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On February 21, 2012, the Centers for Medicare & Medicaid Services (CMS) announced long-term loans totaling almost $639 million for Consumer Operated and Oriented Plans (CO-OPs) to offer private, nonprofit health insurance plans in eight states. 1 This first batch of loans is sure to be followed by others, as the CO-OP program seeks to establish these plans in every state 2 with $3.8 billion in funding under the Affordable Care Act. In fact, CMS will accept four more rounds of applications for funding -- the last one due on December 31, 2012 -- in addition to the first two rounds of applications that have already been submitted. 3

Early on in the debate over the legislation that eventually became the Affordable Care Act, one of the hot topics was whether there should be a “public option,” that is, a government health insurer that would offer plans alongside private health insurers. As a compromise with opponents of such a role for the federal government, reform proponents offered CO-OPs as an alternative. CO-OPs were envisioned as something between the private health insurance market and a government run insurer. To prevent undue influence from either end of this spectrum, both preexisting insurers and government entities are ineligible for the CO-OP program.4

Health insurance cooperatives are not new -- several exist around the country and some of these have existed for decades. However, without the ability to sell ownership interests it is difficult to capitalize more of these member-based organizations. The CO-OP program was designed to overcome this impediment by providing two types of loans: five year loans to cover initial start-up costs, and fifteen year loans to meet state capital requirements. 5

The first phase of CO-OP development was a study by a CO-OP Program Advisory Board 6 of the criteria for funding under the CO-OP program. The Advisory Board issued its recommendations in a report released on April 15, 2010, 7 which outlined four major principles for awarding loans:

  • Consumer operation, control, and focus must be the salient feature of a CO-OP and sustained over time;
  • Solvency and the financial stability of coverage must be maintained and promoted;
  • CO-OPs should encourage greater care coordination, quality and efficiency to the extent feasible in local provider and health plan markets; and
  • Initial loans should be rolled out as expeditiously as possible (by the end of 2011) so that CO-OPs can compete in the Exchanges in the critical first open enrollment period (in 2014).

In the second phase of CO-OP development, CMS used the CO-OP Program Advisory Board report to develop regulations governing the CO-OP program. The rules originally proposed in July 20118 and finalized in December9 fleshed out the standards for CO-OPs, including:

  • Member governance : “A CO–OP must implement policies and procedures to foster and ensure member control of the organization,” including classifying all adult insureds as members, requiring election of all directors by the members, and requiring contested elections for director positions. 10
  • Consumer focus : “The CO–OP must operate with a strong consumer focus, including timeliness, responsiveness, and accountability to members.” 11
  • Ineligible organizations : A health insurer that was in existence on July 16, 2009 does not qualify for CO-OP loans, 12 and neither does a state or local government entity.13
  • Focus on the individual and small group markets : At least two-thirds of the health insurance policies issued by a CO–OP in each state must be qualified health plans offered in the individual and small group markets.14
  • Focus on silver and gold : A CO-OP must offer the middle-tier silver and gold qualified health plans on any exchange for individual coverage in the CO-OP’s service area; likewise, if the CO-OP offers at least one small group plan, it must offer silver and gold qualified health plans on any exchange for small group coverage in the CO-OP’s small group service area. 15
  • Loan terms : The five year loans to cover initial start-up costs, called Start-Up Loans, accrue interest at the rate for 5 year marketable Treasuries minus one percentage point or 0%, whichever is greater, and the fifteen year loans to meet state capital requirements, called Solvency Loans, accrue interest at the rate for 15 year marketable Treasuries minus two percentage points or 0%, whichever is greater. 16 Solvency Loans are structured in a manner that ensures that the loan amount is recognized by state insurance regulators as surplus rather than debt, 17 that is, as a “surplus note.”
  • No conversions : CO-OPs are permanently prohibited from converting to or selling to a for-profit or non-consumer operated entity. 18

CO-OPs are also entitled to their own tax-exempt status under § 501(c)(29) of the Internal Revenue Code,19 and the IRS has issued guidance,20 temporary regulations, 21 and a notice of proposed rulemaking22 setting out the procedures for issuing determination letters and rulings on the exempt status of CO-OPs.

In the third phase of CO-OP development, CMS has been taking and will continue to take applications for CO-OP loans, and will presumably follow its initial February 21, 2012 awards with additional awards in other states. If there are no CO-OP applicants from a state, CMS may use CO-OP funding to encourage such an application or the expansion of another CO-OP into that state. 23

As is often the case when the federal government becomes involved with insurance, there are several elements of the CO-OP program that present thorny insurance regulatory issues. For example, what sort of entity should be used for a CO-OP? Also, how will Solvency Loans qualify as surplus instead of debt under statutory accounting principles? And finally, is it possible for CO-OPs to operate in more than one state?

