The Proposed Federal Triagency Rule and a Post-Chevron Landscape

By Hunter Sexton, JD, MHA

I. Current Regulatory Environment has been Unfavorable

It is no secret that the recent insurance regulatory environment has decidedly been anti-industry. This is especially true for supplemental health benefits. We’ve experienced a marked uptick in state regulators prohibiting entire benefit categories (Wellness is one notable example), promulgating onerous new regulations, and relying more heavily upon ambiguous statutory language to achieve desired outcomes. The culmination of this increased regulatory pressure is, of course, the federal government’s proposed rule on Hospital Indemnity and Other Fixed Indemnity Plans (Federal Register Document Number 2023-14238 at XXX).

II. Federal Tri-Agency Proposed Rule on Hospital and Other Fixed Indemnity Plans

On July 12th, 2023 the Internal Revenue Service, Employee Benefits Security Administration, and The Department of Health and Human Services published a Notice of Proposed Rulemaking that sent shockwaves through the supplemental benefits community; proposing drastic changes to Hospital Indemnity benefit design, and asking the public for comments about a potential similar future rulemaking for Specified Disease (Critical Illness) plans. There are two major policy aims of the proposed rule with respect to Hospital Indemnity and other fixed-indemnity excepted-benefits plans. First, is a “clarification” of tax treatment for non-coordinated benefits, wherein the agencies claim that all benefit amounts received from claimed excepted benefits are taxable. Next, is the agencies’ desire to reduce consumer confusion between comprehensive major medical health insurance and Hospital Indemnity plans.

Regarding the proposed tax changes, the agencies’ position represents a marked departure from the “excess benefit rule,” the standard by which most currently contemplate tax liability associated with these plans. Under the “excess benefit rule” the only amounts considered “income” for purposes of taxation are any amounts beyond what makes the insured whole. For example, let’s say John Insured has a major medical plan with a $500 copayment for an Emergency Room visit and a $100 indemnity benefit for an Emergency Room visit. Under the “excess benefit rule” the $100 indemnity benefit is not classified as income subject to taxation because it does not exceed Mr. Insured’s financial loss (he’s liable for the $500 copayment, so has lost $400 in total). By contrast, under the proposed rule, the $100 benefit amount is fully taxable as income. Clearly, this change threatens to undermine the value proposition of supplemental health plans.

To achieve the goal of distinguishing Hospital Indemnity plans from comprehensive major medical coverage, the proposed rule significantly limits Hospital Indemnity benefit design by prohibiting: i) any benefits that include severity distinctions; ii) any benefits whose payment is contingent upon receiving treatment; and iii) any benefit that is not constructed to pay a fixed daily amount per day of hospital confinement or disease.

If these changes are finalized, Hospital Indemnity plans will have no space for innovative benefit designs that meet the diverse needs of the market. By restricting benefits to only per-day hospital confinement, the proposing agencies have effectively sentenced Hospital Indemnity to “death by boredom.”.

It begs the question: how the heck did we get here? How do non-legislative government agencies have the power to promulgate such wide-sweeping laws? For that answer, we must revisit the landmark 1984 Supreme Court case that many tout as having created the administrative state: Chevron U S A Inc v Natural Resources Defense Council, Inc.

If these changes are finalized, Hospital Indemnity plans will have no space for innovative benefit designs that meet the diverse needs of the market. By restricting benefits to only per-day hospital confinement, the proposing agencies have effectively sentenced Hospital Indemnity to “death by boredom.”

III.“Chevron Deference”

The questions the Court grappled with in Chevron were how to test whether an executive agency’s regulation is Constitutional, and when an executive agency has exceeded its rulemaking powers when promulgating regulations. The Chevron Court understood that agency lawmaking powers are necessary for effective governance of complex modern issues. After all, Congress can only do so much through statutory law, and Congress cannot be expected to be subject matter experts on every issue. Executive agencies, by contrast, can be staffed by permanent civil servants with specific subject matter expertise, and in doing so, are well positioned to oversee nuanced, complex, and evolving issues in their areas of expertise like technology, environmental protection, and insurance. But the Chevron Court also opined that because lawmaking powers are granted to the Legislature and not the Executive branch in the Constitution, executive agencies rulemaking powers are limited by Congressional statutes. Essentially, these agencies are granted limited powers over their specific areas by Congress. For example, the Environmental Protection Agency has a statutory mandate to preserve natural undeveloped environments through its enabling act, but also was granted additional authority to specifically regulate Waters of the United States through the Clean Water Act.

Recognizing the interplay in these important aspects of modern governance, the Court found the answer to its questions in the now-infamous “Chevron two-step” test. The first prong of the test is whether or not the Congressional statute empowering the agency with regulatory authority was ambiguous to begin with. If there is no ambiguity to what Congress intended, an agency’s regulation must strictly adhere to Congressional intent, or it is deemed unconstitutional. However, if a Court finds there is ambiguity in the statutory language, it moves to the next step in the test. The test’s first prong is relatively straightforward and, until Loper Bright Enterprises v Raimondo, hasn’t been the source of major controversy.

The infamy of the “Chevron two-step” is found in the second prong of the test which asks: “is the regulation reasonable?”. This “reasonability” standard for agency rulemaking powers was immediately chastised by dissenting Justices for affording far too much deference to executive agencies in making new law. After all, “reasonable” is a low bar to meet. Reasonable doesn’t require the regulation to be good, or effective, or even fair. When one puts their mind to it, anything can be construed to be reasonable. So, detractors of this standard would ask – is this a standard at all?

