Dueling Appellate Rulings on the Availability of Federal Subsidies for Federally Facilitated Exchange Plans: What's Next for States with Federally Facilitated Exchanges?

The Obama Administration received mixed messages yesterday when two federal appellate courts issued contradictory rulings on whether tax credits are available for individuals to purchase health insurance from federally facilitated Exchanges operating in 36 states. The U.S. Court of Appeals for the D.C. Circuit delivered a strong blow to the Obama Administration, issuing a 2-1 ruling vacating an IRS regulation that allowed the use of tax credits for all Exchanges, whether federally facilitated or established by a State. In Halbig v. Burwell, No. 14-5018 (D.C. Cir. July 22, 2014), the D.C. Circuit held that the plain and unambiguous meaning of the Affordable Care Act tax credit provision, 26 U.S.C. § 36B, limited the availability of subsidies to insurance purchased on Exchanges "established by the State under Section 1311" of the ACA. Some two hours later, however, the U.S. Court of Appeals for the Fourth Circuit, in King v. Burwell, No. 14-1158 (4th Cir. July 22, 2014), reached the opposite—and unanimous—conclusion, holding that the language of the Affordable Care Act is ambiguous and, because the rule advances the ACA's broad policy goals of increasing health care coverage and reducing the costs of health care, the IRS's interpretation of the statute is reasonable and entitled to deference.

The Administration already has signaled its intent to seek rehearing by the D.C. Circuit en banc. The D.C. Circuit's ruling has no immediate impact on the availability of tax credits in federally facilitated Exchanges because it has been stayed pending rehearing and the ruling would be vacated automatically should the full court agree to rehear the case. Given that Democratic presidents appointed 7 of the 11 members of the D.C. Circuit, some speculate that an en banc ruling will favor the Administration. The plaintiff-appellants in the Fourth Circuit case likely will appeal that decision directly to the Supreme Court of the United States, which ultimately may resolve the issue—particularly if there is a circuit split.

If the D.C. Circuit's ruling stands, it would significantly weaken the "complex network of interconnected policies" that includes providing subsidies to millions of Americans so they can afford to buy insurance on Exchanges. Indeed, the D.C. Circuit readily acknowledges that its ruling "will likely have significant consequences both for the millions of individuals receiving tax credits through federal Exchanges and for health insurance markets more broadly." As the Affordable Care Act was being debated and ultimately enacted, this "complex network of interconnected policies"—the guaranteed issue requirement, the individual mandate, and the availability of subsidies—was often referred to as the three pillars supporting the ACA's overarching goals.

As the D.C. Circuit opinion acknowledges, when one of these pillars is missing—such as in the Northern Mariana Islands and other territories, which have guaranteed issue and community rating requirements without an individual mandate—insurance markets have suffered.

The two cases raise an interesting question related to the definition of an "Exchange established by the state." While the D.C. Circuit focused on what it found to be the plain meaning of this provision, the Fourth Circuit stated that language "cannot be understood literally in light of § 1321, which provides that a state may 'elect' to do so." As the Fourth Circuit explained, the ACA mandates the existence of Exchanges, directs the federal government to "establish and operate such Exchange within the State" when states do not. But the D.C. Circuit reasoned that while Section 1321 "creates equivalence between state and federal Exchanges in two respects: in terms of what they are and the statutory authority under which they are established," the availability of subsidies turns on a third characteristic: who established the Exchange.

Several states have begun asking questions about whether they could establish a state-based Exchange by tailoring the federal technology platform to their particular state, rather than buying an off-the-shelf product or developing a distinct technology platform. States may seek to enter into contracts or other arrangements with CMS by which states establish an Exchange, but subcontract administration or other services to Healthcare.gov and the federal platform. In so doing, states and CMS may preserve the availability of tax credits even under a narrow reading of the ACA because the Exchange would be "established by the state."

For example, Oregon, which established a state-based Exchange and then announced in April that it would default to the federal platform for 2015, remains a state-based Exchange in the eyes of CMS. If the D.C. Circuit's reasoning ultimately prevails, it could trigger an expansion of this policy to include states that currently have federally facilitated Exchanges, but want to establish a state-based Exchange via the federal platform. This certainly would make the proposition of establishing a state-based Exchange simpler and cheaper for states, which will be important now that Section 1311 funding—federal grants to support establishment of Exchanges—is nearing an end. This is a likely policy direction regardless of the cases' outcome. But the D.C. Circuit's decision could make discussion of the topic even more critical and time sensitive.

While the law of the land remains unchanged, at present, states, issuers, and other stakeholders should be mindful of potential consequences if the D.C. Circuit's view prevails. For example, the D.C. Circuit's ruling may put significant pressure on states that have expanded Medicaid but have not established Exchanges. The loss of tax credits and unaffordability of Exchange coverage may divert more people into Medicaid and, ultimately, increase costs for states once federal funding for Medicaid expansion recedes. Similarly, there may be political consequences at the state level in states that rely on federally facilitated Exchanges. Finally, the loss of tax credits may render Exchange plans unaffordable for lower-income persons, resulting in a wave of policyholders not paying their premiums and slipping into the 90-day grace period before ultimately disenrolling and leaving insurers with incurred claims and insufficient premium.

We are following these and other issues closely. Please contact us to explore possible solutions and opportunities in greater detail.