The battle over Association Health Plans (AHPs) is indisputably political, but it is being waged on legal terrain. On July 26, 2018, 11 states (New York, Massachusetts, California, Delaware, Kentucky, Maryland, New Jersey, Oregon, Pennsylvania, Virginia, and Washington) and the District of Columbia filed a complaint in the U.S. Federal District Court for the District of Columbia seeking to invalidate a June 2018 U.S. Department of Labor (DOL) final regulation (the “Final Regulation”). The Final Regulation’s purpose is to expand access by small employers and self-employed individuals to AHPs by amending the definition of “employer” in Section 3(5) of ERISA. (We describe the prior law governing AHPs and explain the details of the Final Regulation in an article published by Bloomberg Tax, available here.) In New York v. United States Dep’t of Labor, CV 18-1714 (D.D.C. Mar. 28, 2019), United States District Judge John D. Bates sided with the States, concluding that the Final Regulation is an unreasonable interpretation of ERISA. This post explains the decision and explores its implications.
The debate over AHPs can be reduced to a single, simple question: under what circumstances may a collection of small employers and self-employed individuals band together to form a large group for underwriting and other regulatory purposes? Historically, the ability of small employers to band together for these purposes was limited, and self-employed individuals were entirely barred from doing so.
In October 2017, President Trump issued an Executive Order titled “Promoting Healthcare Choice and Competition Across the United States” (the “Executive Order”), which, among other things, encouraged the DOL to “expand the conditions that satisfy the commonality-of-interest requirements” in the DOL’s existing guidance and to “consider ways to promote AHP formation on the basis of common geography or industry.” In the view of the Trump Administration, these changes would allow small employers and self-employed individuals to be able to combine to more effectively compete for affordable health coverage on par with large employers. (The benefits enjoyed by large employers are explained in the Bloomberg article cited above.)
The Executive Order’s reference to the “commonality-of-interest requirement” is to prior law governing AHPs. Historically, only so-called “bona fide associations” could sponsor a consolidated, large group AHP. Bona fide associations had to display certain employer-like characteristics that distinguished them from commercial insurance-type arrangements. Prior law determined whether an association qualified as a bona fide association under three criteria:
- Purpose. Whether the group or association is a bona fide organization with business/organizational purposes and functions unrelated to the provision of benefits;
- Commonality of Interest. Whether the employers share some commonality and genuine organizational relationship unrelated to the provision of benefits; and
- Control. Whether the employers that participate in a benefit program, either directly or indirectly, exercise control over the program, both in form and substance.
The Affordable Care Act (ACA), which sought to expand the small group and individual market risk pools, raised the regulatory stakes. Among other things, the ACA dictated which benefits small group and individual market health insurance products must cover—so-called “essential health benefits”—and also imposed across-the-board modified community rating rules that applied not only in the small group and individual markets, but also to large groups. As a result, large groups enjoyed a level of design and underwriting flexibility that was unavailable to small employers and self-employed individuals. The Final Regulation sought to change this by allowing small groups to combine into, and to be regulated as, large-group AHPs. The States, fearing that the Final Regulation would wreak havoc on their small group and individual insurance markets, challenged the rule.
Both before and after the ACA’s enactment, an insurance carrier underwriting an AHP was generally required to look-through the group sponsoring the AHP to the underlying size of the AHP member. Under this “look-through” rule, small groups and individuals generally retained their status as such even where coverage was purchased through an association. The look-through rule was articulated in a CMS Insurance Standards Bulletin issued on September 1, 2011, which described the general rule and acknowledged a rarely occurring exception under which an AHP sponsored by a “bona fide group or association of employers” is treated a single plan. The Final Regulation made it easier for small groups to qualify for, and for the first time provided self-employed individuals access to, the bona fide group or association exception.
Colloquially, the DOL sometimes refers to the prior law AHP rules as “Pathway 1,” and to the rules established by the Final Regulation as “Pathway 2.” While these terms have no independent legal significance, they provide a useful shorthand. Importantly, the District Court found fault only with Pathway 2 when rejecting the changes wrought by the Final Regulation. The Court’s decision left prior law intact.
Before addressing the substance of the States’ challenge to the Final Regulation, the Court took up the question of whether the States had standing, i.e., do the States have any legally cognizable injury for which the Court could offer a remedy? The standing analysis takes up a surprisingly large part of the opinion, and the Court rejected many of the States’ standing claims—e.g., a steep rise in uncompensated care costs, loss of tax revenues, and in an increase in regulatory burden. The Court ultimately found that standing existed based on a “fairly direct link” between the Final Regulation’s intended expansion of self-insured AHPs and the decrease in specific tax revenues. Specifically, the Court determined that state tax revenues will decrease due to the failure to collect premium taxes “when individuals select coverage through a self-insured AHP.”
With the matter of standing settled, the Court next moved to the substance of the States’ challenge. The States claimed that the Final Regulation’s bona fide association and working owner provisions conflict with the text and purpose of both the ACA and ERISA and exceed DOL’s statutory authority. The Court agreed.
Judicial Deference and the Chevron Framework
The matter of the DOL’s authority and the deference owed by the Court to that authority has received a good deal of attention lately. In Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-844 (1984), the Supreme Court held that, if a statutory term is ambiguous, the agency has authority to construe that term and interpret its meaning within the statutory scheme by promulgating regulations following Administrative Procedure Act (APA) notice and comment procedures. If the procedures are followed, a court must defer to the agency’s interpretation. This legal doctrine is referred to as “Chevron deference,” and it has been criticized by various judges, including U.S. Supreme Court Justice Neil Gorsuch (then sitting on the Tenth Circuit).
