A First Look at ACA Strategies for 2014
The first set of rules and regulations from the Patient Protection and Affordable Care Act (ACA) has taken effect. What’s next on the horizon?
Because there are comparatively few changes slated for the next few years, employers now have the opportunity to contemplate their health benefit strategy for the 2014 plan year and beyond. The most significant question is whether to exit sponsorship and “pay” a penalty tax or to “play” by continuing to offer health benefits. This article presents a first look at key issues and potential solutions for determining an answer to that question.
Is This Really the Time?
The current political climate, elections in November 2010, and again in 2012 suggest changes or even repeal of ACA that may occur between now and 2014. With all this uncertainty, is this the right time to consider new strategies?
One answer is to wait until after the 2012 elections. The political environment and potential changes to ACA should be better understood at that time. However, a new Congress would not convene until January 2013, with the timeliness of legislative action influenced by Congress’s political composition (including whether a “super majority” exists in the Senate) and the support—or lack thereof—from whoever is President. The consequence is limited time to implement the 2014 design, financing, administration, and communication strategies by the fall enrollment period in 2013.
An alternative is to develop contingent strategies now based on future scenarios, such as under ACA in its current form, a modified form, and repeal. This way an employer is prepared regardless of future legislative action. However, this approach requires additional time and effort in order to create multiple strategies.
Revisiting Goals and Guidelines
Regardless of timing, the process of creating a new strategy should begin by revisiting the underlying goals and guidelines for providing employee health benefits. Today those goals often include:
- Attracting and retaining talent through a competitive form and level of coverage.
- Protecting employees from the possibility of catastrophic loss.
- Enhancing productivity by encouraging healthy lifestyles and providing care that returns employees to work in the event they become ill or injured.
- Providing a tax-effective form of compensation.
- Using group purchasing power to buy protection more cost effective than an employee could on his or her own.
- Sending a positive message about the desired employment relationship.
An employer should test whether these objectives would still be relevant in an environment with American Health Benefit Exchanges (AHBEs), federally-provided premium and cost-sharing subsidies, and employer and individual penalties. Only by clarifying the goals and guidelines for health benefits will an employer know the right strategic direction to take for 2014 and beyond.
Strategic Considerations for 2014
Employers currently provide health benefits worth about 8% to 9% of total compensation (cash and benefits), as shown in Chart 1. At issue for 2014 is what should happen to the health benefits piece of that total compensation pie.
Chart 1: Current Mix of Total Compensation
Guided by updated goals and guidelines, here are three potential solutions for employers to explore.
The “Play” Option. The “play” option would continue health benefits for employees, perhaps in a manner similar to the current state or with minor modifications to meet ACA’s minimum standards. That is, the health benefit piece of the pie in Chart 1 would continue to be there in some form.
This option makes sense when the goals underlying health benefits don’t materially change under ACA and where the cost of any design change is small. This alternative can be attractive because it requires little change to current administration and communication systems, fully preserves a tax-effective form of compensation, and is familiar to employees. However, employees with household income under 400% of the Federal Poverty Level (FPL) may prefer buying through an exchange to take advantage of federal subsidies and cost sharing.
A variation on the “play” option is to redesign health benefits to meet only the minimum requirements to avoid the penalty (i.e., at least a 60% actuarial plan value with employee contributions not exceeding 9.5% of household income). Any savings could be reallocated to employees in another form of compensation.
The “Pay” Option. The “pay” option would involve exiting health benefit sponsorship and paying the nondeductible penalty tax of $2,000 per employee. Therefore, a portion of the health benefit wedge in Chart 1 would go to the government and the rest would go to the employer.
This alternative generates significant savings for the typical employer, considering the average annual health benefit subsidy runs about $10,000 per employee. However, it also constitutes a sizeable cut in employees’ total compensation and may leave an employer vulnerable in the labor market, depending on what competitors do. It also represents a significant change in the employment relationship, sending potentially negative messages about the image and financial status of the company.
The “pay” alternative can make sense if an employer’s costs would be driven up significantly by higher health benefit participation rates, threatening the financial viability of the company, the cost competitiveness of products and services, or both. Companies with large numbers of employees who would qualify for federal subsidies or with a younger population that doesn’t place significant value on health benefits may also be candidates for this strategy.
The “Pay and Play” Option. A third option is to “pay” and to “play.” In this case, the employer would drop health benefits and pay the penalty tax (“pay”), but the company would provide employees with another form of compensation to maintain the competitiveness of total compensation (“play”). That is, a portion of the health benefits wedge in Chart 1 would go to the government with the balance being allocated to one or more of the other pie pieces.
The first step is to look at the current total cost of providing health benefits (including administration, staffing, compliance, and communication) and reducing it by the penalty tax. The balance is what is available to be paid to employees.
Next is deciding in what form the pool should be paid to employees. The simplest is cash. Another possibility is increasing other benefits such as 401(k) or Health Reimbursement Arrangement contributions.
