Today I read an article in a national outlet about proposed legislation in Kansas that touches on a number of themes I’ve dealt with in my professional career. (Full disclosure: Until recently I worked for a major insurer that is identified in the article as leading the lobbying effort against this legislation; however, I had zero involvement in that lobbying effort and in fact was completely unaware of this issue until reading about it today.)
My understanding of the situation, based largely on reporting from the Wichita Eagle, is this:
- It is well known that Gov. Brownback has been pursuing an aggressive tax reduction campaign in Kansas. As part of this, he is looking to find a new revenue source to replace about $80 million of general state tax revenues that are devoted to support Kansas’ Medicaid program.
- His proposal involves increasing a particular Kansas tax that applies only to HMOs (and not to other health insurers) and that has a peculiar name: the privilege fee. This tax is currently defined as 1.0% of annual premiums, but under the legislation it would increase to 5.5% of annual premiums.
- Three of the HMOs to which the tax increase would apply are contractors under the Kansas Medicaid program, KanCare. If I understand correctly, the privilege fee applies to all premiums written by HMOs, including both KanCare and non-KanCare premiums.
This proposal strikes me as suboptimal public policy, for a number of reasons:
The tax increase on HMOs will ultimately get passed through to other parties, so what exactly is the point? Look, it’s potentially very appealing for a politician to be able to say, I’m reducing the general tax burden, and in exchange I’m increasing taxes paid by a special interest group – particularly when the group in question is one of the few industries that is almost as unpopular as Congress.
But, it’s not a particularly intellectually honest position. The privilege fee paid by Kansas HMOs is one part of their cost of doing business; and it is rational to expect that those HMOs will ultimately adjust their pricing – that is, the insurance premiums they charge – to reflect any increase that legislators enact in that aspect of their costs.
So, at the end of the day, this tax increase will be borne broadly: by individuals who purchase insurance policies directly from HMOs; by employers who purchase insurance from HMOs for their employees; by the employees of those employers, to the extent that the employers react to the premium increases by ratcheting up the portion of healthcare benefits that they ask the employees to fund themselves; and by the consumers of those employers’ products, to the extent that employers react to the premium increases by increasing the prices they charge for their goods and services. I think it will also be borne by one other party, which makes this even odder…
Won’t KanCare end up having to pay for part of this tax increase? As far as I can tell, the 5.5% privilege fee will apply to all the premiums that Kansas HMOs write, including those for KanCare business. But what the HMO contractor calls revenue, the state Medicaid program calls an expenditure.
So, to the extent the HMOs need to increase the premiums they charge KanCare in order to cover the privilege fee increase, doesn’t that automatically lead to increased Kansas Medicaid expenditures? A recently-adopted Actuarial Standard of Practice reiterates that, in order to be actuarially sound, the rates that Medicaid agencies pay to HMOs need to take into account any taxes or fees that the HMOs need to pay out of the revenues they receive.
Thus, we have some dollar-trading here: The HMOs that participate in KanCare will pay higher privilege fees, but then they’ll receive correspondingly higher revenues from KanCare. This doesn’t strike me as a model of efficiency.
Having said that: I’m not a Medicaid expert, but the fact that Medicaid is a joint state/federal program may mean that it’s not purely dollar-trading viewed from the standpoint of the state of Kansas. If Kansas collects an additional dollar in privilege fees from a KanCare contractor, and then as a result that contractor needs an additional dollar in revenues from KanCare, does the federal government end up subsidizing some portion of that new dollar in revenues?
Differential tax rates on market participants can create market distortions. The privilege fee we’re discussing applies only to HMOs, who pay this fee but in exchange are exempt from the Kansas premium tax paid by all other insurers.
In my view, this is an accident of history. While there are exceptions, today most HMOs operate in a manner very similar to most other health insurers, in that the underlying healthcare services are provided not by the HMO’s own employees but by an unaffiliated network of providers; the main difference today is that, typically, an HMO network will be narrower than a non-HMO network. This convergence of business models over the past couple of decades calls into question historical practices in some states that treat HMOs differently from other health insurers.
In the Kansas case, today HMOs enjoy a modest competitive advantage relative to other health insurers: HMOs pay a privilege fee of 1.0% of premiums, whereas other health insurers instead need to pay premium taxes equal to 2.0% of premiums. The proposed legislation would turn this around, and give non-HMOs a very significant competitive advantage.
This in turn can be expected to have ramifications on choice in the broader health insurance market in Kansas. It’s a fair generalization that HMO products tend to be cheaper than non-HMO products, to the extent that HMO products generate cost savings via the usage of narrower provider networks. By placing HMOs as a tax disadvantage to non-HMOs, the inherent cost advantage of those HMO products will shrink, which arguably will make consumers worse off. (This is the argument being advanced by Aetna, according to the Wichita Eagle article.)
The tax increase will, in a sense, be retroactive. I argued above that, ultimately, HMOs will react to this tax increase by passing it through to their customers via increased premiums. And while that may be true in the long run, it would likely be far less true in the immediate term.
The statute calls for the increased privilege fee to apply to all premiums written by HMOs in calendar year 2015. The problem is that insurers in general (including HMOs) price their products well in advance of when the premiums take effect, and then by regulation hold each customer’s premiums steady for an agreed policy term (typically 12 months for health insurance, as opposed to 6 months for auto insurance). So, presumably all the HMOs in Kansas had priced their 2015 premiums under the assumption that the privilege fee would remain at 1.0%, and cannot go back and change those premiums if the statute is enacted.
Thus, from the HMO’s standpoint, this proposal represents a material change in the rules in the middle of the game. An unanticipated expense in 2015 equal to 4.5% of premiums (the new rate of 5.5%, less the existing rate of 1.0% already reflected in pricing) could absorb most or even all of an HMO’s expected profits for the year, health insurance being a relatively low-margin business. Regardless of how one may feel about the HMO industry, there’s something untoward about a mid-year tax change that can be expected to have such a dramatic impact on the short-term financial prospects of an industry, given that by regulation the industry cannot take immediately effective action to react to the changed circumstances.