October 17, 2011

The Affordable Care Act and Its Effect on Midsize and Large Employers

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CHRT Policy Brief October 2011

The Patient Protection and Affordable Care Act (ACA) includes a number of provisions designed to increase the number of individuals with health insurance coverage. A major portion of that increase will be accomplished by expanding eligibility for state Medicaid programs; other key provisions are designed to increase the number of individuals covered by private insurance, and involve requirements for both individuals (the “individual mandate”) and businesses.

This policy brief focuses on midsize and large employers, to help illuminate provisions in the ACA most likely to affect them and suggest issues or questions for consideration as ACA implementation progresses.

How will businesses respond to healthcare reform?

Some experts predict that employer-sponsored coverage will decline from 2010 to 2016—as much as 4.5 percent1—while others expect increases of up to 8.7 percent.2 Employees who lose their employer-sponsored coverage will be required instead to purchase their own coverage, either on the individual market or through the newly established health insurance exchanges.

It may take some time to observe these effects: many employers are likely to take a “wait and see” approach before making wholesale changes to their plans, and economic conditions in 2014 will also have an impact on employer decisions about coverage for their employees.

These effects will also vary by employer size and, to some degree, the nature of the workforce. Small employers currently offer coverage at much lower rates than larger firms, but will be eligible for new tax credits that encourage them to do so. Midsize and large employers will not be eligible for new tax credits, but may face new penalties for dropping or not offering coverage. All of these factors will influence business decisions—one way or the other—about offering coverage to employees and retirees.

There are also differences between midsize firms (100 to 1,000 employees) and large firms (1,000 or more employees). Large firms in Michigan currently offer coverage to virtually all (99.9 percent) of their employees and are generally expected to maintain their coverage levels after 2014. Large firms are usually self-insured, meaning they do not purchase insurance from an insurance company but rather contract with a third party to administer the health care claims of their workers. They also enjoy relatively low administrative costs due to their scale and ability to self-insure.

Most midsize firms also offer coverage. Ninety-three percent of those employed by midsize firms have employer-sponsored health insurance. However, unlike larger businesses, many midsize firms are fully insured, meaning they purchase health insurance from an insurance company. Although some midsize firms self-insure, they experience larger overhead costs per employee due to higher administrative costs, such as fees to purchase reinsurance to minimize their risk. Due to these higher administrative costs and smaller scale, midsize firms will generally be more sensitive than large firms to changes coming in the ACA. In 2010, half a million (499,940) Michigan residents worked at midsize firms and nearly 1.5 million (1,448,168) worked at large firms, accounting for a total of 60 percent of the private-sector workforce.3 Figure 1

Figure 1
Number of Michigan Private Sector Employees at Firms Offering Coverage, by Firm Size (Source: AHRQ 2010)

Figure 1

1 Ahlquist, G., Borromeo, P. et al. (2011) The future of health insurance: The demise of employer-sponsored coverage greatly exaggerated. Booz & Company.

2 Eibner, C. Girosi, F. et al. (2010) Establishing state health insurance exchanges: Implications for health insurance enrollment, spending, and small businesses. RAND Corporation.

3 AHRQ data measures firms with 100 to 999 employees. These figures were used to generate estimates for midsize firms with 100 to 1,000 employees.

What are the Key Provisions in the ACA for Midsize and Large Employers?

While most elements of the ACA that will affect employers take effect in 2014, some have already been implemented. Provisions already in effect for employers include:

  • Extension of dependent coverage for adult children up to age 26 (ACA, Section 2714)
  • Prohibition of health plans from excluding children under age 19 from coverage due to a pre-existing condition (Section 2704)
  • Requirement of health plans to cover preventive services without cost-sharing (Section 2713)
  • Elimination of lifetime benefit limits and a phasing out of annual benefit limits (Section 2711)

A series of other ACA provisions will be implemented beginning in 2014. Midsize and large employers could be significantly affected by these provisions, depending on the characteristics of their workforces and the types of coverage they offer. The following summaries describe the particular provisions that will likely have the largest effects.

“Play or Pay” Rules
Section 1513 effective 2014

This provision of the ACA encourages private insurance coverage through what is often called the “play or pay” rule; that is, employers are expected to either offer coverage (“play”) or pay a penalty (“pay”). Employers with 50 or more full-time equivalent employees will be subject to penalties if they do not offer coverage. If an employer does not offer coverage and has at least one employee receiving a federal subsidy to purchase health insurance in 2014, it must pay a penalty of $2,000 per full-time employee per year, beyond the first 30 employees. The penalty does not apply to part-time workers (working less than 30 hours per week) or seasonal workers (working less than 120 days per year). The amount of the penalty will increase by the rate of premium inflation after 2014.

