What Is the Health Maintenance Organization Act of 1973?

The Health Maintenance Organization Act of 1973 (Public Law 93-222) was a federal law that created a program to build prepaid health plans as an alternative to traditional fee-for-service insurance. Signed by President Nixon in December 1973, it authorized $375 million over five years in federal money to launch these organizations, required certain employers to offer them alongside existing coverage, and overrode restrictive state laws that had blocked them from operating.¹ The premise was that paying providers a fixed amount per patient, rather than per visit or procedure, would give them a reason to keep people healthy instead of just billing more when they got sick.

Federal Money to Start New Plans

Almost no private lender in the early 1970s would finance a prepaid health plan. The Act filled that gap with three tiers of federal support. Grants and contracts paid for feasibility studies in prospective service areas and for the administrative design work that followed. Development grants covered the cost of hiring staff and building provider networks. Loans and loan guarantees carried plans through the operating deficits typical of the first years, when enrollment is still growing but fixed costs are already running.¹

The Section 1305 loan program targeted initial operating costs, defined by regulation as expenses incurred during the first 60 months of running or expanding a plan. Borrowers could defer principal for those 60 months and pay only interest, giving new plans time to build membership before facing full repayment.² Public and private nonprofit organizations received priority.

By the end of 1977, the Department of Health, Education, and Welfare had awarded $131.3 million in grant and loan assistance to 197 organizations, with two additional organizations receiving loan guarantees totaling $2.2 million. Fifty-one organizations had achieved federally qualified status by that point.³ Congress repealed the grant and loan provisions in 1986 once private financing had become available to the industry.

What a Plan Had to Do to Qualify

Federal money and employer access came with conditions. To earn “federally qualified” status under Section 1301, an organization had to meet operational standards covering benefits, pricing, governance, and quality oversight.

Required Benefits

A qualified plan had to cover a broad set of basic health services for a fixed periodic payment, with no additional charge at the point of care. The required package included physician services (including specialist consultations and referrals), inpatient hospital care, outpatient services, and emergency care. It also covered short-term outpatient mental health crisis services, treatment and referral for alcohol and drug abuse, diagnostic laboratory and radiology services, home health services, and a slate of preventive care: immunizations, well-child care from birth, periodic adult health evaluations, family planning, infertility services, and children’s vision and hearing screenings.⁴

Building preventive care into the fixed payment was the point. It made healthy patients cheaper for the plan and sick ones expensive, reversing the incentives of fee-for-service billing.

Community Rating

Premiums had to be set using a community rating system, which averaged the cost across the entire pool of enrollees rather than adjusting for any individual’s health status or history.⁵ A healthy young enrollee and an older enrollee with chronic conditions paid the same rate. The design spread risk broadly and kept premiums accessible for people who needed care most.

Member Governance

At least one-third of a private organization’s policymaking board had to be made up of actual plan members, with equitable representation from any medically underserved populations the plan served.⁵ Congress removed this requirement in 1988.

Grievances and Quality Assurance

Every qualified organization had to set up a formal process for hearing and resolving disputes between the plan (including its affiliated medical groups and other providers) and its members. The statute called for “meaningful procedures” rather than a token complaint form. Plans also had to run an ongoing quality assurance program focused on health outcomes, including peer review by physicians and other health professionals looking at how care was actually delivered.⁵

The Dual Choice Employer Mandate

The provision that mattered most for enrollment was the dual choice mandate in Section 1310. It required certain employers to offer a federally qualified plan alongside their existing insurance if one was available in the area and asked to be included. Without this pipeline, new plans would have had to persuade individual consumers one by one to leave familiar coverage.

The requirement applied to any employer that met two conditions: an average of at least 25 workers during a calendar quarter, and coverage under the minimum wage provisions of the Fair Labor Standards Act. State and local governments with at least 25 employees were also covered.⁶ If a qualified organization operating in an area where at least 25 of the employer’s workers lived made a formal request, the employer had to add it as an option.

The Act recognized two organizational models. In a medical group, physicians pooled income and practiced together as a coordinated team. In an individual practice association, independent physicians contracted with a central entity while keeping their own offices.⁷ If both types operated in the area, the employer had to offer one of each.

Employers were not required to contribute more toward the new option than they contributed toward existing coverage. The competition happened on the plans’ merits: benefits, provider networks, and cost-sharing.

Overriding State Barriers

Even with federal money and employer access, new plans still faced state laws that could keep them from opening. Section 1311 declared that specific categories of state restrictions did not apply to federally qualified organizations. The preempted categories included:

Laws requiring approval by a local medical society before a plan could operate, which had given incumbent physicians veto power over new competitors.
Laws requiring that all or a fixed share of a plan’s governing board be physicians.
Rules forcing plans to accept any local physician into their provider network, which undermined the plan’s ability to select and credential its own doctors.
Financial reserve requirements pegged to those of traditional insurers, which were often far higher than a startup prepaid plan could meet.
A catch-all against any state rule that would prevent compliance with the Act.⁸

States also could not enforce laws that prevented federally qualified plans from advertising their services and charges to the public. Plans still could not run advertisements identifying individual health professionals by name or making qualitative judgments about specific providers.⁸

Penalties for Noncompliance

An employer that knowingly failed to comply with the dual choice requirement faced a civil penalty of up to $10,000, and if the violation continued, the penalty could be assessed for each 30-day period of ongoing noncompliance. The Secretary set the amount based on the seriousness of the violation and whether the employer had made a good-faith effort to comply after being notified. Either side could demand a full trial on the assessment in federal district court.⁹

Plans faced accountability too. If an organization that had received federal grants, loans, or loan guarantees failed to deliver the required services or operate according to its commitments, the Secretary could bring a civil enforcement action in federal court. Financial fraud carried heavier consequences: anyone who knowingly made false statements in financial filings required under the Act committed a felony punishable by up to $25,000 in fines, up to five years in prison, or both.⁹

How the Law Changed Over Time

The 1973 Act did not stay fixed. The HMO Amendments of 1988 loosened requirements that organizations had found difficult to work under. Strict community rating was relaxed to allow “adjusted community rating,” which let plans account for a group’s prior medical service use when setting premiums. The amendments also protected small employers with 100 or fewer workers by capping the rates plans could charge them.¹⁰ The one-third member board rule was eliminated at the same time.

The federal grant and loan programs were repealed in 1986 as private capital reached the industry. The dual choice employer mandate was eventually phased out as well, once managed care had grown large enough to compete without a legal push. By the mid-1990s, more than 50 million Americans were enrolled in HMO-style plans.

The Act’s structural contributions outlasted its specific programs: federally set minimum benefit standards, a preventive care coverage requirement, mandated outcome-based quality review, and preemption of state laws that stood in the way of the federal design.

1
Social Security Administration. Social Security Bulletin – Health Maintenance Organization Act of 1973
2
eCFR. 42 CFR Part 417 – Health Maintenance Organizations, Competitive Medical Plans, and Health Care Prepayment Plans
3
U.S. Government Accountability Office. Implementation of the Health Maintenance Organization Act of 1973
4
GovInfo. 42 USC 300e – Requirements of Health Maintenance Organizations
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Office of the Law Revision Counsel. 42 USC 300e – Requirements of Health Maintenance Organizations
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Office of the Law Revision Counsel. 42 USC 300e-9 – Employees Health Benefits Plans
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Office of the Law Revision Counsel. 42 USC 300e-1 – Definitions
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GovInfo. 42 USC 300e-10 – Restrictive State Laws and Practices
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GovInfo. Public Health Service Act – Title XIII, Health Maintenance Organizations
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Health Affairs. Legislation, Publications and Reports, and Programs