Health Insurance Basics: Roles for the Market and Government in Providing, Financing, and Regulating Private Insurance Coverage

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Both the market and government have important roles in ensuring the availability, affordability,
and adequacy of private health insurance. These roles complement one another, but even together
the market and government have limitations.
The market provides a variety of insurance products for consumers and employers with different
needs and preferences. These products differ on many dimensions, including the breadth of
provider networks, amount of beneficiary cost-sharing, and techniques for managing the use of
health care services. Large employers, small employers, and individuals have different health
insurance options, but all must make tradeoffs between the cost of coverage and desired features.
A strength of the market is its flexibility to adapt over time to changing circumstances. As
economic conditions, consumer preferences, and government policies evolve, the market
generates different products with different features. The primary limitation of the market is its
failure to provide affordable options for all consumers.
The federal government helps ensure access to health coverage through public programs, such as
Medicare and Medicaid, and it influences the market for private insurance through tax and
regulatory policies. Some tax subsidies help people purchase insurance, and others—including
those for Health Savings Accounts—help pay for medical expenses not covered by insurance. By
far the largest subsidy is the tax exclusion for employer-provided health benefits. Because of this
exclusion, most people get health insurance through work.
Tax subsidies make health insurance and health care seem more affordable for certain taxpayers,
but do not provide equivalent support to everyone. In addition, subsides may increase health care
spending by reducing the apparent cost of health insurance and health care services.
Regulations affect both access to insurance and the adequacy of benefits. States have primary
responsibility for regulating insurance, but the federal government has sought to address selected
issues regarding health coverage. For example, the Health Insurance Portability and
Accountability Act of 1996 and the Consolidated Omnibus Budget Reconciliation Act of 1985
include provisions that allow certain people to obtain or continue health coverage under certain
circumstances. In addition, several federal laws mandate coverage for specific health benefits.
Although regulations provide some protection for consumers, neither federal nor state rules
guarantee access to coverage for everyone. In addition, even where regulations require insurers or
employers to offer coverage, consumers may find this coverage unaffordable. This report will be
updated.

The Market......................................................................................................................................2
Offering Insurance Products with Different Features...............................................................2
Adapting to Changing Conditions.............................................................................................2
Limitations of the Market..........................................................................................................3
The Government..............................................................................................................................4
Tax Policy..................................................................................................................................4
Subsidies for Health Insurance...........................................................................................4
Other Subsidies...................................................................................................................5
Limitations of Tax Policy....................................................................................................5
Regulation ................................................................................................................................. 6
Access to Insurance.............................................................................................................6
Adequacy of Benefits..........................................................................................................6
Limitations of Regulation...................................................................................................7
Current Policy Initiatives.................................................................................................................7
Conclusion ....................................................................................................................................... 8
Author Contact Information............................................................................................................8

ealth insurance coverage facilitates access to health care and protects individuals and ¹
families from catastrophic health expenses. Both the market and government have
important roles in helping ensure the availability, affordability, and adequacy of private H

health insurance.
In 2006, about two-thirds of Americans had private coverage, including about 60% with
employment-based and 9% with directly purchased health insurance. In the same year, about 27%
of the population had government benefits through Medicare, Medicaid, and military health ²
programs. About 16% of the population was uninsured.
The market for private insurance excels in creating new products and adapting to changing
demand, but is not set up to ensure that everyone gets coverage. Consumers who are sick or poor
may not be able to find adequate insurance at an affordable price, while others may decide that
premiums are more than they are willing to pay. If health insurance were another good or service,
people might not care about consumers who cannot afford it or choose not to buy it. But many
think that health insurance and the health care it pays for are different from other goods and
services.
Government helps ensure access to health coverage where the market might not. It does this
through public programs, such as Medicare and Medicaid, and through policies that affect the
market for private insurance. Federal policies include tax subsidies and regulations. Subsidies
make health insurance more affordable for consumers and employers, and regulations help ensure
access to insurance and the adequacy of benefits. States play a fundamental role in regulating
health insurers and the products they sell. Functions vary by state, and may include licensing
insurance companies and agents, ensuring financial solvency through standards and oversight,
approving rates, and assessing insurance companies to fund programs for consumers.
Of course, there is no bright line between the market and government. Market limitations prompt
government policies, and government policies in turn shape market trends. In addition,
differences among state policies and the interaction between federal and state requirements create
a complex landscape for consumers, employers, and insurers who wish to buy or provide health
benefits.
This report analyzes the roles of the market and government in providing, financing, and
regulating private health insurance. It focuses on federal policy, and shows that although both the
market and government play important roles, both also have limitations.