Form of Entity

As noted above, a CO-OP must be controlled by its members, who are defined as adult individuals covered by the CO-OP’s policies. 24 In addition, a CO-OP must be “a nonprofit, not-for-profit, public benefit, or similar membership entity organized as appropriate under State law.” 25 In short, a CO-OP must be a not-for-profit entity controlled by its members. So what sort of insurance entity might fit this description? In theory, there are at least four possibilities: An actual cooperative, a nonstock insurer, a health maintenance organization, and a mutual insurer.

Cooperatives have many different purposes, but generally share the idea of member ownership and control, and not-for-profit operation. With respect to offering insurance, some states allow cooperatives to be licensed as insurers, others prohibit it, and some states simply have no provision for it. While the very name of the CO-OP program indicates that the entity should be a cooperative, the law does not explicitly require that approach. However, the cooperative form obviously fits very well with the CO-OP requirements for a not-for-profit that is controlled by members.

Nonstock insurers are more commonly recognized by states than cooperative insurers. Generally, nonstock insurers can form with or without members, and they are not operated for profit. When formed with members, nonstock insurers therefore also fit very well with the CO-OP requirements.

Most states provide for forming a health maintenance organization under an HMO Act or a health service corporation. The HMO Model Act of the National Association of Insurance Commissioners (NAIC) does not state whether an HMO must be a nonprofit, and state laws will vary on this issue.

Mutual insurers are also very commonly recognized by the states. Generally, each insured of a mutual is a member of the mutual, and the mutual is operated on a not-for-profit basis. While this form also seems to fit very well with the CO-OP requirements, states often impose specialized member voting requirements on mutuals that might not be compatible with the very specific CO-OP governance requirements. 26

Solvency Loan Terms

CO-OP regulations recognize that Solvency Loans must be “structured in a manner that ensures that the loan amount is recognized by State insurance regulators as contributing to the State determined reserve requirements or other solvency requirements (rather than debt).” 27 Of course, the only way to have debt count as capital is in the insurance world using a surplus note. A note is a surplus note only if (1) the insurance regulator of the insurer’s state of domicile provides prior approval for any payment of principal or interest under the note, and (2) the note is subordinated to all policyholders, claims, and other creditors.28

In spite of the regulation cited above, CMS did not mention these criteria when describing subordination of Solvency Loans. Instead, CMS said that Solvency Loans “will be structured so that premiums would go to pay claims and meet cash reserve requirements before repayment to CMS. The goal of this provision is to satisfy the reserve requirements of the individual insurance department in the States in which each CO-OP seeks licensure.” 29 CMS continued this approach through initial drafts of the loan documents for the Solvency Loans, but included the language required for surplus notes prior to closing the initial group of loans.

Multiple State Operations

It seems likely that some CO-OPs would find it most effective to operate in a market that covers two or more states. The initial group of loans, for example, included one group that plans to provide coverage in Iowa and Nebraska. In this situation, our state-based system of insurance regulation means that the CO-OP would either have to (1) form one insurer in one of the states and get it licensed in the other(s), or (2) form an insurer in each state in which it operates.

The latter approach results in additional costs because forming multiple insurers means satisfying multiple capitalization requirements and paying for multiple applications. Incurring these costs seems unavoidable, however, because there are major timing problems with forming one insurer and getting it licensed in other states: It is generally not possible to file license applications in other states until the home state grants a license; thus, multistate licensing for a single CO-OP would be a two-step process that might make it difficult to be operational by October 2013 (as strongly encouraged by CMS). Worse yet, many states impose “seasoning” requirements, which prohibit an insurer from applying for a license until it has operated in its home state for several years. Moreover, some states make it difficult or impossible for some nondomestic insurers (e.g., out-of-state HMOs) to obtain a license.


While CO-OPs offer a good deal of promise for the individual and small group health insurance market, realizing that potential will depend on how well the various recipients of CO-OP loans implement their business plans. Moreover, that promise will take years to develop as CO-OPs open their doors on January 1, 2014 and begin the long-term task of building an alternative health care financing mechanism.


1 . The states with the first funded CO-OPs are Iowa, Montana, Nebraska, New Jersey, New Mexico, New York, Oregon, and Wisconsin.

2 . Patient Protection and Affordable Care Act, Pub. L. 111-148 (March 23, 2010) (Affordable Care Act), § 1322(b)(2)(A)(iii) and (B).

