, health coverage providers often have multiple risk pooling

arrangements. They may establish separate arrangements for different markets (e.g.,
individuals who buy on their own, small businesses, and trade associations) and for

different benefit plans within markets (e.g., plans with different levels of deductible).
In part, this product differentiation protects the health coverage provider because
problems in one risk pooling arrangement will not have a direct effect on people
participating in another pooling arrangement.

Health coverage providers use underwriting to maintain a predictable and stable

level of risk within their risk pools and to set terms of coverage for people of different

risks within a risk pool. Underwriting is the process of determining whether or not to
accept an applicant for coverage and determining what the terms of coverage will be,
including the premium. As discussed below, both state and federal laws circumscribe
the ability of health coverage providers to reject some applicants for coverage or to

vary the terms of coverage.

A primary underwriting decision involves whether or not the health coverage

provider will accept an applicant for coverage. Health coverage providers typically
underwrite each person seeking to purchase coverage in the individual insurance
market (where people buy insurance on their own), reviewing the person’s health status

and claims history. If an applicant is in poor health, a health coverage provider (subject
to state and federal law) may decide not to offer coverage. However, in most states, a
health coverage provider also may choose to accept the applicant but vary the terms of
coverage -- they may offer coverage at a higher than average premium (called a

substandard rate), exclude benefits for certain health conditions or body parts (called
an exclusionary rider), or do both. As discussed below, state and federal laws generally
require health coverage providers to accept small employers applying for coverage, so

the underwriting decisions are more limited to determining the premium and other
terms of coverage (though these actions are also limited by law in many states).

To maintain the attractiveness of the risk pool to different segments of the

population with different expected costs, health coverage providers typically vary
premiums based on factors associated with differences in expected health care costs,

such as age, gender, health status,

occupation, and geographic location. For
example, on average the expected health
costs of people over age 50 are more than

twice as much as the expected health costs
of people under age 20. In cases where the
individual is paying the full premium for
coverage, health coverage providers will

want to charge a higher premium to people
who are older to recognize the higher

expected costs. If premiums are not varied to account for the differences in expected

costs, the pool may attract a disproportionate share of older, more expensive people,
raising the average cost in the pool and making coverage in the pool less attractive to
younger people (who would have to pay a premium that exceeded their expected

average health care costs). This is another form of adverse selection and would lead to
a breakdown of the risk pooling. Other examples of underwriting include health
coverage providers charging different premiums to small employers based on the
industry of the employer or on the employer’s prior health claims.

Adverse selection

: People with a

higher than average risk of needing

health care are more likely than

healthier people to seek health

insurance. Adverse selection results

when these less healthy people

disproportionately enroll into an risk

pool.

The most efficient and effective underwriting mechanism for avoiding adverse

selection is to provide coverage to already formed large groups of people, such as the

employees of a large employer. In such cases, the health coverage provider knows that
the individual members of the group did not join it primarily to get insurance, so there
is a much lower chance that the group is composed disproportionately of people in poor
health. In such cases, the underwriting focuses on the group – its claims history, age

distribution, industry, and geographic location –not on individual members of the group.
Even in group underwriting situations, however, health coverage providers need to
assure that they are not getting only those members of the group who are in poor

health. To avoid adverse selection within the group, health coverage providers often
limit the opportunity for employees to enroll in the plan (called an “open enrollment
period”), require a minimum percentage of employees to participate in the coverage,

and/or require the employer to contribute a minimum percentage of the premium on
behalf of workers (to encourage participation).

The advantages of group underwriting break down in certain situations. For

example, when a very small employer group (e.g., 2 to 5 employees) seeks coverage,
there is a possibility that the need for health care by one member of the group (e.g., a
family member of the owner) is the reason that the group is seeking coverage. A

health coverage provider in such a case may (if permitted by state law) charge a higher
premium based on the higher risk associated with smaller groups (called a group size
factor) or review the health status of each of the members of the group in order to vary

the premium for the group. The higher inherent risk in providing coverage to small
employers explains in part why a risk pool with 1000 five-employee groups will be less
stable (and more expensive to cover) than one employer with 5000 employees.

Health coverage providers also take steps to protect themselves from adverse

selection that may not be uncovered in the underwriting process by excluding benefits
for a defined period of time for the treatment of medical conditions that they determine

to have existed within a specific period
prior to the beginning of coverage. For
example, if a person seeks benefits for a
chronic condition within a few months of

enrolling for coverage, the health coverage
provider may investigate to determine if
the condition was diagnosed (or apparent)

within a defined period prior to enrollment.
If the health coverage provider determines that the condition was diagnosed (or
apparent), it may exclude coverage of the preexisting medical condition. Treatments

for other medical conditions would not be affected by the exclusion. As discussed
below, state and federal law substantially circumscribes the applicability of preexisting
condition exclusions.

