Combined, Two Studies Predict The Near Collapse Of Employer-Provided Health Coverage Under ObamaCare 

June 2011

Two different reports by reputable consulting firms each conclude that more than half of employers will eliminate or change their existing health care plans. The two reports focus on entirely different reasons for the predicted changes. Because of the combined effects of the two reported challenges, there will be few employer-paid health care plans that will be left unscathed by the time the Patient Protection Affordability and Care Act (“PPACA”) becomes fully effective.

Released last week, a survey designed and conducted by notable consulting firm McKinsey indicates a surprising conclusion that over half of companies will materially alter their healthcare plans once PPACA provisions become fully effective. The report said:

“Our research suggests that when employers become more aware of the new economic and social incentives embedded in the law and of the option to restructure benefits beyond dropping or keeping them, many will make dramatic changes. The Congressional Budget Office has estimated that only about 7 percent of employees currently covered by employer-sponsored insurance (ESI) will have to switch to subsidized-exchange policies in 2014. However, our early-2011 survey of more than 1,300 employers across industries, geographies, and employer sizes, as well as other proprietary research, found that reform will provoke a much greater response.

• Overall, 30 percent of employers will definitely or probably stop offering ESI in the years after 2014.

• Among employers with a high awareness of reform, this proportion increases to more than 50 percent, and upward of 60 percent will pursue some alternative to traditional ESI.

• At least 30 percent of employers would gain economically from dropping coverage even if they completely compensated employees for the change through other benefit offerings or higher salaries.

• Contrary to what many employers assume, more than 85 percent of employees would remain at their jobs even if their employer stopped offering ESI, although about 60 percent would expect increased compensation.”

The survey results are actually not surprising once the math is run on the unintended consequences of the PPACA. Particularly for employers with primarily lower-paid employees, employers can save money by curtailing benefits, thereby shifting the cost to the state insurance funds and/or the federal government.

An employer who does not offer required healthcare coverage is penalized $2,000 annually for each full-time employee (excluding the first 30 employees). The employer may not deduct these $2,000 penalties for tax purposes. However, other than the $2,000 penalty per employee, there is nothing that requires an employer to offer the otherwise expensive healthcare insurance mandated by PPACA. Consequently, the business decision faced by employers is whether to pay the $2,000 penalty for not offering health coverage, or pay for significantly more expensive health insurance that is otherwise required.

Under the PPACA, states are required to offer health insurance to individuals. Numerous Americans will be eligible for federal subsidies when coverage is purchased from these mandated state insurance funds. Consequently, individuals will have a realistic means of purchasing insurance outside of their work. Because of this, medical insurance through one’s employer will no longer be a “must have” benefit, particularly for those who are eligible for the federal subsidies.

The government subsidy for many employees is greater than the $2,000 penalty. Consequently, an employer could pay the $2000 penalty, the employee could purchase insurance thorough the government-subsidized plan, and the employer could offer an alternative pay or benefit for the loss of the health insurance. In the correct circumstances, the employee and employer would collectively be as good or better off. Of course, the government will have an additional health insurance and related subsidy cost, but those are the economic motivations and incentives currently established in the PPACA.

These requirements and the related $2,000 penalty apply to “large” employers. A “large” employer is one that employed an average of at least 50 full-time employees during the preceding calendar year. For the purposes of measuring the number of employees (i) an employee working at least 30 hours per week is considered full-time, and (ii) other part-time employees are added together to convert to full-time equivalents. Interesting, an unintended consequence of these rules is that employers are incentivized to reduce their hourly workers hours to less than 30 hours per week so that the $2,000 penalty does not apply. In certain industries, this type of change is feasible.

The McKinsey survey explained the difference in their results from prior estimates as follows:

“Our survey shows significantly more interest in alternatives to ESI than other sources do, for several reasons. Interest in these alternatives rises with increasing awareness of reform, and our survey educated respondents about its implications for their companies and employees before they were asked about post-2014 strategies. The propensity of employers to make big changes to ESI increases with awareness largely because shifting away will be economically rational not only for many of them but also for their lower-income employees, given the law’s incentives.”

McKinsey estimates the possible change caused by PPACA is staggering, as follows:

“If employers could adjust premium costs perfectly, so that every person with a household income below 400 percent of the federal poverty level had an ESI premium above 9.5 percent of household income, our economic projections show that about 60 percent of employees could be made eligible for subsidies. This level of premium adjustment would be difficult in practice. If employers set premiums so that the bottom quartile (by income) of their employees becomes eligible for subsidies, however, our economic modeling shows that over 90 percent of employers will benefit economically. That remains true if some employees eligible for subsidies prefer to remain on ESI because of the time and effort required to switch.

Even if premium sharing isn’t increased intentionally to shift lower-income employees to an exchange, so long as employers’ medical costs continue to increase faster than wages, more employees will become eligible for subsidies every year. Assuming that employee ESI premiums continue to increase at the current rate of 9 percent for employers’ medical costs, about 15 percent of employees’ families will be eligible for subsidies in 2014, growing to 20 percent in 2016 and to 28 percent in 2018. This will happen without a single employer discontinuing coverage or increasing premiums above its level of medical-cost inflation.”

Although the number qualifying for government subsidies will increase, upper income employees will never qualify for the subsidy. Consequently, employers will need to address how to compensate upper income employers for the loss of their health care benefits. The McKinsey study suggested that employers might be able to avoid this result by setting up two separate companies, with one company covering employees who would generally be appropriate for the state insurance funds, and a second company for higher paid employees. On this point, the McKinsey analysts need better tax advice. As occurs with other employer-provided benefits, PPACA and the Internal Revenue Code counts all employers under common control as a single employer, and applies nondiscrimination rules that prohibit better benefits for higher-paid employees.

Cadillac Rules will Cause the Majority of Remaining Plans to be Dropped

The McKinsey survey does not address the additional impact of the penalties on so-called Cadillac health care plans. Employers that offer more expensive health plans (except for union plans that received an exemption) will be penalized for offering better plans. The penalty is a 40% nondeductible penalty on the value of health care plan benefits that exceed $10,200 for single coverage or $27,500 for family coverage in 2018. The effect of the Cadillac plan provisions were addressed in May 2010 by notable benefits consulting firm Towers Watson. In the Towers Watson study, more than 60% of employer-sponsored plans will be classified as a penalty-incurring Cadillac plan once expected cost inflation has its effect by the provision’s 2018 effective date.

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