Depending on the form, further adjustments to the pool may be needed. For example, if employees receive cash, the pool of dollars should be reduced by the employer’s share of FICA taxes and possibly for increases in overtime pay for nonexempt employees. Also, an adjustment to the definition of covered compensation should be made to pay-based benefits (retirement, life, and disability benefits) so the cost of these plans do not increase.
Table 1 shows an example of how the amount could be calculated for a hypothetical employer with 5,000 employees, assuming payment as cash.
Here are three examples of how that cash could be allocated back to employees:
1. Flat-dollar amount. The payment could be paid as a flat-dollar amount ($7,460 in the example). This payment could be tracked separately and adjusted annually going forward based on medical inflation or other factors, or added into base compensation and implicitly adjusted with merit budgets.
This approach is simple and gives employees freedom of choice over how to spend the cash, including paying for health insurance premiums. However, cash is not as tax efficient as tax-free health benefits, and employees pay the employer’s tax penalty through lower overall total compensation. (In the example, only about 75% of the value of health benefits is left after these adjustments.) Depending on current health benefit subsidy policies, total compensation might shift from employees with families to single employees: the flat-dollar payment replaces subsidies that traditionally are higher for employees with families. Also, this strategy does not recognize that lower-paid employees can receive subsidized coverage through an exchange. Therefore, a flat-dollar allocation theoretically over compensates lower-paid employees when combined with the government subsidy.
2. Percent of pay. A variation on this strategy is to allocate the cash as a percent of pay. Doing so indirectly acknowledges the federal subsidies by paying more to higher-paid employees, who receive small or no federal subsidies. When the cash is combined with available federal subsidies, the total amounts are more equitable than the flat-dollar approach.
3. Government subsidy offset. To fully recognize the available government subsidies and minimize potential inequities, a more aggressive and complex approach is to allocate cash based on each employee’s actual AHBE health plan election. In this case, the employer pays cash equal to what the company would have paid as a health benefit subsidy reduced by the federal premium assistance credit the employee receives from the exchange. The concept is analogous to an integrated defined benefit pension formula that offsets Social Security benefits from a targeted level of retirement income.
Table 2 provides an example of projected 2014 subsidies for this calculation. In the example, the employer sets its targeted financial commitment equal to what its subsidy would have been had health benefits continued, broken out into two coverage categories. The AHBE offers plans that are rated by age and coverage category, with the federal subsidies tied to household income as a percent of FPL. (As an alternative, an employer could allocate its financial commitment in a manner that matches that of the exchanges, such as age and additional coverage categories.)
Table 3 shows the cash payments the hypothetical employer would make, based on household income, the employee’s age, and the coverage category selected by the employee. The amounts equal the “employer commitment” minus the “federal subsidies through AHBEs” (but not less than zero). Employees participating in Medicaid or choosing not to buy insurance would not receive an employer payment.
This “pay and play” approach generates savings for the employer because the federal government now picks up a portion of the employer’s financial commitment. The magnitude of savings depends on the age and income demographics of the employee population. Because premium assistance credits are higher for older and lower-paid individuals, savings are higher for employers with more of these employees in their populations. Savings could be used to gross up cash payments for taxes, increase other forms of total compensation, or enhance the bottom line.
The three-year break from significant ACA rules and regulations gives employers the opportunity to step back and revisit their commitment to health benefits. Armed with the key issues and strategic possibilities in this article, employers should be considering when and how to build a comprehensive strategy that integrates with the employer’s goals and guidelines, recognizes anticipated health reform features, and makes financial sense for the employer and employees.
About The Author
Michael J. Murphy is an HR and total rewards consultant for mid-size and large employers. His total rewards expertise includes base pay programs, short-term incentives/variable pay, employee benefits, supplemental benefits, and recognition plans. Drawing on more than 25 years of experience, he finds solutions for clients who are addressing challenges with tight merit budgets, health care reform, health promotion/wellness, retirement plan expense volatility, incentive plan effectiveness, employee decision-making support, and merger integration. Michael earned a Finance degree from Michigan State University and an MBA from University of Chicago. He is based in Atlanta, GA and can be contacted at email@example.com.
Notes and References
 Bureau of Labor Statistics, Employer Costs for Employee Compensation, Table 8: Employer costs per hour worked for employee compensation and costs as a percent of total compensation: Private industry workers, by establishment employment size, June 2010, 500 workers or more. http://www.bls.gov/news.release/pdf/ecec.pdf Reassignment of data for the pie chart by the author.
 Towers Watson, 2010 Health Care Cost Survey, February 2010, http://www.towerswatson.com/assets/pdf/1265/2010_HCCS.pdf, and The Henry J. Kaiser Family Foundation and Health Research & Education Trust, Employer Health Benefits: 2010 Annual Survey, September 2010, http://ehbs.kff.org/pdf/2010/8085.pdf. Projected 2014 employer subsidies in Table 2 are based on 2010 averages projected at 9% per year to 2014.
 Estimates for AHBE premiums and premium assistance credits come from The Henry J. Kaiser Family Foundation’s Health Reform Subsidy Calculator, using a “medium” regional cost factor. http://healthreform.kff.org/SubsidyCalculator.aspx