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By generating diverse insurance products and by adapting to different and changing conditions,
the market for private health insurance provides choices for consumers and employers who have
different needs and preferences.
Consumers and employers want affordable yet generous coverage. They also want unfettered
access to health care providers and services, but generally they must make tradeoffs between cost
on the one hand and generous coverage and access on the other. For example, some may be
willing to pay higher premiums in exchange for unrestricted access to health care providers, while
others accept restrictions or higher cost-sharing to make coverage more affordable.
To meet demand, the market offers a variety of health insurance products. These products include
traditional indemnity insurance, relatively restrictive health maintenance organizations (HMOs),
and high-deductible health plans with associated savings accounts. Certain products are
characterized by certain features. For example, indemnity coverage is associated with choice of
health care providers, while HMOs are associated with restricted choice, including limited
provider networks and constrained access to care. In practice, distinctions between the product
types are not clear. Any type of product may have nearly any combination of features, including
broad or restricted access to health care providers, low or high cost-sharing, and limited or fully
integrated programs for managing patients’ use of services.
Consumers and employers choose among different products according to their preferences,
although individuals, small employers, and large employers tend to have different options. In
addition to having more options, large employers can choose between purchasing insurance and
self-insuring and buying administrative services from an entity that processes paperwork but does
not bear financial risk.
In addition to providing a variety of products, the market adapts over time to changing
circumstances. Health insurance products evolve, and different features become more or less
prominent.
In the early 1990s, the trend was toward managed care, with restricted access to health care
providers, low beneficiary cost-sharing, and health plan management to limit use of services.
These strategies slowed growth in premiums for health insurance, but also led to complaints by
patients and providers about restrictions on access to care and interference in the practice of
medicine. In response to these complaints, the market began to offer more flexible products with
higher premiums. By the late 1990s, with a booming economy and low unemployment,
employers were willing to pay more for health insurance in an effort to recruit and maintain a
qualified workforce. More recently, as prices have continued to rise, renewed concern by
consumers and employers about the cost of health benefits has led to more changes in insurance

products. Given the managed care backlash, these products have fewer restrictions on access to ³
care, and instead rely on higher cost-sharing to influence consumers’ use of services.
In addition to responding to changing circumstances, the market responds to policy changes. For
example, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA)
authorized new tax-advantaged accounts to pay for medical expenses not covered by insurance or
other reimbursements. These Health Savings Accounts (HSAs) must be paired with high-⁴
deductible health plans, and the market has responded by developing such plans. The MMA also
established Medicare drug coverage. Private insurers provide this coverage through Medicare
Advantage (MA) and stand-alone prescription drug plans (PDPs). Depending on where
beneficiaries live, they may be able to choose among one or more MA plans with drug coverage ⁵
and more than 50 PDP options.
Although private insurers offer a variety of products and respond to changing conditions, they do
not serve everyone equally. Premiums and access to health insurance vary across and within
geographic markets, and for different consumers and employers. Across markets, premiums vary
with differences in the cost of living, in patterns of health care practice, in the mix of medical
providers, and in the relative market power of health care providers and insurers. Within markets,
premiums vary both because products differ and because individual consumers and employers
differ.
Differences in consumer and employer characteristics affect not just premiums, but also access to
insurance, including the number, type, and generosity of plan options. Some people and firms
have many choices, while others have few. Large firms and their employees tend to have more
options than smaller firms and their employees. Many people have no employment-based option,
either because their employer does not offer coverage or because they are not working. Lack of
employment-based coverage can be a particular problem for high-risk populations—including
people who are older, sick, or disabled—as they may have few or no choices in the private
market.
A large number of choices may or may not improve insurance coverage. On the one hand, many
options increase the likelihood that consumers and employers will find a satisfactory combination

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of benefits and costs. On the other hand, the number of options may be irrelevant if prices are
burdensome or unaffordable.

