Health Care Reform’s Impact on Rewards Strategies.
Is it time to change the mix of compensation and benefits?

Some critics of health care reform predict that the low $2,000 employer mandate penalty will cause many employers to exit the employer-sponsored benefit (ESB) system and dump their entire workforces on the new Exchanges.  The truth is that most employers will find it in their best interest to continue to offer coverage.

Nevertheless, even with the availability of ESB programs, some workers will find the new subsidized Exchanges a "better deal" and will opt out of the employer’s plan. This creates a unique opportunity for employers to reevaluate their premium contribution strategies and rebalance compensation and benefits – a process that begins with asking the following questions:

•    What portion of my workforce will be eligible for the new federal subsidies?

•    Will my employees be better off dropping our benefit plan and moving to the new Exchanges?

•    Do we have the best mix of cash and benefits?

The Patient Protection and Affordable Care Act (PPACA) dramatically changed the rules of the game for compensation and benefits professionals.  Some employers may find they can simultaneously improve total compensation and reduce their organization’s total labor costs.

The Exchanges

Ideally, the Exchanges in 2014 will be robust marketplaces offering portable, individual policies without pre-existing exclusions or other underwriting restrictions.  The range of choices (in carriers and plan options) is expected to be significantly greater than the choices generally available in the workplace at open enrollment.

Lower income families will qualify for generous federal premium and out-of-pocket cost sharing subsidies (see Table 1).  The eligibility for these subsidies is very broad, covering those up to 400 percent of the federal poverty level (FPL) or approximately $88,200 for a family of four.  Therefore, some employers could find that a large portion of their workforce will become eligible for federally subsidized coverage through the Exchanges.

Exchange coverage that is too attractive, however, threatens to undermine or “crowd out” ESB programs – the system where most non-elderly Americans get their health insurance today.

It may be very tempting for an employer to exit the ESB system. The $2,000 employer mandate penalty is certainly a lot cheaper than the cost of providing health coverage.  Undoubtedly, some employers, particularly those with many low-wage earners or those in financially troubled industries, will choose to exit the ESB system, leaving their employees to the Exchanges.  Even though the new employer mandate penalty is intended to increase coverage, there is expected to be a small net decrease in the total number of Americans covered by ESB⁴.  Indeed, some of this crowd-out is probably needed for a robust individual market to emerge.

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1.The premium credits will be tied to the second lowest cost “Silver” plan (i.e. actuarial value of 70%) in the area.

2. The cost-sharing credits have the effect of increasing the actuarial value of the basic benefit plan to the indicated percentages of the full value of the plan

3. 2010 Poverty Level guidelines ($000s)– all states except AK, HI, DC

4. CMS Office of the Actuary – April 2010

Minimizing Crowd-Out

But dropping out of ESB is the extreme.  Even post reform, most Americans will continue to get their coverage from ESBs for three important financial reasons.

First and foremost is that ESBs remain a very tax-effective form of compensation (though this will be capped in 2018 when the so-called Cadillac tax becomes effective).

The second is the Affordability Test – the requirement that the employer’s plan must be deemed "unaffordable," i.e. premium contributions greater than 9.5 percent of Modified Adjusted Gross Income (AGI)⁵ before an employee can be eligible for Exchange subsidies (see Example 1).

The third is the Free Rider surcharge – the non-deductible $3,000 penalty for each employee purchasing subsidized Exchange coverage instead of the employer's plan.

Crunch the numbers and most employers will conclude that it is financially advantageous to stay in the ESB game and continue to offer coverage. However, the economics of subsidizing it have clearly changed⁶.

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5. According to the Joint Committee on Taxation, the affordability test is performed on costs of employee-only coverage, irrespective of the employee’s actual family status.   If subsequent regulations provide that this test is performed on family contributions (for those with families) substantially more employees will be eligible for Exchange subsidies. Section 1004 of PPACA (as amended by the Health Care and Education Reconciliation Act of 2010) defines “Modified Adjusted Gross Income” as IRS-defined “Adjusted Gross Income” plus tax-exempt interest and income earned while living abroad.
6. Merely offering a Section 125 cafeteria plan with out any employer subsidy is sufficient to retain all the tax advantages of ESBs as well as avoid the $2,000 mandate penalty.  Though an employer with a low or non-existent subsidy is exposed to the Free Rider surcharge, this is likely to be much less onerous in aggregate than the mandate penalty.