Preexisting medical condition

This is an illness or medical condition

for which a person received a

diagnosis or treatment within a

within a specified period of time prior

to becoming insured under a policy.

3. Regulation of Private Health Coverage

This section describes the basic regulatory framework for private health coverage

under state and federal laws.

Understanding how private health coverage is regulated is complicated by the

overlapping state and federal requirements for health coverage arrangements. States
generally regulate the business of insurance, including health insurance. States license
entities that offer private health coverage and have established laws that control the

legal structure of insurers, their finances, and their obligations to the people that they
insure. At the same time, a number of federal laws also regulate private health
coverage. The most important of these laws, the Employee Retirement Income
Security Act of 1974 (ERISA), establishes standards for employee benefit plans

(including benefit plans providing medical care) established or maintained by an
employer, an employee organization (i.e., a union), or both. Since the vast majority of
Americans with private health coverage receive it through such an employee benefit

plan, understanding the interaction between federal and state laws is essential to
understanding how private health coverage operates.

Unfortunately, this interaction is messy: In some cases, ERISA requirements

coexist with state law and in other cases, ERISA requirements preempt state law. And,
precisely when ERISA preempts state laws is still the matter of much litigation, even
though ERISA was passed over 25 years ago. Important interactions between state

and federal law also occur under the Health Insurance Portability and Accountability Act
of 1996 (HIPAA).

This part begins with a general description of how states regulate health

insurance and continues with a general description of the applicable provisions of ERISA
and HIPAA and their interaction with state law and state oversight of state-licensed
health insuring organizations.

State Regulation of Health Insurance

The regulation of insurance has traditionally been a state responsibility. In 1945,

Congress enacted the McCarran-Ferguson Act,

which clarified federal intent that states

have the primary role in regulating the business of insurance.

_________________________

The McCarran-Ferguson Act was enacted in response to the U.S. Supreme Court's decision in

United States

South-Eastern Underwriters Assn.

, 322 U.S. 533 (1944), which held that insurers that conducted a substantial part of

their business across state lines were engaged in interstate commerce and thereby were subject to federal antitrust
laws. State and industry concern over the effect of the decision on state authority over insurance lead Congress to
pass the McCarran-Ferguson Act to restore the primary role of states in regulating the business of insurance. See

United States Department of Treasury v. Fabe

, 508 U.S. 491, 499 (1993).

State regulation of health

and other insurance starts with

the licensing of entities that sell
insurance within the state. The
licensing process reviews the
finances, management and

business practices of the insuring
entity to evaluate whether it can
provide the coverage that is

promised to policyholders. States
establish requirements for state
licensed health insuring

organizations in a number of
areas to protect the people that
they cover.

The discussion below

describes the types of insurance
laws that states have typically

enacted, though the content and
extent of regulation in these areas varies among the states, sometimes significantly.

Financial Standards

State financial standards include requirements for minimum capital, investment

practices, and the establishment of claims and other reserves. States require state-

licensed health insuring organizations to submit quarterly and annual financial
statements, and also perform periodic on-site financial examinations to ensure that
state-licensed health insuring organizations remain financially viable.

Market Conduct

State market conduct standards include requirements relating to claims practices,

underwriting practices, advertising, marketing (including licensing of insurance

producers), rescissions of coverage, and
timely payment of claims. States have

broad authority to address unfair trade
and unfair claims practices, and perform
periodic market conduct examinations of

state-licensed health insuring
organizations to review business practices.

Minimum capital requirements

: These

are state laws that set a minimum amount

of net worth than an insuring organization

must have in order to operate. This

minimum amount must be unencumbered –

i.e., it must be available to pay for claims.

The amount varies with the type of

insurance that is being sold by the insurer

(e.g., life, health, auto, workers

compensation). Relatively recent state laws

establishing "risk-based" capital

requirements relate minimum capital

requirements to insurers' risk exposure and

business practices. For example, an HMO

may have lower minimum capital

requirements than an indemnity health

insurer because the HMO has additional

tools to manage risk.

Guaranty fund

: This is a funding

mechanism established under state law

to pay the claims of insurers that

become insolvent. The funds to pay

claims generally are provided by

assessing other insurers that provide

coverage in the state.

Policy Forms

Policy forms are the pieces of paper that establish the contractual relationship

between the health insuring organization and the purchaser. State standards for policy

forms address the content of the form
-- including required and prohibited

contract provisions and standard
definitions and terminology -- as well
as how they are issued to purchasers.