Insurance Exchanges & Affordability Tests
Section 1401 effective 20144

The ACA establishes state-operated health insurance exchanges in 2014. These exchanges will enable both individuals and small businesses (with up to 50 employees)5 to obtain health insurance coverage through an entity that can provide some of the same economies of scale and human resource capabilities currently enjoyed by large employers.

Individuals and families who purchase insurance through an exchange are eligible for tax credits to subsidize premiums if their income is at or below 400 percent of the federal poverty level ($89,400 for a family of four in 2011).6 According to a previous CHRT report, 41 percent of non-elderly Michigan residents could be eligible for exchange subsidies in 2014.7 Those with incomes at or below 138 percent of the poverty level ($30,843 in 2011 for a family of four) will be eligible for expanded Medicaid coverage. Combined, over 63 percent of non-elderly Michigan residents could be eligible for coverage through one or the other.8

In 2009, 65 percent of Michigan residents with incomes from 139 to 400 percent of the federal poverty level were receiving coverage through an employer.9 Figure 2

Figure 2
Coverage for non-elderly in Michigan between 139-400% FPL (Source: CHRT Analysis of 2009 Census Data)

Figure 2

These residents are eligible for subsidies if their employer’s health plan does not pass certain affordability tests. To meet the affordability standard, employee premium contributions for single coverage cannot exceed 9.5 percent of the employee’s annual income, and the employer plan must cover at least 60 percent of healthcare expenses. If neither condition is met, the employee is eligible for subsidies and the employer is subject to an annual $3,000 penalty for each employee receiving exchange subsidies.10 However, the amount of this penalty cannot exceed the amount of their “play or pay” penalty if the employer drops coverage. In other words, an employer cannot reduce its penalty costs by dropping employee coverage.

4 On July 15, 2011, the Department of Health and Human Services released draft regulations for the implementation of health insurance exchanges and other related issues. Regulations regarding the establishment of exchanges and qualified health plans are available at http://federalregister.gov/a/2011-17610. Regulations regarding standards for reinsurance, risk corridors, and risk adjustment are available at http://federalregister.gov/a/2011-17609.

5 States have the option to allow small businesses with up to 100 employees in their exchange.

6 Department of Health and Human Services. January 2011. 2011 HHS Poverty Guidelines. Available at http://aspe.hhs.gov/poverty/11poverty.shtml

7 Center for Healthcare Research and Transformation. June 2010. Impact of Health Reform on Coverage in Michigan.

8 CHRT analysis of 2009 Census data

9 Ibid.

10 The Department of Treasury has issued draft regulations that include a “safe harbor” provision that allows firms that offer coverage to avoid this penalty if employee contributions are less than 9.5 percent of W-2 wages. Since employers do not always know the household incomes of their employees, this provision makes facilitating coverage more workable. The draft regulations are available at http://www.federalregister.gov/articles/2011/08/17/2011-20728/health-insurance-premium-tax-credit

Community Rating Rules
Section 2701 effective 2014

The ACA will introduce community rating rules for insurance plans sold to individuals and small groups both inside and outside the exchanges. Community rating rules limit the factors that can be used by insurers to adjust premiums. Under the ACA, insurers will only be allowed to vary premium costs for family size, age, geographic location, and tobacco use. Community rating provisions prohibit the use of previous healthcare claims or health status as a factor in premium determination, and premiums for older Americans can be no more than three times that for younger Americans.

Firms with an average of fewer than 100 workers in a given year that purchase insurance will be subject to community rating rules. All firms that self-insure, however, will not, since they assume the financial risk for covering their own workforce.

Essential Health Benefits Tests
Section 1302 effective 201411

The ACA will establish benefit guidelines to standardize health plans offered to individuals and small groups inside and outside the exchanges. Specifically, health plans must cover “essential benefits,” limit annual cost-sharing in high- deductible plans, and standardize benefit packages. The secretary of the Department of Health and Human Services (HHS) will prescribe what must be included in essential benefits but the law specifies these benefits must cover ambulatory patient services, emergency services, hospitalization, maternity and newborn care, prescription drugs, rehabilitative services, laboratory services, pediatric services, preventive services, and mental health and substance abuse disorder services. In 2014, cost-sharing in high-deductible plans cannot exceed $5,950 for individuals and $11,900 for families. Employers with an average of fewer than 100 workers in a given year will have to comply with the essential benefits guidelines if they offer coverage.

