Will Employers Drop Coverage After 2014?

Probably…Not, Industry Observers Tell AIS

Reprinted from HEALTH PLAN WEEK, the most reliable source of objective business, financial and regulatory news of the health insurance industry.

By Steve Davis, Managing Editor

June 13, 2011Volume 21Issue 20

Nearly one-third of employers will “definitely” or “probably” drop insurance coverage and send employees to state insurance exchanges in the years after 2014 — the year the exchanges are slated to be operational — according to a new report that has attracted a lot of attention in the mainstream media. But industry observers contacted by HPW are dubious that employer-based coverage — particularly among large employers — will change much once exchanges are up and running.

The report, published in the June issue of the McKinsey Quarterly, is based on a survey of 1,300 employers conducted early this year across various industries, geographies and employer sizes. The study also concludes that at least 30% of employers “would gain economically from dropping coverage” even if they countered the loss of health coverage with higher salaries or other benefits. But coverage offered through state exchanges probably won’t be as rich and most likely will be more expensive than employer-based coverage, sources tell HPW. And employers that drop coverage could find it difficult to attract and retain employees.

The study’s conclusion “is not credible,” says David Godofsky, the leader of the Employee Benefits & Executive Compensation Group at the law firm Alston & Bird. Reduced FICA taxes for employers, reduced income and FICA taxes for employees, and group rates — which are less expensive than individual rates — for insurance are among “the powerful incentives” that compel employers to offer coverage now, he tells HPW. And those incentives won’t change after 2014. “Employees want insurance not only for the risk reduction but also for the negotiated discounts that insurers get — which are substantial — and the tax benefits.”

Reform May Push Benefit Changes

Bill Sharon, a benefits consultant at Towers Watson, says he’s surprised by McKinsey’s findings. A mere 3% of employers surveyed by his company last year indicated that they would likely drop health coverage once insurance exchanges become an option. Those survey respondents were predominantly large employers (i.e., more than 1,000 employees). “Although the McKinsey study is more recent,…I don’t think we’ve had more clarity in the past year. In fact, some would argue we have less clarity now than we did a year ago,” he tells HPW.

But Paul Fronstin, Ph.D., a senior research associate with the Employee Benefit Research Institute, says the exchanges will be a “game changer” by creating a viable alternative to employer-based coverage. Once some employers opt to make the move, others will follow. “It doesn’t matter if the percentage in a survey is 30% or 3% — the first one to [drop coverage] is going to trigger others to do it,” he contends.

Small Employers Have More Incentive to Drop

The threat of fines could give employers another reason to maintain existing benefits, says Carol Taylor, director of compliance at Orlando, Fla.-based Beacon Benefit Consulting. Beginning in 2014, employers that have at least 51 employees and don’t offer coverage are subject to an annual per-employee penalty of $2,000 for each full-time employee (FTE) after the first 30. And employers that do offer coverage could be penalized $3,000 for each employee who qualifies for a subsidy (i.e., 133% to 400% of the Federal Poverty Level (FPL)) and opts for coverage through an exchange. Rules about exactly how these penalties will work still need to be clarified through guidance, Taylor notes.

But employers with fewer than 51 workers won’t be penalized for not providing health coverage. As a result, low-wage firms that provide coverage will be at a competitive disadvantage if similar-sized firms drop coverage and boost wages, says Devon Herrick, Ph.D., senior fellow at the right-leaning National Center for Policy Analysis. “For moderate-income workers, the exchange subsidy is about five times greater than the tax subsidy for employer plans,” he explains. “In many instances, workers will qualify for subsidies worth $15,000 or more depending on their income and where they live. This is especially true in high-cost areas,” he says. “Any time the exchange subsidy far exceeds the penalty for much of a firm’s work force, it makes sense from an employer standpoint to drop coverage, pay the fine, raise cash wages and send workers to the exchange.”

Penalties based on the number of FTEs also could provide employers with a financial reason to use more part-time workers, adds Taylor. But HHS could minimize that issue, for example, by implementing a “look-back” rule that bases penalties on the number of FTEs a company had a year earlier, Taylor suggests.

Health care consultant Robert Laszewski, president of Health Policy and Strategy Associates, LLC, agrees that the lack of penalties, combined with guarantee-issue coverage in the exchange, could create a compelling financial case for small employers to drop coverage.

“Uncle Sam is the new payer subsidizing premiums, and the leading health plans will all be on the exchange with benefit plans that will look a lot like the plans employees will be leaving behind,” he tells HPW. “It gets a lot harder for the employer to make such a decision when the fine is taken into consideration. Also, when the work force has higher incomes, the decision is more problematic since the federal subsidies are most generous for families making less than about $55,000 per year.” Employees who are below 140% of the FPL aren’t subject to rating bands, which could make the coverage even more affordable, Fronstin adds.