In some cases, states review or
approve policy forms, although these
practices vary by type of purchaser

and by state.

States most often

review or approve policies that are
offered directly to consumers or to
small employers; larger purchasers are

presumed to be sophisticated buyers
that need less protection.

Access to Coverage and Required Benefits

State standards relating to access address when, and on what terms, state-

licensed health insuring organizations must accept an applicant for coverage. Most
states have laws that require state-licensed health insuring organizations to provide
coverage to small employers that want it, with some limitation on the rates that can be

charged (e.g., restrictions on how premiums can vary based on age and health status).
Fewer states apply these types of rules to the individual insurance market, where
people buy coverage on their own rather than through an employer. Federal law also

includes requirements for access to coverage, as discussed under HIPAA below.

All states also have laws that

require state-licensed health insuring

organizations selling health coverage to
offer or include coverage for certain
benefits or services (known as mandated

benefits), including items such as mental
health services, substance abuse
treatment, and breast reconstruction

following mastectomy. The number and
type of these mandates varies
considerably across states. Federal law
also includes certain mandated benefits,

as discussed under HIPAA below.

Policy form

: This is a representative

contract of the policies that health

insuring organizations offer to

policyholders. Health insuring

organizations will have different policy

forms representing different

configurations of benefits and different

types of customers (e.g., individuals or

small groups). In some states, health

insuring organizations have to file the

policy forms that they offer to certain

types of customers with the insurance

department.

Guaranteed issue or guaranteed

availability of coverage

: This is a

requirement that insurers accept specified

applicants for coverage, generally without

regard to their health status or previous

claims experience. For example, health

insuring organizations generally are

required by state and federal law to issue

coverage to small employers that apply.

Separate provisions of law generally

address the extent to which health

insuring organizations can vary premiums

based on health status, claims experience

or other factors.

State standards also address the ability of state-licensed health insuring

organizations to offer restricted coverage to people with preexisting health problems.

As discussed above, health coverage providers generally exclude benefits for a defined
period of time for treatment of medical conditions that they determine to have existed
within a specific period prior to the beginning of coverage. States set standards for
how these limitations can be structured, and generally limit the application of such

exclusions under group policies when people are switching from one health coverage to
another (often called “portability” protection). Federal law also ensures this type of
portability, as discussed under HIPAA below.

Premiums

State standards for premiums

address the cost of insurance to
consumers, both initially and when
coverage is renewed. The degree of

regulation varies by type of purchaser
and by state. For health coverage offered
directly to individuals, many states

establish minimum loss ratios (the
percentage of premium that must be paid
out in claims rather than for administrative costs or profits) and also reserve the right to

review or approve the rates submitted by state-licensed health insuring organizations.

State standards generally require that rate variations (e.g., variations due to age.
gender, location) be actuarially fair (meaning that they are based on true variations in
health costs). Some states further limit the rights of insurers to vary premiums for

individual policyholders by age or health status (often referred to as “rate band” or
“community
rating”). Health

coverage sold to
small employers
also is regulated,
but the regulation

tends to focus
more on limiting
the extent to

which the rates
offered to a small
employer can

reflect the claims
experience or
health status of
workers in the

group.

Rate bands

: These are laws that restrict the difference between

the lowest and highest premium that a health insuring organization

may charge for the same coverage. For example, a rate band may

specify that the highest rate a health insuring organization may

charge for a policy may be not more than 150 percent of the lowest

rate charged for the same policy. The rate bands may limit all

factors by which rates vary, or may apply only to specified factors,

such as health status or claims experience.

Community rating

: This is a rating method under which all policy

holders are charged the same premium for the same coverage.

"Modified community rating" generally refers to a rating method

under which health insuring organizations are permitted to vary

premiums for coverage based on specified demographic

characteristics (e.g., age, gender, location) but cannot vary

premiums based on the health status or claims history of policy

holders.

Loss ratio

: This is the ratio of benefits

paid to premiums. Loss ratios can be

calculated for a particular policy form,

for a line of business (e.g., small group

health insurance), or for a health

insuring organization's overall business.

Minimum loss ratios for established by

law or regulation typically apply to a

policy form.

Renewability

Health coverage is generally provided for a limited period (typically one year),

and state requirements address the
extent to which a purchaser has a
right to renew the policy for another

year without being reevaluated for
coverage. Federal law also is
important in this area, and is

discussed under HIPAA below.

State standards also address the ability of individuals covered under group

policies to continue coverage if the group policyholder cancels the coverage or the
person is no longer part of the group. Standards in some states permit these people to
continue coverage or to convert to individual insurance in some instances. The

requirements for terms of coverage and rates vary substantially across states. Federal
law (often referred to as “COBRA” continuation) provides similar protection to
individuals with employer-sponsored coverage, as discussed under ERISA below.