11 HHS is scheduled to release regulations about implementation and coverage of essential benefits later in 2011.

Nondiscrimination Rules
Section 2716 effective 201412

The ACA will apply new nondiscrimination rules to fully insured groups. These rules impose financial penalties on firms that offer richer health benefits to highly compensated individuals (HCIs). The employer penalty is $100 per day per employee not receiving the more generous benefit accorded the HCI. A civil action can also be brought against employers by the Department of Labor to force them to comply with these rules.13 Large employers usually self-insure and are already subject to nondiscrimination rules, but the new guidelines will impact many midsize firms who are fully insured. In addition, the ACA regulations may expand the current nondiscrimination rules applicable to large employers.

12 IRS is scheduled to release regulatory guidance about the application of nondiscrimination rule to fully insured plans. The ACA calls for these rules to be applied to fully insured plans “similar to” how they are currently applied to self-insured plans. The application of nondiscrimination rules is estimated to begin in 2014.

13 McGraw Wentworth. March 2011. Benefit Advisor: “Section 105(h) Nondiscrimination Rules.” http://www.mcgrawwentworth.com.

Automatic Enrollment of New Employees
Section 1511 effective 2014

The ACA will require employers with more than 200 full-time employees that offer at least one health plan to automatically enroll new full-time employees in the employer health plan with the lowest employee premium contribution. Employees will be allowed to opt out of this plan and choose a more expensive employer plan or receive family coverage through a spouse or family member. Currently, most employers assume employees waive coverage if they do not actively enroll in a plan. Automatic enrollment changes this practice, and could increase the number of employees covered under group plans, especially for those employers with passive enrollment processes.

Excise Tax on High Cost Plans
Section 9001 effective 2018

Beginning in 2018, employer health plans will face a 40 percent marginal tax on amounts that exceed $10,200 for single workers and $27,500 for families (with some adjustments for retirees and those in high-risk occupations). Beginning in 2020, the cap will be adjusted annually by the Consumer Price Index for Urban Consumers (CPI-U) plus one percentage point. Of note: from 2000-2010, CPI-U grew at 2.4 percent annually but family premiums in employer plans grew at 7.9 percent. In other words, an increasing number of health plans could be subject to the tax if healthcare inflation remains high.

The excise tax cannot be avoided by shifting premium costs to employees because the tax is triggered by the sum of employer and employee premium contributions.

Illustrative Examples of the Impact of ACA Provisions

The effects of the ACA on midsize and large employers will vary depending on particular workforce and insurance coverage characteristics. The majority of midsize and large employers currently offer coverage that meet minimum affordability standards to all of their employees, so they will be subject to few ACA penalties. Many large and some midsize employers also currently offer coverage to their retirees. Employers most likely to experience changes resulting from the ACA are those that:

  • Currently purchase insurance where their rates are based on their own healthcare claims experience
  • Offer high cost coverage
  • Have high concentrations of low income workers
  • Cover only a portion of their workforce

These employers are the most likely to be subject to penalties or increased costs resulting from provisions in the ACA.

The following are examples that illustrate how relevant ACA provisions could apply to different types of employers, based on the nature of their workforces and how much coverage they offer to employees. These examples are meant to help employers understand key provisions of the ACA that may affect them. Employers should consult a professional benefits advisor to obtain a tailored analysis for their particular firms.

Type of Midsize or Large Employer Most Relevant ACA Provisions Why Provision is Relevant
1. Firm that is fully insured and offers robust coverage with low employee contributions to all its workers Community Rating Rules If the firm is paying insurance premiums based on the healthcare claims of its employees (experience rating) and drops below 100 workers in a given year, its premium costs may either increase or decrease when claims can no longer be used to adjust premiums under community rating rules.

 

