Is This Obamacare's Biggest Kink Yet?

"Kinks in the system." 

That's how President Obama described the multitude of problems that have been experienced with the health insurance exchanges established by the Affordable Care Act, commonly known as Obamacare. The President also said that a "tech surge" is under way to resolve the problems.

However, there's another Obamacare issue that made news recently that could be the biggest kink of all. And this problem can't be resolved by expert software gurus.

President Obama with health exchange enrollees. Source: WhiteHouse.gov. 

Exchange frustrations
A group of individuals and small employers have sued the federal government over the legality of an Internal Revenue Service decision that subsidies can be given to people in states that don't operate their own health insurance exchange. The group's frustration is that because of the IRS ruling, they will have to pay penalties that they wouldn't be forced to pay if they didn't receive the subsidies.

On Tuesday, U.S. District Judge Paul Friedman ruled against the federal government's motion to dismiss the lawsuit. However, the judge also refused to grant a preliminary injunction blocking the subsidies as requested by the plaintiffs. His reasoning was that the case should conclude prior to the February 2014 deadline for individuals to purchase insurance to avoid paying penalties.

This isn't the only lawsuit climbing its way through the court system arguing against the IRS ruling about subsidies. It's also not the only time that the federal government has lost in a dismissal attempt. In August, federal judge Ronald White allowed key portions of the state of Oklahoma's lawsuit to move forward. Another case is pending in federal court in Indiana. 

Technicality?
The premise behind this litigation is that the Affordable Care Act doesn't authorize subsidies to be given to individuals in states that opted against creating their own exchange. Many Americans who don't receive subsidies won't be subject to financial penalties for not buying health insurance, because Obamacare exempts those who can't obtain coverage that costs less than 8% of their income. However, if the IRS decision stands, receiving subsidies could cause many individuals, like the lawsuit plaintiffs, to lose their exemption from the penalties.

What does the text of the legislation actually say? Section 1401 states that tax subsidies can be given to individuals who enroll "through an Exchange established by the State under [section] 1311" of the bill. Section 1311 details how states should setup their exchanges, but it doesn't mention federally operated exchanges at all. The federally operated exchanges are authorized in section 1321 -- but there's no reference to subsidies for individuals using those exchanges.

If this issue is regarded by the courts as a minor drafting error, the IRS can overlook it and provide subsidies to individuals in states that don't operate their own exchange. However, the history of how the Affordable Care Act was passed provides some grounds for arguing that Congress intended to provide federal subsidies as an incentive for states to operate their own exchanges. 

These lawsuits seem likely to eventually wind up at the Supreme Court. If that happens, the nine justices will again be called upon to make a decision with the fate of Obamacare in the balance.

System malfunction
The potential impact of what happens is huge. 27 states chose not to operate their own exchanges. If citizens of these states can't get federal subsidies, many won't buy insurance. A system malfunction of massive scale could develop -- in this case, the U.S. health care system itself.

Several publicly traded companies could feel the brunt of such a meltdown. Hospital stocks have soared over the past couple of years as Obamacare has moved forward. However, companies with hospitals primarily in the states that don't operate exchanges could miss out on the potential benefits of health reform while still absorbing some of the negative financial consequences of the law.

Tenet Healthcare (THC -0.76%), for example, has seen its stock more than double in just the last year. However, of the 10 states where Tenet operates, nine are in states that use the federally operated exchanges.

Similarly, shares of HCA Holdings (HCA -1.54%), the largest hospital operator in the nation, are up nearly 60% in the past year. HCA's facilities are located in 18 states. Two-thirds of those states opted against setting up their own health insurance exchanges. 

Community Health Systems (CYH 7.26%) is also up around 60% over the last year. The company operates hospitals in 29 states. 18 of them didn't establish a state-run exchange.

These stocks have held up well in the midst of all of the Obamacare exchanges' technical glitches. If the plaintiffs in the different lawsuits mentioned earlier prevail in court, though, look for shares to be clobbered.

At this point, of course, it's too early to know what will happen. Court decisions have proven to be quite unpredictable. A real possibility exists, though, that this Obamacare "kink" could bring down the system in a way that makes the website problems of the past few weeks look trivial by comparison.