HMOs, Managed Care, and Network Arrangements

States for many years have had separate standards for HMOs, recognizing their

dual roles as providers and insurers of health care. State HMO standards, in addition to
addressing typical insurance topics such as finances, claims administration, policy forms
and minimum benefits, also establish standards that affect HMOs as entities that

directly deliver health care and closely manage the health care use of those that they
insure. Such state standards include requirements relating to the establishment of
utilization review and quality assurance programs, the establishment of enrollee

grievance processes, and the contents of contracts with participating health care
providers.

As the use of managed care has proliferated among non-HMO state licensed

health insuring organizations (e.g., insurers offering PPO-type coverage), and as
managed care practices have become more controversial with the general public, states
have extended HMO-type standards to other entities offering managed care and have

generally increased their regulatory scrutiny in this area. Standards relating to network
adequacy (e.g., the number, location, and types of physicians), utilization review
practices, credentialing of participating health care providers, and quality assessment

and improvement have recently been adopted in a number of states.

Guaranteed renewability

: This is a

provision of an insurance policy or law which

guarantees a policy holder the right to renew

their policy when the term of coverage

expires. The health insuring organization

generally is permitted to change the premium

rates at renewal.

Complaints, Remedies, and Appeals

States also have laws and regulations that assist people who do not receive the

benefits that they believe are covered under their health plans. States receive
consumer complaints, and in some cases are able to act as intermediaries to resolve
specific conflicts between consumers and health coverage providers. The receipt of a

large number of complaints about a particular health coverage provider also may alert
regulators to more pervasive market conduct abuses and trigger a broader review of
marketing or claims practices.

State law also generally permits people who feel aggrieved by a state licensed

health coverage provider to seek redress through a lawsuit. Such suits may be brought

under the contract for coverage, tort, or in some cases under special state insurance
laws (such as unfair claims practices laws). For example, HMOs and other managed
care arrangements may be sued under state medical malpractice laws if their delivery of
health care does not meet ordinary standards of care. Under state law, a person

covered by a health insurance policy also generally can sue the insurer if benefits are
not delivered as promised and the failure to deliver the benefits was negligent and the
proximate cause of the person’s injury. In some cases where the aggrieved person is

covered under an employee benefit plan, however, ERISA preempts the person’s right
to bring certain types of lawsuits. This interaction between state and federal law is
discussed in more detail under ERISA below.

In the last few years, most states have adopted standards that provide for an

independent, external party to review certain benefit decisions made by state licensed
health coverage providers. For example, these states permit a covered person to

appeal a decision by a health coverage provider that denies a benefit because it was
not medically necessary or because it was experimental. The types of claims that are
subject to review, who the reviewers are, and the procedures for requesting a review

vary substantially across the states. There also is a question as to whether ERISA
preempts state external appeal laws as they apply to benefit decisions for people
covered under an employee benefit plan (as discussed under ERISA below).

Federal Laws Governing Health Insurance

Although the business of insurance is primarily regulated by the states, a number

of federal laws contain requirements that apply to private health coverage, including
ERISA, HIPAA, the Americans with Disabilities Act, the Internal Revenue Code, the Civil
Rights Act, the Social Security Act (relating to private coverage that supplements

Medicare), and the Gramm-Leach-Bliley Act (relating to financial services and bank
holding companies). The discussion below focuses on two of these laws, ERISA and
HIPAA, because of the significant impact that they have on the structure of private
health coverage.

ERISA (Employee Retirement Income Security Act)

ERISA

vii

was enacted in 1974 to protect workers from the loss of benefits

provided through the workplace. The requirements of ERISA apply to most private
employee benefit plans established or maintained by an employer, an employee
organization, or both (referred to here generally as “plan sponsors”). Employee benefit

plans that provide medical benefits (and other non-pension benefits) are referred to as
employee welfare benefit plans.

ERISA does not require employers or other plan sponsors to establish any type of

employee benefit plan, but contains requirements applicable to the administration of
the plan when a plan is established. The important requirements for employee welfare

benefit plans include:

Written document.

ERISA requires that an employee benefit plan be plan be

established and maintained

pursuant to a written
document, which must provide
for at least one “named

fiduciary” who has authority to
manage and administer the
plan.

Disclosure requirements.

ERISA requires the administrator of an employee

welfare benefit plan to provide a summary plan description (SPD) to people

covered under the plan (called participants and beneficiaries). The SPD must
clearly inform participants and beneficiaries of their benefits and obligations
under the plan and of their rights under ERISA. The SPD must include
information about how to file a claim for benefits and how a denial of a claim can

be appealed.