Government plays a role in helping ensure access to health coverage. In 2007, federal spending
on Medicare, Medicaid, and the State Children’s Health Insurance Program (SCHIP) is expected ⁶
to total $634 billion. These programs serve primarily older, low-income, and disabled people,
populations that otherwise would have difficulty finding adequate and affordable coverage in the
private market. For vulnerable individuals who lack access to employer-paid insurance,
government benefits may be the only viable alternative.
In addition to providing health benefits for vulnerable populations, the federal government uses
tax and regulatory policy to influence the market for private health insurance. Tax policy supports
access to care through subsidies for insurance and medical care expenses, while regulatory policy
supports access by laying ground rules that affect the availability and adequacy of insurance
coverage.
Federal law includes significant tax benefits for health insurance and medical care expenses. In
addition to supporting access to care, these benefits have shaped the market for private health
insurance. Largely because of tax policy, in 2006 about 60% of Americans got health benefits
through work.
By far the largest health-related tax benefit is the exclusion for employer-paid insurance. For
people receiving employer-paid benefits, premium costs are not counted as income and therefore
not subject to income and employment taxes. In 2007, the income tax exclusion for employer-⁷
paid insurance is expected to be about $100 billion. Employers also do not pay employment
taxes on health insurance premiums. These tax benefits help make insurance more affordable for
consumers and employers, but they also reduce federal revenue that otherwise could be used for
different purposes. In effect, consumers who receive employer-paid insurance transfer part of the ⁸
cost of coverage to taxpayers.
Other tax benefits for health insurance include a deduction for self-employed taxpayers, and a tax
credit for a limited group of individuals who either lost manufacturing jobs or receive payments
from the Pension Benefit Guaranty Corporation. These tax benefits serve fewer people than the

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exclusion for employer-paid coverage. In 2007, the deduction for self-employed workers is ⁹
expected to be about $4.2 billion and the tax credit only about $200 million.
Tax benefits also help consumers pay for qualified medical expenses not covered by insurance.
Taxpayers who itemize may deduct health insurance premiums and other costs to the extent that ¹⁰
qualified expenses exceed 7.5% of adjusted gross income (AGI). Because eligibility depends on
high spending relative to income, this deduction limits financial loss for people who face
catastrophic costs. In 2007, this tax benefit is expected to be about $8 billion.
People also can use several tax-advantaged accounts to pay for qualified medical expenses. These
accounts include Health Savings Accounts (HSAs), Archer Medical Savings Accounts (MSAs),
Health Reimbursement Accounts (HRAs), and Flexible Spending Accounts (FSAs). The newest ¹¹
such option, HSAs, is expected to provide about $300 million in tax benefits in 2007.
Although all of these tax benefits help people pay for health insurance and health care,
government—like the market—does not serve everyone equally. People may or may not be
eligible for various benefits; and if they are eligible, support may or may not affect access.
Because many tax benefits are tied to employment, workers may receive support that is not
available to the unemployed. In addition, higher-income workers realize greater tax savings than
lower-income workers because tax benefits are based on marginal tax rates. Tax support does not
guarantee access, and lack of support does not preclude it. Low-income people may be unable to
afford coverage or all of the care they desire, even with support. Conversely, high-income people
may be able to buy insurance and whatever care they need, even without support.
In addition to failing to distribute support based on need, tax benefits may increase health care
spending. With subsidies, people can afford more insurance than they would otherwise; and with ¹²
insurance, people may use more care.