Premium contribution strategy

Fortunately, PPACA does not require any specific employer contribution to the cost of health care coverage. This important decision remains with plan sponsors who must now reevaluate their premium contribution strategy.  It is no longer just a cost-sharing formula – it becomes an important tool in influencing each employee’s decision to opt in or out of the Exchanges.

Early Flex plans were designed to create a cost-effective choice architecture which encouraged employees to buy only the benefits they needed and to capitalize on the growing availability of alternative coverage through a working spouse.PPACA now adds to these alternatives by presenting some workers with an additional option to buy medical coverage subsidized by their government (instead of their employer).

Despite the individual mandate requiring all Americans to have coverage starting in 2014, many large employers will see a net decline in the number of participants in their plan because of this expanded access.

The need to rebalance

With this new availability of federal subsidies, many lower-income workers will now be financially better off with total rewards packagesfavoring cash compensation over benefits – preferring instead to get their health insurance from the government (via expanded Medicaid eligibility or the Exchanges). Example 2 illustrates how it is possible to both increase an individual's take-home pay and reduce labor  costs for the company.

Of course, any redistribution of total rewards from health care premium subsidies to cash will create some winners and losers but depending on demographics, it should create more winners overall.

Dependent subsidies

As a class, single employees and married employees who can choose their spouse's coverage would be winners, preferring a rewards package favoring cash over ESB subsidies.

Currently contribution strategies vary widely among employers – even in the same industry and geographic location. Despite these variations, there is a strong correlation between the level of dependent subsidy and the employer group size as demonstrated in the chart below.  

Because of sizable dependent subsidies in many ESB plans, employees enrolled in family coverage would generally be losers with any redistribution of total rewards.  However, many employers are already contemplating a reduction in these dependent subsidies as a response to the mandated expansion of the eligibility rules for dependent children.

Salary-based cost sharing

Employers with salary-based cost sharing in particular need to review their rewards strategy. Today, about one in five large employers vary employee health care contributions by salary level – a benefits strategy that also serves the broader societal goal of making health care more affordable for many lower-paid workers.

The new Exchange subsidies however, will be much more effective than ESBs in providing economic security for lower-income families.

Even though most of a typical ESB budget is for dependents, the premium subsidies in these plans completely ignore the income of those family members.  In contrast, the income-related subsidies in the Exchanges will be more equitably distributed as they are based on household income.  According to the same government statistics used to score PPACA, 75 percent⁷ of married workers also have a working spouse so spousal income cannot be ignored.

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7. 2007 MEPS Household Component Survey

Therefore, the goal of helping the lower paid will be much more effectively accomplished federally (looking at family income) than in the workplace (looking at just the employees’ income).

Additionally, with salary-based contributions few employees would ever fail the Affordability Test.  Hence, they can’t get federal subsidies and must stay on the employer’s plan (at higher costs to the sponsor).

Finding the sweet spot

So how does an organization determine the optimal mix of rewards and provide the most competitive compensation program for workers at the lowest cost to the employer?

The best answer is highly dependent on the demographics of the workforce and eligibility for these new federal subsidies which are based on household income.  Since most married workers also have a working spouse, how can an employer determine household income for its entire workforce?  They can’t just pull that information from their payroll and HRIS systems.

Actuarial models have been developed to solve this problem by forecasting the unknown (household income) based on the known demographics of the particular workforce (age, gender, enrollment tier, employee base pay, geography, and industry).

These models are based on the same population statistics and labor bureau data used by CBO and CMS to "score" the various federal reform proposals.  While the models can’t predict household income for a given individual employee, they can produce reliable, actionable data across an entire workforce population.

Conclusion

PPACA is a new trillion-dollar package of subsidies and taxes that is rewriting the traditional economics of benefits and compensation programs.  A wholesale exodus from employer-sponsored medical plans is unlikely; coverage will still be offered in the workplace.

However, the level of corporate subsidies is sure to result in a significant reshaping of compensation and benefit programs to maximize their effectiveness for both employees and shareholders.

It’s time for compensation and benefits professionals to do some long-range planning.

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About The Author

Steve Ferruggia is a Principal in the Health and Productivity practice of Buck Consultants.  He can be reached at 201.902.2970 or steve.ferruggia@buckconsultants.com