Reporting requirements.

ERISA requires administrators of certain employee

benefit plans to file annual reports describing the operations of the plan.
Reports are filed with the Internal Revenue Service, which forwards the
information to the Department of Labor. Certain types of employee welfare

benefits plans (e.g., those that purchase insurance rather than self-fund and
have fewer than 100 participants) are not required to file a report.

Fiduciary requirements.

ERISA establishes standards of fair dealing for

“fiduciaries” who exercise discretion or control in the management of an

Fiduciary

: This generally refers to a person

who manages funds or benefits for another. A

fiduciary acts in a position of trust and generally

is required to act in the best interests of the

beneficiary. Under ERISA, a fiduciary is a

person who exercises discretion or control in the

management of an employee benefit plan or in

the management or disposition of the assets of

an employee benefit plan.

employee benefit plan or in the management or disposition of the assets of an
employee benefit plan. ERISA fiduciaries may be corporate entities or

individuals. ERISA requires that employee benefit plans have at least one
“named fiduciary” who is responsible for administration and operation of the
plan. The plan documents may designate additional fiduciaries.

ERISA requires plan fiduciaries to carry out their responsibilities “solely in the
interest of plan participants and beneficiaries and for the exclusive purpose of
providing benefits and defraying reasonable expenses of administering the

plan.”

viii

ERISA also requires plan fiduciaries to act with the same skill, care,

prudence, and diligence that a prudent person would use in like circumstances,
and to carry out their responsibilities in accord with the lawful provisions of the

plan documents.

Claims for benefits.

ERISA requires employee benefit plans to maintain

procedures for requesting benefits under the plan and to inform participants and

beneficiaries of the procedures. Employee benefit plans must also have a
procedure permitting participants and beneficiaries to appeal a denial of benefits
to a fiduciary.

The Department of Labor recently updated their ERISA regulation relating to
claims procedures. The new rule establishes shorter timeframes for making

decisions on claims for benefits and on appeals of denials of claims, and also lays
out procedures that must be followed for appeals.

The new rule becomes

effective in 2002.

Remedies and enforcement.

ERISA contains civil enforcement provisions that

permit participants and beneficiaries to bring actions to obtain benefits due to
them under an employee benefit plan, for redress of fiduciary breaches, to stop

practices that violate ERISA or the provisions of the employee benefit plan, or for
other appropriate equitable relief. Courts may award reasonable costs and
attorney fees to participants and beneficiaries who prevail. ERISA does not,
however, provide a remedy to recover economic or non-economic (e.g. pain and

suffering) damages that may result from improper claims denials, fiduciary
breaches, or other improper acts.

Continuation coverage.

ERISA requires plan sponsors that employ more than

20 employees to offer continuation coverage to qualified beneficiaries (including
dependents) who lose health coverage under an employee benefit plan for

certain specified reasons (e.g., death of an employee, termination of
employment, divorce, or legal separation). ERISA requires the plan sponsor to
notify individuals of their right to continuation coverage and establishes the
benefits that must be offered, the period that qualifying individuals are eligible

for continuation coverage, and premium that they must pay.

ERISA Interaction With State Law

How ERISA interacts with state law is quite complex and has generated

numerous court cases. As a general matter, ERISA preempts state laws that would
regulate the operation of employee benefit plans. ERISA preemption of state laws

occurs under two different provisions of the statute.

First, ERISA contains an express provision that preempts state laws that “relate

to” an employee benefit plan.

In applying the term “relates to,” courts have looked to

whether the state law in question has a “connection with or reference to” an employee
benefit plan.

For example, state laws that prohibited garnishment of benefits

provided under an employee benefit plan or that required employers to maintain
existing health coverage for employees who are eligible for workers compensation
benefits have been found to be preempted by ERISA.

xii

State laws of general

applicability, however, are not preempted merely because they impose some burdens

on an ERISA plan. For example, a state law that imposes a surcharge on hospitals bills
was found not to be preempted as applied to hospitals owned by an employee benefit
plan.

xiii

The ERISA preemption provision has an exception that saves from preemption

those state laws that regulate insurance. This “saving” provision permits states to

continue to apply their insurance laws to insurers, including state licensed health
insuring organizations, even when they provide coverage to or under an employee
benefit plan. For example, state laws that mandate the inclusion of certain benefits in
health insurance contracts are saved from preemption, even though application of the

law affect the benefits provided under the employee benefit plan.

xiv

Similarly, a state

insurance law that prohibits insurers from automatically denying a claim for benefits
because it is not filed in a timely manner is saved from preemption because the law

regulates insurance, even though the application of the law affects the administration of
an employee benefit plan.