3 . The Funding Opportunity Announcement may be accessed by searching for CFDA Number 93.545 at

4 . Affordable Care Act § 1322(c)(2). See also § 1322(c)(3)(b) (a CO-OP’s governing documents must “incorporate ethics and conflict of interest standards protecting against insurance industry involvement and interference.”)

5 . Affordable Care Act § 1322(b)(1) and (3) (as inserted by § 10104(l)(2)). While § 1322(b)(1)(B) refers to the 15 year loans as “grants,” § 1322(b)(3) clearly requires them to be repaid.

6 . The Affordable Care Act required the Comptroller General to appoint 15 board members with expertise or experience related to health insurance and health care delivery but without significant interests in the insurance sector. § 1322(b)(4) (as redesignated by § 10104(l)(1)).

7 .

8 . 76 FR 43237 (July 20, 2011).

9 . 76 FR 77392 (December 13, 2011).

10 . 45 CFR § 156.515(b)(1). See Affordable Care Act § 1322(c)(3)(A).

11 . 45 CFR § 156.515(b)(4). See Affordable Care Act § 1322(c)(3)(C).

12 . 45 CFR § 156.510(b)(1)(i) and (ii). See Affordable Care Act § 1322(c)(2)(A). This ineligibility extends to holding companies for such an insurer; a trade association of such insurers that represents the interests of the health insurance industry; a foundation established by such an insurer; an affiliate of such an insurer that provides services to the insurer; a predecessor of such an insurer or its affiliate; and an organization that receives more than a quarter of its funding (aside from CO-OP loans) from such ineligible entities. Note that representatives of these entities (other than one that meets the funding criterion) also are not allowed to serve on a CO-OP's board. § 156.515(b)(2)(v). On the other hand, an entity that is sponsored by a nonprofit that also sponsors a preexisting health insurer is eligible for CO-OP loans so long as the entity does not share any of its board or a CEO with the insurer. § 156.510(b)(2)(i). Also eligible is an entity that purchases the assets of a preexisting insurer in an arm's-length transaction. § 156.510(b)(2)(ii).

13 . 45 CFR § 156.510(b)(1)(iii). See Affordable Care Act § 1322(c)(2)(B). This ineligibility extends to an instrumentality of a state or local government entity, as well as an organization that receives more than 40% of its funding (aside from CO-OP loans) from such ineligible entities. Note that representatives of federal, state, or local governments also are not allowed to serve on a CO-OP’s board. § 156.515(b)(2)(v). On the other hand, an entity is eligible if it is not a government organization under state law; has no employee of a state or local government serving in an official capacity as one of its senior executives; and has fewer than half of its directors who are state or local government employees serving in an official capacity. § 156.510(b)(3).

14 . 45 CFR § 156.515(c)(1). This regulation interprets Affordable Care Act § 1322(c)(1)(B), which requires that “substantially all of the activities” of a CO-OP must consist of issuing qualified health plans in the individual and small group markets. Qualified health plans are defined in Affordable Care Act § 1301(a)(1) as plans that offer essential health benefits and that are certified as meeting the criteria for being offered on the American Health Benefit Exchanges.

15 . 45 CFR § 156.515(c)(2). The silver and gold plans described in Affordable Care Act § 1302(d) offer benefits that are actuarially equivalent to 70% and 80%, respectively, of the full actuarial value of the benefits provided under the plan; the other plans are bronze, at 60%, and platinum, at 90%.

16 . 45 CFR § 156.520(c).

17 . 45 CFR § 156.520(a)(2).

18 . 45 CFR § 156.520(f).

19 . Affordable Care Act § 1322(h).

20 . Revenue Procedure 2012-11 (February 7, 2012).

21 . 77 FR 6005 (February 7, 2012).

22 . 77 FR 6027 (February 7, 2012).

23 . Affordable Care Act § 1322(b)(2)(B).

24 . 45 CFR § 156.505.

25 . 45 CFR §§ 156.505 and 156.510(a).

26 . 45 CFR § 156.515(b).

27 . 45 CFR § 156.520(a)(3).

28 . Statement of Statutory Accounting Principles No. 41, paragraph 3. See also insurer delinquency laws, such as § 801K of the Insurance Receivership Model Act of the National Association of Insurance Commissioners, that subordinate the claims of surplus note holders to all other claims in liquidation except interest on claims and the claims of equityholders.

29 . Initial Announcement, Invitation to Apply for the CO-OP Program, Funding Opportunity Number OO-COO-11-001, CFDA: 93.545 (July 28, 2011), § I.E.2.