Combined with Courts’ presumptions that executive agencies are subject matter experts, the extremely low legal standard for “reasonability” created what is referred to now as “Chevron deference;” the current legal paradigm wherein agencies are empowered to interpret ambiguous laws and to push, and perhaps exceed in some cases, their legislative boundaries when making new rules and regulations.

IV. The Proposed Tri-Agency Rule is Lawful Under Chevron’s Reasonability Test

There are numerous and substantive issues with the Tri-Agency Rule that leaves it ripe for legal challenges. Firstly, challengers may argue that the “clarification” on tax treatment for non-coordinated benefits is actually a new tax by suggesting treatment that departs from the long-standing “excess benefit rule”. By doing so, the agencies have exceeded their regulatory authority because tax-powers are reserved solely to the Congress. Challengers are also likely argue that the proposing agencies have failed to meet rulemaking requirements of the federal Administrative Procedures Act by: i) not supporting the proposed rule’s changes with substantial evidence (the evidence provided was non-scientific and anecdotal); ii) not considering reasonable alternatives (like stricter enforcement of marketing practices); and iii) failing to provide a robust cost-benefit analysis (agencies did not consider heightened consumer costs due to reduced benefits in their analysis). Furthermore, challenges may argue that the proposed rule imposes “undue burdens” on key stakeholders like carriers and state regulators due to the extremely truncated 75-day window between final rule promulgation and its effective date.

While these challenges may delay the rule’s promulgation and even force significant concessions from the proposing agencies, legal challenges may still have a steep hill to climb with respect to Chevron deference. If challenged, the agencies are likely to lean heavily on this doctrine and claim that the rule’s proposed changes reasonably address the issues of mis-taxation and consumer confusion. Given that the agencies start from a position of subject-matter-expertise, it is possible that Courts will “defer” to the agencies under the Chevron doctrine, finding most (if not all) the proposed changes to be constitutionally valid.

But what about a standard that is something more than “reasonable?”. Would the proposed rule survive legal challenges in a world where the Chevron twostep is abandoned? Interestingly, that world may be on the horizon.

V. Current SCOTUS Challenges to Chevron: Loper Bright Enterprises v. Raimondo

Chevron and the progeny of cases drawing from Chevron to afford more power to executive agencies have been consistently and vociferously derided by conservative legal scholars, both academically and through formal dissenting opinions. Chevron critics espouse that the “reasonable” standard is too ambiguous for Courts to apply properly or consistently, as what constitutes “reasonable” for one judge may significantly deviate from what their peer considers “reasonable” Worse still, the deference. Courts afford to agency rulemaking unconstitutionally strips the Judiciary of its central role in our system of governance: to interpret and apply the law. For the most part, these arguments have been little more than footnotes in the history of how administrative law has evolved. But perhaps, that’s about to change.

The Supreme Court has picked up a series of administrative law cases in its current term, most notably Loper Bright Enterprises v. Raimondo, which involves a challenge to an executive agency regulation and the application of Chevron deference. While Raimondo purports to examine the previously less controversial question of “ambiguity,” many SCOTUS watchers are pointing to this case as having the potential to end Chevron deference.

Considering the political makeup of the current Supreme Court, we share in the optimism that the days of Chevron deference may be numbered, presumably being replaced with a higher legal standard for administrative rulemaking.

VI. Implications of a Post-Chevon Regulatory Landscape

Regarding the proposed Federal Tri-Agency Rule, it becomes much harder for agencies to defend the legitimacy of the proposed rule against likely legal challenges without the protection afforded by Chevron deference. It stands to reason that if the rule is already hard-pressed to meet a low “reasonable” standard, it will fail to meet a higher legal standard. In a post-Chevron landscape, the proposed rule is likelier than not to be dramatically revised, if not abandoned outright.

While a revised or rebuffed Tri-Agency Rule would certainly be a welcome start, the implications of a higher legal standard for administrative rulemaking are even broader for insurance regulation. Though Chevron is federal law, its holding has found its way into the machinations of state-level rulemaking processes, which of course, has fueled the recent zealousness in state-level insurance regulation. Thus, in a post-Chevron landscape, it is reasonable that the reverse will also be true, with stronger legal constraints around agency rulemaking flowing through to other administrative exercises of power (e.g. issuing guidance documents, reliance on highly ambiguous “fairness” statutes, etc.).

Nothing is written in stone, of course. The proposed rule is presumably still being finalized by the proposing agencies, and the Loper v Raimondo decision may not be published until October 2024. That said, a post-Chevron regulatory landscape is certainly worth the wait Stay tuned!

Hunter Sexton, JD, MHA

Compliance Consultant, Sydney Consulting Group

Hunter Sexton, JD, MHA, Compliance Consultant, Sydney Consulting Group - Hunter leads a best-in-class Regulatory Compliance Team that works with carriers and regulators to bring supplemental health and life products to market. Hunter earned his Masters in Healthcare Administration from the University of South Florida’s College of Public Health and his Juris Doctorate from Stetson University’s College of Law. Hunter came to Sydney Consulting after 12 years of industry experience with major medical carriers that included sales, marketing, plan operations, and finance.