State laws that simply apply to insurers, however, but

which do not primarily regulate the business of insurance, are not saved from
preemption.

Although the ERISA preemption provision saves state laws that regulate

insurance, ERISA prohibits states from “deeming” employee benefit plans to be

insurers. This later provision prohibits states from treating employee benefit plans as
insurers and attempting to regulate them directly under their insurance laws.

_________________________

In recent cases, the U.S. Supreme Court expressed concern about the unhelpful nature of the preemption language

in ERISA, and has stated that in looking at whether a state law is preempted it "must go beyond the unhelpful text
and the frustrating difficulty of defining its key term, and look instead to the objectives of the ERISA statute as a
guide to the scope of the state law that Congress understood would survive."

New York State Conference of Blue

Cross & Blue Shield Plans v. Travelers Insurer. Co.,

514 U.S. 645, 656 (1995).

As a practical matter under ERISA, states can continue to regulate the insurance

activities of state licensed health insuring organizations that provide health coverage

under an employee benefit plan established by an employer or other plan sponsor.
States generally cannot regulate the content or activities of self-funded employee
benefit plans. States also cannot indirectly regulate the practices of employee benefit
plans by trying to regulate how third parties, including state licensed health insuring

organizations, provide administrative services to self-funded employee benefit plans. As
an example, states can require insurance companies and HMOs to include coverage for
specified benefits (e.g., mental health services) in the policies they sell. Any employer

or individual purchasing insurance coverage would therefore have to purchase a policy
that included those benefits. States cannot, however, require self-funded employer
plans to offer any specified benefits.

The second area of ERISA preemption involves the civil remedies available to

participants and beneficiaries relating to a claim for benefits. As discussed above,
ERISA provides a limited set of civil remedies to participants and beneficiaries. The

courts have determined that these remedies are the exclusive remedies available to
participants and beneficiaries to contest a denial of benefits under an employee benefit
plan. State laws that provide for causes of action against the administrator or another

fiduciary of an employee benefit plan (e.g., for breach of contract or tort) are
preempted if they could have been brought under the civil enforcement provisions of
ERISA.

This aspect of ERISA preemption poses difficult questions and has been the

subject of numerous court decisions. And, the questions have become harder to
resolve as health coverage providers have through managed care become more deeply

involved in the medical treatment decisions affecting covered people. For example,
when an employee
benefit plan provides

benefits through an
HMO, it is often difficult
to distinguish situations
when the HMO is making

a determination on a
claim for benefits under
the plan from situations

when it is exercising
medical judgement in
determining the

appropriate medical
treatment for a person
covered under the plan.
This distinction matters,

particularly if the person

Economic damages

: These are financial losses that a

person may suffer as the result of another person's

wrongful act. Examples of economic damages include

lost wages and medical bills.

Non-economic damages

: These are non-financial

losses that a person may suffer as a result of another

person's wrongful act. Examples of non-economic

damages include pain and suffering, physical

disfigurement, and loss of consortium.

Punitive damages

: These are damages awarded to an

injured party in addition to economic or non-economic

damages in order to punish the wrong-doer for conduct

that is particularly egregious.

believes he or she was injured by the decision, because actions based on a denial of
claim for benefits must be brought under ERISA (where no economic or non-economic

damages would be available), while actions based on providing inappropriate medical
care may be brought under state law in some instances (where economic, non-
economic, and punitive damages may be available).

A related ERISA preemption issue involves whether state external appeal laws

apply to benefit determinations made by state licensed health insuring organizations
providing coverage under employee benefit plans. There currently is a split in the

courts. One federal court of appeals has determined that a state external appeal law is
preempted in this situation because it provides “an alternative mechanism through
which plan members may seek benefits due them under the plan,” which is contrary to

the principle that the ERISA civil enforcement provisions are the exclusive remedy for
participants and beneficiaries contesting a denial of benefits.

xvi

Another federal court of

appeals has found that state external appeal laws are not preempted in this situation,
determining that the external review provisions were incorporated into the insurance

contract and, rather than establishing an alternative remedy, “simply establishes an
additional internal mechanism for making decisions about medical necessity and
identifies who will make that decision in those instances when the HMO and the

patient’s primary care physician cannot agree on the medical necessity of a course of
treatment.”

xvii

This latter case is currently pending before the U.S. Supreme Court.

HIPAA (Health Insurance Portability and Accountability Act)

A second federal act that established important regulatory requirements for

private health coverage is HIPAA, enacted in 1996. HIPAA was motivated by concern

that people faced lapses in coverage when they change or lose their jobs. As discussed
above, health coverage providers often exclude benefits for preexisting health
conditions for new enrollees. HIPAA also addressed other concerns of federal

policymakers about private health coverage.