Excise Tax If the cost of the employer health plan exceeds $10,200 for single coverage or $27,500 for family coverage, the cost of the plan beyond these caps will be taxed at 40% beginning in 2018.
2. Firm that is self-insured that offers varying levels of coverage to all its workers Affordability Tests If an employee’s premiums cost 9.5% or more of their income or the health plan does not cover 60% of costs, the employee is eligible for exchange subsidies and the firm is penalized $3,000 per worker receiving a subsidy.
Excise Tax If the cost of the employer health plan exceeds $10,200 for single coverage or $27,500 for family coverage, the cost of the plan beyond these caps will be taxed at 40% beginning in 2018.
3. Firm that does not offer coverage to any of its workers “Play or Pay” Rules Since the employer does not offer any coverage, it will be have to pay a penalty of $2,000 for each employee, beyond the first 30 employees.
4. Firm that is fully insured offers coverage to its senior staff but not to low wage workers who work 35 hours per week “Play or Pay” Rules Since the low-wage workers work more than 30 hours per week, the firm will pay a penalty of $2,000 for each low-wage worker, beyond the first 30 employees.
Nondiscrimination Rules Since the firm offers coverage only to its senior employees, it may face nondiscrimination penalties of $100 per employee per day not offered coverage.
Community Rating Rules If the health plan offered to senior employees is based on the healthcare claims of these workers and the total number of workers drops below 100 in a given year, premiums may either increase or decrease when claims can no longer be used to adjust premiums under community rating.
Excise Tax If the cost of the employer health plan exceeds $10,200 for single coverage or $27,500 for family coverage, the cost of the plan beyond these caps will be taxed at 40% beginning in 2018.
5. Firm that is fully insured offers coverage to full time workers but not to seasonal workers who work 8 months per year “Play or Pay” Rules Since the seasonal workers work more than 120 days per year, the firm will have to pay a prorated penalty of $1,200 per worker, beyond the first 30 workers.
Nondiscrimination Rules Since the firm offers coverage only to its full-time employees, it may face nondiscrimination penalties of $100 per employee per day not offered coverage.
Community Rating Rules If the health plan offered to full-time employees is based on the healthcare claims of these workers and the number of workers drops below 100 in a given year, premiums may either increase or decrease when claims can no longer be used to adjust premiums under community rating.
Excise Tax If the cost of the employer health plan exceeds $10,200 for single coverage or $27,500 for family coverage, the cost of the plan beyond these caps will be taxed at 40% beginning in 2018.

Conclusion

An analysis of upcoming ACA provisions and recently-released regulations might lead some employers—especially those with low-wage workers—to conclude it would be best to drop employer-sponsored coverage in favor of helping employees get individual, subsidized coverage through individual health insurance exchanges.

However, the healthcare market is unlikely to be static in the face of these changes. For example, insurers may develop new, targeted insurance products to respond to the 9.5 percent affordability threshold provision in the law, and/or design benefit packages to encourage employers to retain employer-sponsored coverage. Because the market is likely to be fairly fluid in the early stages of implementation of health insurance reform, it will be very important for employers to consult with their insurance carriers and health benefits advisors before making final decisions on coverage.

In addition, the financial penalties employers will face if they drop coverage are only part of the financial equation they must take into account in determining whether or not to continue offering health benefits. If they drop coverage in favor of having employees purchase coverage on their own through an exchange, employers will almost certainly be expected to raise wages to enable employees to afford that coverage. The wage adjustment plus the penalty could, in fact, be more expensive for employers than continuing to provide coverage.

The federal tax code is also relevant to the decision, as it provides significant tax advantages to employers for offering insurance coverage instead of additional wages. Since employer contributions for insurance are not taxed, it would cost an employer $1.38 to raise the after-tax wages of an employee by $1 (assuming a 20 percent marginal tax and standard payroll tax rates). In contrast, it only costs $1 to offer another $1 in additional insurance coverage. If an employer drops coverage, it is much more expensive to make workers as well off.

In addition to ACA provisions affecting the bottom line cost of coverage, there are other factors that influence the decision to offer coverage to employees, including the attractiveness of insurance to workers and the tax advantages of offering insurance. Offering coverage remains an effective strategy to attract and retain talented workers; employer-sponsored coverage can bind employees to their employers and minimize lost productivity due to illness.

Employers will have to balance both strategic and financial factors when making decisions about offering coverage to their employees in the months and years to come. While the most fundamental changes related to the ACA don’t take effect until 2014, it is not too soon for employers to begin the process of considering options and ramifications. Even though the ACA is still under debate in Congress and the courts, planning for the future based on what is known today is a prudent step for employers and will assure the smoothest possible transition in 2014.

Acknowledgements

The staff of the Center for Healthcare Research & Transformation (CHRT) would like to thank Paul Austin, Consulting Actuary, and the staff of Blue Cross Blue Shield of Michigan and McGraw Wentworth for their assistance with the development of this policy brief.

 

Suggested citation: Fangmeier, Joshua; Udow-Phillips, Marianne. The Affordable Care Act and Its Effects on Midsize and Large Employers. October 2011. Center for Healthcare Research & Transformation. Ann Arbor, MI.