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Regulatory policy is another tool for influencing the market for health insurance. Regulations
affect access to coverage and the adequacy of benefits by setting ground rules for insurance
companies and employers that provide health benefits. States have primary responsibility for
regulating insurance, but the federal government has sought to address selected issues regarding
health coverage. In general, federal regulations do not address premiums.
Federal policy does not guarantee access to private health insurance, but it does help certain
consumers get or keep access to coverage under certain conditions. For example, the Health
Insurance Portability and Accountability Act of 1996 (HIPAA) helps ensure access to new
insurance coverage for individuals and their families when the policyholder changes jobs. This
protection is called portability. The act also helps ensure continuing coverage when a beneficiary
gets sick. HIPAA accomplishes these guarantees by requiring insurers to sell or renew both
individual and group insurance policies without regard to health status or claims experience. The
law similarly helps small businesses. Insurers that offer coverage in the small group market must ¹³
accept every applicant without regard to the claims history of the group.
The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) also helps ensure
access to health insurance. COBRA allows certain workers and family members who lose ¹⁴
eligibility for group coverage to continue to purchase this coverage for a limited time period.
Under the law, firms that employ at least 20 people must allow beneficiaries to continue health
coverage following a qualifying event. For workers, qualifying events include loss of coverage
due to job termination, a reduction in work hours, or a firm’s reorganization due to bankruptcy;
for family members, qualifying events include loss of coverage due to the death of or divorce
from a covered employee.
In addition to helping ensure access to insurance, regulations address the adequacy of coverage.
Almost all such regulations come from the states. According to the Council for Affordable Health
Insurance, an industry group, the number of state-mandated benefits currently tops 1,900. These
mandates require affected insurers to cover specific health benefits, providers, and patients.
Examples include mandated coverage for cancer screening tests, chiropractors, and handicapped ¹⁵
dependents.

¹³^For^m^o^r^e^inf^o^r^m^a^{tion a}^b^o^u^{t H}^I^PA^A^,^s^e^e^C^R^S^R^e^por^{t R}^L³¹⁶³^4,^T^h^e^He^alth^Insur^anc^e^P^o^rta^b^ility^a^{nd Ac}^c^o^unt^ab^ility
^Ac^{t (}^H^{IPAA) of 1}⁹⁹⁶^{: Ov}^e^r^vⁱ^e^w^a^{nd G}^u^id^anc^e^oⁿ^Fre^q^ue^ntly^Ask^e^{d Que}^s^tio^ns^,^by^Hⁱ^nda^Chaⁱ^kⁱ^nd^e^t^a^l^.
¹⁴^For^m^o^r^e^inf^o^r^m^a^{tion a}^b^o^u^{t C}^O^B^R^A^{, s}^e^e^C^R^S^R^e^por^{t R}^L³⁰⁶²^6,^H^e^{alth I}ⁿ^s^u^r^a^nc^e^C^oⁿ^tin^uat^io^{n C}^o^v^e^r^age^Uⁿ^de^r
^COBRA^{, by}^H^e^{idi G}^.^Y^a^c^k^e^r^.
¹⁵^Couⁿ^c^{il f}^o^{r A}^f^f^o^rda^b^le^Heal^t^h^Insu^ran^ce,^Hea^l^t^h^In^su^r^aⁿ^{ce Ma}^nd^at^{es i}ⁿ^t^h^e^S^t^a^t^{es 20}⁰⁷^{, a}^t^http^://w^ww^.c^a^h^i.org^/
^c^a^h^i_c^onteⁿ^ts^/^r^e^s^our^c^e^s^/pdf^/Ma^nda^te^sⁱ^nthe^Sta^t^e^s²⁰⁰⁷^.p^df^.

Federal law includes a few benefit mandates. These mandates regard parity for mental health
benefits, hospital coverage following normal childbirth or cesarean delivery, and coverage for ¹⁶
prosthetic devices and reconstructive surgery following a mastectomy.
Regulations may facilitate access to insurance or specific benefits, but they do not serve everyone
equally. For example, although HIPAA and COBRA require insurers and employers to offer
coverage to certain individuals under certain circumstances, these Acts do not guarantee access to
insurance for everyone. In addition, even where regulations require insurers to sell or employers
to offer coverage, eligible people may find coverage unaffordable.
Benefit mandates also do not serve everyone equally. Sometimes the issue is uniform protection,
and sometimes the issue is variable protection. On one hand, while some argue that benefit
mandates help guarantee adequate coverage, others maintain that mandates increase costs and
limit coverage options for consumers. On the other hand, because most benefit mandates come
from the states, consumers may or may not be protected, depending on where they live. In
addition, while policies sold by insurance companies generally must comply with state mandates,
firms that self-insure are exempt from the requirements.