HIPAA and related standards address several areas, including: portability, access

to coverage, renewability, nondiscrimination, and mandated benefits. The standards

established by HIPAA vary by market segment (e.g., large group, small group or
individual coverage) and by type of coverage provider. HIPAA creates separate but
similar standards for state licensed health insuring organizations and employee welfare
benefit (i.e., ERISA) plans. Generally, the provisions applicable to employee welfare

benefit plans and plan sponsors are incorporated into ERISA and into the Internal
Revenue Code, and the provisions applicable to state licensed health insuring
organizations are incorporated into the Public Health Services Act. In addition, the

HIPAA standards which create individual rights (e.g., portability) and which are
applicable to state licensed health insuring organizations providing health coverage to
employee benefit plans also are incorporated into ERISA and the Internal Revenue

Code. Three federal agencies – the U.S. Departments of Labor, Health and Human
Services, and Treasury -- coordinate rulemaking under HIPAA.

xviii

Portability.

As discussed above, some private health coverage excludes

benefits for treatment of preexisting medical conditions for defined period of
time after initial enrollment. HIPAA requires state licensed health insuring

organizations providing group coverage and employee welfare benefit plans
providing health benefits to limit preexisting condition exclusion periods to no
more than 12 months (18 months for late enrollees unless they enroll under

special circumstances). Any preexisting condition exclusion period must be
reduced by the number of months that a newly enrolling person was previously
covered by public or private health coverage. For the protection to apply, the

time between lapse of the previous coverage and enrollment in the new
coverage must be no longer than 63 days.

Access to coverage.

HIPAA requires state licensed health insuring

organizations to make all of their small group products available to any qualifying
small employer that applies, regardless of their claims experience or of the
health status of their employees. Under HIPAA, a small employer is defined as

having 2 to 50 employees. HIPAA does not have standards for the premium that
can be charged to small employers seeking coverage, although, as discussed
above, most states have laws that limit rate variation in the small group market.

HIPAA also requires state licensed health insuring organizations to accept certain
people leaving group health coverage for coverage in the individual market
regardless of their health status and without any exclusion period for preexisting

medical conditions. To be eligible, the person must not be eligible for other
public or private health coverage, have been previously covered for a period of
at least 18 months, must apply for the individual coverage within 63 days of

leaving the group coverage, and must have exhausted any federal or state
continuation rights under their group policy. States are provided substantial
flexibility in determining the mechanism for making coverage available to eligible
people. For example, in most states, eligible people are guaranteed access to

coverage in the state’s high-risk pool; private insurers are not required to sell
coverage to them. HIPAA generally does not regulate the premiums that people
can be charged for the coverage that is offered under HIPAA.

xix

Renewability.

HIPAA requires state licensed health insuring organizations and

certain employee benefit plans which provide benefits to multiple employers to

guarantee that the coverage can be renewed at the end of the period of
coverage. This protection generally means that group or individual coverage
cannot be terminated by the health coverage provider excepted in cases of
nonpayment of premium and fraud. HIPAA, however, does not have standards

for the premiums that may be charged at renewal.

Nondiscrimination.

HIPAA prohibits state-licensed health insuring

organizations providing group coverage and employee welfare benefit plans
providing health benefits from considering the health status of a member of the
group in determining the member’s eligibility for coverage or premium
contribution.

HIPAA was structured in a way that reasonably clearly delineates the state and

federal roles in enforcing its standards. As described above, HIPAA standards

applicable to employee welfare benefit plans and plan sponsors are incorporated into
ERISA and the Internal Revenue Code, and are enforced by the U.S. Departments of
Labor and Treasury. Standards applicable to state licensed health insuring

organizations generally are incorporated into the Public Health Services Act, and are
under the jurisdiction of the U.S. Department of Health and Human Services (DHHS).

HIPAA provides however, that if a state’s law establishes standards for state licensed
health insuring organizations that are at least as stringent as the HIPAA standard, the

state is the primary enforcer of the standard, with DHHS having authority to enforce the
standard if the state does not. Where a state’s laws do not contain a standard at least
as stringent as the HIPAA standard, enforcement falls to DHHS.

Although HIPAA establishes generally clear federal and state enforcement

responsibilities, in practice there have been some difficulties. The test for when a state

assumes enforcement responsibility is conducted separately for each different standard
under HIPAA, which can lead to a patchwork of federal and state enforcement
responsibilities.

This is most problematic for federally-mandated benefits.

