It barks, but will it bite?

The obvious question is: Where's the teeth? On Dec. 21, HHS issued proposed regulations that will require health insurers to disclose and justify premium rate increases of 10% or more starting in July. But the federal government—along with most states—lacks the authority to reject insurance premium increases. Instead, federal and state officials say they hope increased transparency and publicity about soaring premiums will help dissuade insurers from jacking up rates.

“Ultimately, we believe the bright light of sunshine will convince more insurers to think twice and check their math before submitting large rate hikes, which means the benefits of these new rules will be felt by millions of Americans,” HHS Secretary Kathleen Sebelius said at a news conference announcing the proposed regulations. On the surface, that may seem like wishful thinking. From insurers' perspective, big rate increases, especially in the individual and small-group markets, are a reflection of rising medical costs and sicker customers.

However, close observers said that with these new rules, HHS is on a path toward far tighter regulation of the insurance industry. With the help of state regulators, the rule is just one weapon in its arsenal with the goal of ending soaring and often unpredictable rate increases. “This is one of the softer regulations that has come out under the Affordable Care Act, but the states will have more authority to act,” said Richard Zall, partner and chair of the healthcare department at the law firm Proskauer Rose in New York. “The HHS is going to be providing significant resources to the states to attack this problem.”

Federal oversight of premium rate increases could be interpreted as creeping federalism into well-established state authority in this area. But Zall said this won't be the intent, or the outcome. “I really don't think there is either the desire or the resources to take over state insurance regulation functions,” he said. “The feds recognize that the states are best suited to do this job.” The Patient Protection and Affordable Care Act directs the HHS secretary to set up an annual review of “unreasonable” health insurance premium rate increases. The 136-page proposed rule released last month fleshes out that requirement. Although HHS will review public comments, the rules go into effect this summer.

Premium rate increases of 10% or more filed after July 1, 2011, for the individual and small-group markets will be subject to review by the relevant state or HHS. In 2012, what constitutes an unreasonable rate increase will be determined on a state-by-state basis. Between about a quarter and a half of small-group plans, and up to three-fourths of individual plans, are expected to be subject to this rate review next year, with that number increasing in subsequent years, according to HHS.

If HHS decides a state doesn't have an effective rate review system in place, the federal agency itself will conduct the review. HHS estimates that 43 states have some sort of premium rate review process in place.

Significantly, states don't need to possess the authority to reject rates in order to review these large rate increases. Instead, HHS lays out four criteria that would cause it to step in and conduct a review in lieu of a state. First, states must require insurers to provide data and documents supporting rate change requests. Second, states must conduct a timely and effective review of this data. Third, they must be able to analyze the data in a meaningful way and verify its validity. And fourth, states must apply the rate review to standards in state statutes.

And the federal government is helping states meet these criteria. The Affordable Care Act provides $250 million to support states to enhance their premium rate review processes. To date, 45 states and the District of Columbia have received grants of $1 million to boost their rate review capabilities.

One state eager for this support is Illinois. The Land of Lincoln is one of only three states with no authority over premium rate increases on the individual market. Insurers aren't even required to report rate increases to state regulators, in both the individual and small group markets.

Michael McRaith, director of the Illinois Department of Insurance, said the situation is so untenable that any help in this area is appreciated.

McRaith cites an example of a small business with five workers. All the workers were in their 20s, and none came close to hitting their annual deductibles. Even so, their insurance rate went up last year by more than 30%. They were personal trainers, he said, in top physical condition. “The expectation is not that rates are going to dramatically or miraculously decline,” McRaith said. “But that rates will be more stable.”

Already, the Illinois department is using the $1 million federal grant to obtain information about rate increases from insurers and then publicize them. He said he would use the funding to educate policymakers and the public about excessive rate increases. The issue has not been a focus in the Illinois Legislature. Last year, a draft bill was introduced to give the department more authority over rates but did not go anywhere.

One of McRaith's goals is to meet and exceed HHS criteria in the new proposed rules so Illinois can conduct its own rate reviews, he added. “We absolutely intend to do the rate reviews ourselves.” So even if Illinois lacks the authority to reject excessive rate increases, it can move down the line toward more regulation, with help from the federal government.

Jay Angoff, director of the HHS Office of Consumer Information and Insurance Oversight, said more rate regulation is an important goal. “The number of states with effective rate review will increase over time,” he told reporters last month at a news conference.

State and federal authority to control rate hikes is expected to grow in the next five years, experts said.

In 2014, when the state health insurance exchanges get up and running as required by the federal reform law, insurers will be eager to participate. Individuals and small businesses will be able to buy insurance through the exchanges, and some will receive federal subsidies to offset the cost. States can opt to run their exchange themselves or have HHS do it.

Timothy Jost, law professor at Washington and Lee University, said the “teeth” of rate regulation comes into sharp focus in 2014.

“If an insurer consistently and unreasonably raises rates, they can be kept out of the exchanges,” Jost said.

Most states have yet to draft rules on how they intend to operate their exchanges, but Sebelius has hinted that in states where HHS will run the exchanges, rate review will be a factor.

“We will certainly look at these practices in terms of the ability to participate in future exchanges,” Sebelius said last month about insurers' unreasonable rate increases.

Not surprisingly, the health insurance industry reacted unfavorably to the proposed rule on rate review, saying it does nothing to address a broken system.

Karen Ignagni, president and CEO of America's Health Insurance Plans, said in a statement the rule “establishes a threshold for review that is incomplete because it does not adequately factor in all of the components that determine premiums, including the cost of new benefit mandates and the impact of younger and healthier people dropping coverage.”

Analysts said systematic rate review required under the health reform law will negatively affect the managed-care sector over time.

“Unfortunately for plans, it seems that in many cases in which rates have been strenuously reviewed this year, the increase has either been reduced or denied because of math errors or unsupported assumptions by the plans,” Carl McDonald, analyst at Citi, wrote in a December research note.

McDonald added that though the health reform bill didn't give HHS as much latitude over premium rate increases as it could have, “HHS still has considerable power, since plans will now have to provide justification and specific assumptions for all big increases.”

That's what happened in California last spring, when Anthem Blue Cross of California, a WellPoint subsidiary, withdrew a planned rate hike of up to 39% for individual members. News of the rate hike prompted hearings in Congress and the California Legislature, and provided much-needed ammunition in the Obama administration's battle to pass health insurance reform. The California Department of Insurance found mathematical errors in the rate filing after hiring an outside actuary to conduct the review.

The white-hot spotlight of public attention on the Anthem rate hike allowed the state to move forward with its own review, said David Link, deputy commissioner at the California Department of Insurance. “But for that kind of transparency, that mathematical error may not have been found,” he said. A brighter spotlight on insurance rates will likely also affect providers, observers said.

“I would certainly hope that insurers would become a bit more aggressive in negotiating contracts with providers,” Jost said. “We just can't keep escalating healthcare costs indefinitely.”

In its recommendations to HHS on the rate review regulations, the National Association of Insurance Commissioners approved a rate filing last month disclosure form that insurers would fill out to justify excessive premium increases. The form requires detailed information about medical prices. Claims for clinical services are broken down into eight categories, including hospital inpatient and outpatient, physician services, pharmacy, emergency room, imaging and laboratory.

If HHS requires insurers to fill out this information as part of rate inquiries, Jost said, transparency around medical costs also could improve.