In the 110^th Congress, committees in both the House and the Senate have held hearings and
developed legislation regarding access to and the adequacy of private insurance. For example, the
Senate Budget Committee has held a series of hearings on health care costs and universal ¹⁷
coverage. In addition, committees in both the House and Senate have reported legislation that
would regulate private insurance. One set of House and Senate proposals would extend and
expand federal requirements affecting mental health coverage under group health insurance ¹⁸
policies. Another set would prohibit the use of genetic information by insurers in making ¹⁹
enrollment determinations and setting insurance premiums.
State policy makers have been more proactive in pursuing policies to increase the availability and
affordability of private health insurance. For example, both Massachusetts and Maine currently
are implementing a variety of initiatives with an eye to achieving universal coverage. These

¹⁶^For^m^o^r^e^inf^o^r^m^a^{tion o}ⁿ^f^e^de^r^a^{l ins}^u^r^a^nc^e^m^a^nda^te^s^,^s^e^e^C^R^S^R^e^por^{t R}^L³¹⁶⁵^7,^M^e^nta^l^H^e^alt^h^P^a^rⁱ^ty^:^Fe^de^r^a^{l a}ⁿ^d
^State^Ac^ti^on^a^nd^Ec^on^om^ic^I^m^p^a^c^t^{, by}^R^a^m^y^a^Sunda^r^a^r^a^m^a^{n a}^{nd C}^.^Ste^p^he^{n R}^e^d^h^e^a^d^{; C}^R^S^R^e^por^t⁹⁸^-¹^{4 E}^P^W^,
^N^e^w^bor^ns^’^an^{d M}^o^the^r^s^’^H^e^alt^h^Pr^ote^c^tion^Ac^t^,^by^Sha^r^{on K}^e^a^r^ne^y^C^o^lem^a^{n (}^a^v^a^ila^ble^{on r}^e^q^u^e^s^t)^;^a^{nd C}^R^S^R^e^por^t
^R^L³¹⁶³^4,^T^h^e^He^alt^h^Iⁿ^sura^nc^e^Porta^b^ility^an^{d Ac}^c^o^unt^abi^lity^Ac^{t (}^H^{IPAA) of}¹⁹^{96: Ov}^e^r^vⁱ^e^w^an^d^Guid^anc^e^oⁿ
^F^r^eq^u^eⁿ^t^l^y^A^s^ked^Q^u^estⁱ^oⁿ^s^oⁿ^HI^P^AA.
¹⁷^In^addⁱ^tⁱ^oⁿ^t^o^t^h^{e S}^eⁿ^a^t^e^B^u^d^g^et^Co^mmⁱ^t^t^ee,^o^t^h^e^{r co}^mmⁱ^t^t^{ees t}^h^at^h^a^{ve h}^e^l^d^h^eariⁿ^{gs o}ⁿ^t^h^{ese t}^o^pⁱ^c^sⁱⁿ^cl^ud^{e Ho}^u^s^e
^Ene^r^gy^a^{nd C}^o^m^m^e^r^c^e^;^H^ous^e^Sm^a^{ll B}^u^sⁱ^ne^s^s^a^nd^Entr^e^p^r^e^ne^ur^s^h^{ip; Se}^na^te^H^e^a^{lth, E}^duc^a^tio^{n, L}^a^b^o^r^aⁿ^d^P^e^nsⁱ^ons^;
^a^{nd Se}^na^te^Fina^nc^e^.
¹⁸^Curre^{nt re}^quire^m^e^{nts f}^o^{r m}^e^nta^l^he^a^{lth pa}^ri^ty^a^r^e^s^e^{t to}^e^x^pire^a^t^th^e^e^{nd of}^this^c^a^l^e^nda^{r y}^e^a^r^{. In a}^d^d^ition^to
^e^x^te^nding^c^u^r^r^e^nt^la^w^,^pr^op^os^e^d^l^e^gⁱ^s^l^a^{tion w}^{ould e}^x^paⁿ^d^r^e^q^u^ir^e^m^eⁿ^ts^on^ins^u^r^a^nc^e^p^o^lic^ie^s^tha^t^c^o^v^e^r^{both m}^e^nta^l
^a^{nd p}^h^y^s^ic^a^l^illne^s^s^e^s^.^{For a}^ddi^tio^na^{l inf}^o^rm^a^{tion, s}^e^e^{CRS Re}^p^o^rt^RL³¹⁶⁵^7,^M^e^nt^{al H}^e^alt^h^P^a^r^ity^:^Fe^de^r^a^{l a}ⁿ^d^St^ate
^Ac^tion^an^{d Ec}^on^om^ic^I^m^pac^t^.
¹⁹^For^a^dditi^ona^l^inf^o^r^m^a^{tion, s}^e^e^C^R^S^R^e^por^t^R^L³³⁹⁸⁸^,^G^e^ne^tic^N^o^ndis^c^rⁱ^mⁱⁿ^a^tio^{n i}ⁿ^H^e^alt^h^Iⁿ^s^u^r^a^nc^e^:^{A Si}^de^-^b^y^-
^Side^C^o^m^par^is^{on of the}^Ti^tle^I^Pr^ov^is^ions^{in S. 35}^{8 an}^d^H^.^R.⁴⁹³^,^b^y^C^.^Ste^phe^{n R}^e^dhe^a^d^aⁿ^d^A^m^aⁿ^da^K^.^Sa^r^a^ta^.