Other Federal Mandated Benefits

Although enacted separately from HIPAA, recent federal laws have required

health coverage providers to cover certain benefits as part of their benefit
arrangements. These benefit requirements are incorporated into the same legal
framework as the HIPAA standards, and include the following: (1) requiring that health
coverage providers that provide coverage for mastectomies also to cover breast

reconstruction surgery following a mastectomy;

xxi

(2) prohibiting health coverage

providers from restricting hospital stays following childbirth to less than 48 hours (or 96
hours following delivery by cesarean section);

xxii

and (3) restricting the ability of group

health plans sponsored by employers with at least 50 employees to impose annual and
lifetime dollar limits for mental health benefits that are more stringent than for medical
and surgical benefits.

xxiii

_________________________

As discussed above, standards for some HIPAA provisions applicable to state licensed health insuring

organizations providing coverage to employee benefit plans also are incorporated in ERISA, and individuals may
bring actions under ERISA to enforce those standards.

4. Conclusion

Health coverage is subject to significant requirements at both the state and

federal level. While new laws and regulations have created important protections for
consumers, they have also produced overlapping and sometimes duplicative or
conflicting state and federal rules. At the same time, concerns about managed care

practices have lead policymakers at both the state and federal levels to consider new
requirements. For example, federal proposals to establish a “Patient Bill of Rights”
would establish new standards for both ERISA employee benefit plans and state-

licensed health insuring organizations. It will be a challenge for policymakers to build
upon the current state and federal regulatory structure in ways that do not increase the
confusion for health coverage providers and consumers.

Continued interest by policymakers in expanding access to health care and to

health care coverage may also lead policymakers to revisit current regulatory standards.
For example, proposals to provide federal tax credits for people purchasing individual

health insurance are likely to prompt discussion of how to permit people in poorer
health to have access to private individual coverage so that they can make use of the
tax credit. As some state policymakers have discovered in addressing this issue, it will

be a challenge to find ways to expand access to those in poorer health without
undermining the stability of risk pools in this market.

As federal policy issues increasingly focus on regulation of the private health

insurance market, there will be greater need for policymakers to understand how this
market functions and how state and federal rules interact.

Notes

Unpublished estimates for 2000 prepared by the Urban Institute and the Kaiser Commission on Medicaid and the

Uninsured, based on verified Current Population Survey data.

Ibid.

iii

See

NAIC’s Compendium of State Laws on Insurance Topics,

Departmental Regulation of HMOs,

National

Association of Insurance Commissioners, 2000.

15 U.S.C. 1011-1015.

See

NAIC’s Compendium of State Laws on Insurance Topics,

Filing Requirements, Health Insurance Laws Forms

and Rates,

National Association of Insurance Commissioners, 2000.

Ibid.

vii

29 U.S.C. 1001

et. seq.

viii

29 U.S.C. 1104(a).

See Federal Register, Vol. 65, No. 225, p. 70271.

29 U.S.C. 1144.

Shaw v. Delta Air Lines, Inc.,

463 U.S. 85, 96-97 (1983).

xii

District of Columbia v. Greater Washington Bd. of Trade

, 506 U.S. 125 (1992).

xiii

De Buono v. NYSA-ILA Medical and Clinical Services Fund

, 520 U.S. 806 (1997).

xiv

Metropolitan Life Ins. Co. v. Massachusetts

, 471 U.S. 724 (1985).

Unum Life Insurer. Co. of Am. V. Ward,

526 U.S. 358 (1999).

xvi

Corporate Health Insurance, Inc., v. Texas Department of Insurance,

215 F.3d 526, 537 (2000).

xvii

Moran v. Rush Prudential HMO, Inc.,

230 F.3d 959 (2000).

xviii

The provisions incorporated into ERISA may be found at 29 U.S.C. 1181 et. seq. ; the provision incorporated

into the Internal Revenue Code may be found at 26 U.S.C. 9801 et. seq.; the provision incorporated into the Public
Health Services Act may be found at 42 U.S.C. 300gg et. seq.

xix

See

General Accounting Office,

Health Insurance Standards, New Federal Law Creates Challenges for

Consumers, Insurers and Regulators,

GAO/HEHS-98-67, February 1998, and General Accounting Office,

Private

Health Insurance, Progress and Challenges in Implementing 1996 Federal Standards,

GAO/HEHS-99-100, May

1999, pp. 10-16.

See

General Accounting Office,

Implementation of HIPAA, Progress Slow in Enforcing Federal Standards in

Nonconforming States,

GAO/HEHS-00-85, March 2000.

xxi

The Women's Health and Cancer Rights Act of 1998.

xxii

The Newborns' and Mothers' Health Protection Act of 1996.

xxiii

Mental Health Parity Act of 1996, as extended by P.L. 107-147.