If the efficacy of Chevron deference was on the Court’s mind, there is no indication of it in the opinion. Rather, the Court agreed that the deferential standard applied to the DOL’s interpretation of “employer” in ERISA. Following the two-step Chevron framework, the Court had no problem determining that the statute (here, ERISA) was ambiguous. The Court next moved on to the second Chevron prong, explaining that it would uphold the Final Regulation unless the rule was “procedurally defective, arbitrary or capricious in substance, or manifestly contrary to the statute.” The Court held that the DOL’s interpretation failed this latter prong because the Final Regulation constituted an impermissible construction of the statute. The Court thereupon undertook a thorough analysis of why the DOL’s regulatory interpretation of ERISA was not reasonable:
ERISA and the employment relationship
The Court was troubled by the DOL’s failure to establish meaningful limits on the types of associations that may qualify to sponsor an ERISA plan. This, said the Court, violated “Congress’s intent that only an employer association acting in the interest of its members falls within ERISA’s scope.” The Court was of the same view where self-employed individuals are concerned. In sum, the Court was persuaded that the Final Regulation fails to honor the employment nexus that is at the core of the ERISA regulatory scheme.
Employers acting in the interest of employers
The Court next focused on the ERISA requirement that, for employer associations to qualify as “employers” for the purpose of sponsoring an employee benefit plan, the group or association of employers acts “in the interest of an employer.” Explaining that associations qualifying as employers must act “in the interest of” an employer, the Court noted that the statutory text is not infinitely elastic. Rather, the phrase “in the interest of an employer” distinguishes employer associations that stand in the shoes of an “employer” for the purpose of sponsoring an ERISA plan from every other employer association. Thus, entrepreneurial ventures selling insurance for a profit to unrelated groups are unequivocally outside of ERISA’s scope. The Court flagged this issue, returning to it later throughout the balance of the opinion.
The Final Regulation is not reasonable
According to the Court, the Final Regulation’s bona fide association provision is not reasonable because it unlawfully expands ERISA’s scope. While the Final Regulations adopted the same prior law standards for determining which associations are “bona fide” (purpose, commonality of interest, and control), the Court determined that Final Regulation departs too far from the DOL’s prior sub-regulatory guidance.
The purpose test allows an association to sponsor an AHP as long as the association has “at least one substantial business purpose” unrelated to the provision of health care, even if its primary purpose is “to offer and provide health coverage to its employer members and their employees.” But the DOL’s rule does not define “substantial business purpose.” Rather, it simply requires that a group or association would be a viable entity in the absence of sponsoring an employee benefit plan. For the Court, this approach went too far. In particularly frank language, the Court opined that:
The Final Rule’s “safe harbor” provision reveals how flimsy the purpose test really is. The safe harbor provision specifies that an association that “would be a viable entity in the absence of sponsoring an employee benefit plan” will satisfy the purpose test. The “substantial business purpose” test, then, is only an ex post facto, perfunctory requirement—merely a box to check—that virtually any association may fulfill on the side and thereby qualify to sponsor an AHP under the Final Rule. This business purpose does not, in fact, need to be “substantial” in the ordinary sense of that term, because it need not make the association viable in the absence of the association’s AHP. This requirement therefore is more aptly called the “other business task” test. It sets such a low bar that virtually no association could fail to meet it.
Thus, the Court concluded that the Final Regulation’s purpose test provides no meaningful limit on the associations that would qualify as bona fide ERISA employers.
Commonality of Interest
The Court characterized the commonality of interest test as “arguably the most important of the three criteria because it most directly relates to the core concern of the statute: employers’ interests.” Under the Final Regulation, to demonstrate commonality of interest, employers must either share a common trade, industry, line of business, or profession, or else each employer must have “a principal place of business in the same region that does not exceed the boundaries of a single State or a metropolitan area (even if the metropolitan area includes more than one State).” It was the latter requirement, geography, that troubled the Court. Before an association can act “in the interest of” an employer member, said the Court, “that interest must be defined, which common geography cannot do.”
The Final Regulation did not materially change the control requirement. According to the Court, the control test largely duplicates the conditions in the DOL pre-2018 guidance. Both under prior law and under the new rule, control requires that the functions and activities of the group or association are controlled by its employer members, and the group’s or association’s employer members that participate in the group health plan control the plan. Employer members are deemed to have control where they can nominate, elect, and remove directors and approve or veto material amendments. A careful reading of the previous sentence discloses that there are two levels of control, the level of the association and the level of the plan. This means, for example, that a Chamber of Commerce with a self-nominating board (which is common in our experience) cannot satisfy the control test, since members are not generally free to nominate, elect, and remove directors and approve or veto material amendments.
It’s too soon to tell whether the decision in State of New York et al. v. United States Department of Labor et al. is a battle in a larger war or the war itself. That depends on the parties. The government is likely to appeal the decision. Despite our past predictions about the outcome of the case, which turn out to be flat-out wrong, the decision appears to us to be at least sound. Whether that outcome rises to the level of unassailable, only time will tell.
Lest it go unnoticed, we hasten to add that one not need stray at all from the decision’s text to discern a powerful and ringing endorsement of the prior law ERISA rules governing bona fide associations, i.e., Pathway 1. The opinion enunciates clearly what those standards are (purpose, commonality of interest, and control), holds them up as exemplars, and finds the new rules wanting by comparison. The Court found no fault with the September 2011 CMS notice, which posits a general rule that looks thought an association and a narrow exception for bona fide, Pathway 1 arrangements. This has important ramifications for those state regulators who, in the wake of the issuance of the Final Regulation, issued guidance categorically rejecting any large group AHPs.