Supreme Court Rules Individual Mandate a Tax

In a five-to-four decision, the U.S. Supreme Court upheld the Affordable Care Act (ACA), ruling that it does not represent an overreach of federal taxation power granted under the Constitution.

The Obama administration will now breathe a huge sigh of relief, especially the Solicitor General who argued the case for the Government. At the same time, you can bet conservatives will ramp up their opposition to ACA implementation as the election approaches.

The consequences go far beyond a simple matter of constitutionality or states’ rights. The ruling has long term effects for insurance companies and policyholders.

In a clear message, the Justices’ decisions show that conservative principles can be reconciled with the Democratic logic of clear benefits to the majority of the population as laid out in the ACA.

Clearly, the big losers of the battle are the strict constitutionalist movement — those who narrowly interpret the constitutional powers granted to the federal government. But as conservatives have prioritized overthrowing of the entire legislation, the war is far from over as the election draws near.

First, the Justices were to decide whether the penalty for not having health insurance amounted to a tax subject to the Anti-Injunction Act. On March 26, 2012, the court invited amicus curiae (friend of the court), Robert Long, to present a case for the “individual mandate” being a tax.

Unusually, in this politically charged case, both sides — The Department of Health and Human Services (HHS), and the States, led by Florida — agreed that the penalty for not maintaining health insurance was not a tax.

It was largely believed that the Justices could not rule on the remaining issues addressing the constitutionality of the ACA until at least 2014, if they agreed the penalty mandate was a tax, because the Anti-Injunction Act would require the tax to be implemented, challenged and denied in appeal before it could be presented to the Supreme Court. Neither side of the political argument wanted that.

At the time, the Justices appeared to simply want to move on. But now, looking back, what seemed a sleepy start was actually a critical factor in the Justices’ decisions. We now see that 89 minutes after arguments started, the case was decided.

With today’s announcement, the Justices surprisingly and conclusively partially agreed with the amicus curiae argument. They held that the penalty for not having insurance coverage is a tax and Congress is entitled to make tax laws.

Relying on the word “penalty” they concluded that Congress did not intend to create a tax. Therefore, the penalty is not considered a tax for purposes of the Anti-Injunction Act and did not bar the Court from ruling on the remainder of the case.

With the tax decision essentially confirming the constitutionality of the Act, the question about the individual mandate and the Constitutional Commerce Clause became irrelevant. The ACA was effectively upheld by the tax decision.

Although the court no longer had to rule over the constitutionality of the individual mandate, they decided to address the issue. They ruled that the government requirement to have health insurance isn’t covered by the Commerce Clause because “Congress cannot compel individuals to become active in commerce by purchasing a product.” After the battering the Justices gave Donald Verrilli — the Solicitor General for the Department of Health and Human Services — during the oral arguments in March, it would have been a shock had it been upheld.

However, Donald Verrilli can claim partial victory and potentially full vindication of his case. It had been a terrible day for the Solicitor General, but in his final arguments, what appeared to be a last gasp effort may have won the day — he suggested that maintaining minimum health coverage was a proper exercise of the taxing powers of Congress.

Unfortunately for the constitutionalists, the ruling on the Commerce Clause will have no affect on the ACA. And as the second Supreme Court decision this week asserting that federal powers are superior to states’ rights, narrow interpretation of the Constitution may be losing ground.

The third issue that faced the Justices was focused on government coercion. Never in the history of the Supreme Court has it ruled that the government has coerced with respect to commerce, until now.

The Court did not agree with the idea that government could withhold all Medicaid funding. However, in a seven-to-two ruling, they held that funds slated for Medicaid expansion can be withheld if the states do not agree to the new provisions.

So there are winners and losers, but who are they and what are some of the consequences?

The winners are most certainly the government and, by inference, President Obama who has set this legislation as the signature event of his presidency. Now that the legal hurdle has been passed, there is very little chance that the ACA will not be implemented as proposed, give or take the occasional tweak.

Non-insurer health companies such as hospitals, diagnostic centers and pharmacies could be big winners as they benefit from a larger customer base. These include companies like Express Scripts (ESRX), HCA Holdings (HCA), and Tenet Healthcare (THC).

Individual policyholders should be able to breathe a little easier knowing that gains such as extension of coverage to young adults at home, removal of lifetime coverage limits and prohibition of rescission of coverage for minor mistakes or denial of coverage for children based on pre-existing conditions will remain.

In addition to the strict constitutionalists, the losers could include stockholders of insurance companies. This includes companies like Aetna (AET), Coventry Health (CVH), Humana (HUM), UnitedHealth Group (UNH) and WellPoint (WLP) that may have slimmer profit margins, diluting earnings.

Despite the certainty that will follow from knowing the ACA is constitutional, there is still significant, but waning, concern that a Mitt Romney victory in November could lead to a successful Congressional effort to overturn the legislation.

However, time is the ACA’s friend. The chances of the act being repealed drop as time moves on and it becomes essentially impossible to unwind already implemented portions of the ACA without significant monetary and political cost.

Additionally, there could be political push back against repeal from the insurance community considering the cost of the work that has been done to prepare for the 2014 implementation of the major portion of the ACA.

And, imagine the political fallout if there is an attempt to take away benefits that clearly improve the lives of large groups of people. In the cold hard light of day, this is unlikely to attract a super-majority vote in Congress.

Looking at this from an economic perspective, health insurers are already facing difficulties managing small profit margins and rising health care expenses. The clarity of this ruling and the reduced uncertainty it brings is a positive for the insurers who are already gearing up to accommodate the presumed influx of new policyholders and have begun implementing other requirements of the ACA.

We have seen many health insurers withdraw from the market, fail, or be taken over by another insurer in the past three years. Clearly with size comes the advantage of potential efficiency and the trend is expected to increase with the implementation of the ACA.

As time progresses it is certain that there will be continued reductions in numbers of independent health insurance companies, and this will lead to a reduction in choice for policyholders. Contrary to stockholder concerns, the largest insurers could benefit significantly, in the long-term, from the new pool of policyholders assuming they leverage the size with efficiency.

Reduced carrier choice could also lead to less competition over premiums — another potential downside for consumers. However, the fear of uncontrolled policy increases was addressed within the ACA with minimums established in 2011 for how much insurers must actually spend for customer healthcare as a proportion of premium income.

Gavin Magor, senior financial analyst at Weiss Ratings, has more than 25 years of international experience in credit-risk management, insurance, commercial lending and analysis. He leads the firm’s insurance ratings division and developed the methodology for Weiss’ Sovereign Debt Ratings.

Supreme Court Rules Individual Mandate a Tax

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