initiatives include insurance market reforms, requirements on employers and consumers, public ²⁰
subsidies for private insurance, and the expansion of public coverage under Medicaid. In
California, policy makers continue to debate the merits of different approaches for achieving
universal health coverage. These approaches include requiring individuals to have coverage,
requiring employers to make contributions for health benefits, and adopting a statewide single-²¹
payer system.

Both government and the market have important roles in helping ensure the availability,
affordability, and adequacy of private health insurance. The market excels in creating new
products and adapting to changing demand, but is not set up to guarantee that everyone gets
coverage.
Government complements the market through tax and regulatory policies aimed at improving
access to coverage and the adequacy of benefits. Ideally, these policies would reflect widely held
social values, but setting priorities is difficult. Should the priority be affordability, and if so, for
whom? For consumers and employers purchasing insurance? For taxpayers who subsidize
coverage? Or should the priority be facilitating access to benefits? Again, for whom? For
workers; for people with lower income; for people who are older, sick, or disabled; or for
everyone?
Policymakers face a challenge in improving access to health insurance, while making efficient
use of limited public resources and avoiding unnecessary regulations that might hinder market
innovation.
^J^eⁿⁿⁱ^fe^r^J^e^nsoⁿ ^B^e^rn^{adette Fern}^an^dez
^Specialis^{t i}ⁿ^Healt^h^Econ^o^m^ic^s^Aⁿ^a^l^ystⁱⁿ^H^e^a^l^t^h^Ca^r^e^Fi^na^ncⁱ^ng
^jj^en^s^oⁿ^@^cr^s^.^loc.g^o^v^{, 7-}⁴⁴⁵³^bf^ern^aⁿ^d^ez^@^c^rs^.l^oc.g^o^v^{, 7-}⁰³²²

²⁰^{For a}ⁿ^ov^e^r^vⁱ^e^w^o^f^re^f^o^rm^initia^tiv^e^s^{in Ma}^ssa^c^huse^{tts, se}^e^{CRS Re}^{port RS}²²⁴⁴^7,^T^h^{e Ma}^ssa^chu^s^et^t^s^He^{alth Re}^form
^P^l^aⁿ^:^A^B^rⁱ^e^f^Overvi^ew^{, by}^A^p^ril^G^r^a^d^y^.^{For inf}^o^rm^a^{tion a}^bou^{t he}^a^lth^ref^o^rm^{s in}^Main^{e, see a d}^e^scrip^tioⁿ^o^f^Dirig^o
^He^a^{lth a}^t^htt^p^://w^ww^.sta^te^c^o^v^e^ra^g^e^.ne^t/sta^te^re^ports/m^e^14.pdf^.
²¹^{For i}ⁿ^f^o^rm^a^{tion on}^the^he^a^{lth c}^o^v^e^ra^g^e^de^ba^teⁱⁿ^Ca^lif^ornia^,^g^o^{to http:}^//^www^.^cal^h^eal^t^h^ref^o^r^m^.^o^rg/^.