Adverse Selection = Bigger Premiums

Individual options offered through an exchange are usually going to be high-deductible, expensive plans that will be financially unattractive to the typical employee, according to several industry observers. And that will put more pressure on employers to keep coverage intact, particularly for large employers.

The exchanges are likely to attract people who qualify for a subsidy and those who were previously uninsured due to a pre-existing condition. That sort of risk pool will make adverse selection within the exchanges a significant threat.

Godofsky predicts that adverse selection will ensure that premiums for exchange-based coverage will be more expensive than those for employer-sponsored plans. “In order to keep employees, an employer who drops coverage will have to increase salaries by more than the cost savings. All of this comes before you apply the penalty of $2,000 per employee if you drop coverage. Paying a penalty for not offering coverage provides an incentive to offer coverage. Having to provide insurance for currently uninsured groups is not an incentive to drop coverage; it is an incentive to raise the employee premium.”

Insurers Must Create ‘Seamless Transition’

If the exchanges do prompt a mass exodus from employer-based coverage, McKinsey suggests that health insurers might be able to counter losses on the group side by boosting enrollment on the individual side if they can offer “a seamless transition for workers” who transition from employer-sponsored coverage to an exchange-based option. More than 70% of employees would stay with their insurer, according to McKinsey’s research.

Assuming nothing changes legislatively, Carl Doty, vice president and practice leader of consumer product strategy at Forrester Research, agrees that consumers are likely to stick with their existing carrier if the transition is easy and the coverage is similar. McKinsey’s statement “indicates consumers’ desire to not be disrupted,…but I think that disruption is inevitable,” he tells HPW. “Most consumers can’t afford to pay what their [employer-based] policies actually cost, so they will have to downgrade their coverage significantly. This will trigger a ‘shopping effect,’ and insurers will suffer large hits to retention rates.” To fend off member attrition, insurers will need to disrupt their own business models and create plans that emphasize “simplification, personalization and digitization,” he says.

The transition from coverage offered by a self-insured company to full-risk, exchange-based coverage “will be a net positive for managed care,” Credit-Suisse analyst Charles Boorady wrote in a June 6 note to investors. “However we will likely see winners and losers within managed care,” he added.

The McKinsey study looks to “the years after 2014,” which is still a long time away, and details about coverage, premiums and how the exchanges will operate are still unknown. While Fronstin says employers are likely to move employees onto exchanges at some point, the transition will probably occur over many years rather than overnight. The move to exchanges “is likely to play out no differently than other changes in employee benefits,” he says. The move toward managed care, for example, occurred over decades. “The difference today might be desperation.…Employers are desperate to do something.”

Ken Sperling, global leader of the Health & Benefits Practice with Aon Hewitt, agrees that big changes will take time. “We may, in fact, see a shift from traditional group models to individual products, just as we are currently seeing in the post-65 retiree marketplace,” he says. “But it will happen slowly, and only when the alternative offers a superior value proposition to the employer and employee. That’s what health insurers will need to offer in order to grow as the market shift occurs.”

And many employers want to wait to see how the reform law — and the development of exchanges — plays out before making any bold moves. “Both proposed and final regulations for key provisions [of the law] have yet to be promulgated. Additionally just over half the states are currently pushing for reform’s repeal through the court system, an indication of the significant resistance to the law and just the first big challenge of many that are probable,” notes Bill TenHoor, president of TenHoor and Associates, a strategic planning and market analysis firm based in Duxbury, Mass. Even if the reform law stays intact, it will take several years for attitudes among employers to change. But if the reform law does help to stabilize coverage costs, employers will have even less incentive to drop coverage, he adds.

For employers, determining whether to drop coverage will be a matter of crunching the numbers. While some small employers will determine it makes more financial sense to eliminate health benefits, tax incentives and a need to attract and retain employees will give larger employers a reason to maintain benefits, says Shawn Nowicki, director of health policy at Northeast Business Group on Health. Many employers, he says, are tweaking existing plans to avoid the 40% excise tax on high-cost plans, “a clear sign that they intend to stay in the game for a number of years.”

“I think all employers will be doing the math to see what their situation will be in 2014,” says Helen Darling, president and CEO of the National Business Group on Health. “If you do the math, the penalty [for not offering coverage] is relatively low compared to cost of coverage. But that might not continue to be the case.”

Presumably, in the end, most companies will make the financial decision that is best for them. And that will rarely, if ever, be to drop coverage entirely. More likely, employee premiums will rise, Godofsky says.