Employer-sponsored insurance (ESI) has been central to the U.S. health care system. The Affordable Care Act (ACA) adds many requirements and imposes many costs on employers that could change how – and if – they offer employee health care coverage.  But estimating the effect of changes to ESI is complicated.

This post takes a look at estimates of the ACA’s impact on ESI cost, and of what employers can expect to grapple with after the health reform law’s coverage expansion provisions take effect in 2014. Also see my previous post about an excellent new report on ACA cost projections in general: Society of Actuaries Estimates of Health Reform Law.

ACA Rules For Employers:

The basic requirement behind the ACA’s employer mandate is that employers must offer a certain level of affordable health coverage to its employees, or pay a fine. Employers with fewer than 50 full-time employees are exempt.

The specific requirements are, naturally, more complex. The Internal Revenue Service (IRS) recently published draft rules about the employer mandate. Here is an overview:

1. Which employers will face penalties under the ACA?

Employers will face a penalty under one of two conditions:

  • The employer does not offer health coverage or offers coverage to less than 95% of its full-time employees, and at least one of the full-time employees receives a premium tax credit to help pay for coverage on a Health Insurance Exchange (HIX).
  • The employer offers health coverage to at least 95% of its full-time employees, but at least one full-time employee receives a premium tax credit to help pay for coverage on an Exchange, which may occur because the employer did not offer coverage to that employee or because the coverage the employer offered that employee was either unaffordable to the employee (see question 11, below) or did not provide minimum value (see question 12, below).

“Unaffordable” is defined as a health plan that requires employees to contribute more than 9.5 percent of household income. To meet the “minimum value” requirement, the health plan must cover at least 60 percent of benefit costs. Minimum value will be determined using a calculator from the IRS similar to the actuarial value calculator for Qualified Health Plans (QHP) on the Health Insurance Exchanges, which the Centers for Medicare and Medicaid Services (CMS) has provided.

2. How much are the ACA employer penalties?

If an employer does not offer coverage to at least 95 percent of its full-time employees, the penalty will be $2,000 times the total number of employees per year. If an employer does offer insurance more than 95 percent of employees, but the coverage does not meet minimum value and affordability requirements, the penalty rate increases: Employers must pay $3,000 per employee per year, but only for those employees who received premium tax credits through the exchanges.

Employers Should Reevaluate Employee Health Benefits under ACA:

A recent Milliman brief gives an excellent framework for employers to reevaluate their ESI offerings in light of the ACA requirements and uncertainty. Both costs and enrollment in ESI are likely to increase for most employers after 2014, when the health reform law’s coverage expansion and employer mandate take effect. But different employers will be affected differently, based on the proportions of employees who are eligible for Medicaid or for subsidized coverage through the exchanges. Different situations will require different reactions from employers.

An overview of the basic factors employers should contemplate:

1. Composition of employees by income level

Whether or not an employee is eligible for premium or cost-sharing subsidies through the HIX plays a central role in determining whether the employer must pay a penalty. Individuals who earn between 138 percent and 400 percent of federal poverty level (FPL) are eligible for subsidies.

Medicaid adds a level of complication. Under the ACA Medicaid expansion, people with incomes up to 138 percent of FPL are eligible for Medicaid. Employers pay no penalty for employees who take that option. States have a choice about whether to expand Medicaid, thanks to the Supreme Court’s decision in NFIB v. Sebelius. In states that choose not to expand Medicaid, subsidies will become available to people with incomes down to 100 percent of FPL instead of 138 percent – increasing the potential penalties for employers with workers in that range of income.

See Seller Dorsey’s list of state decisions on the ACA Medicaid expansion.

2. Is it cheaper to take the penalty than to offer ESI?

Premiums for ESI family coverage doubled from 2002 to 2012, according to the Kaiser Family Foundation’s excellent Employer Health Benefits Survey. In 2012, the average employer contribution to family ESI premiums was about $4,300, a figure that does not include other costs associated with employee health care. Depending on its employees’ health care usage, health costs and spending could be much more for certain employers.

Milliman’s brief, for example, estimated post-health reform employer costs of up to $13,579 per employee. Not only will health costs per person continue to rise after 2014, but more employees are likely to enroll. Those two factors combined have the potential to make ESI very expensive.

Given that the cost of ESI in many cases will far outweigh the cost of penalties for not providing insurance, employers should investigate whether they ought to let certain employees choose health insurance through the exchanges instead of ESI. In some cases, exchange-based insurance might give better coverage at a lower cost, making it a better option for the employee as well as the employer.

Employers also should consider whether encouraging employees to use HIX-based coverage is worthwhile over the longer term. Penalties for doing so increase roughly 25 percent by 2018, to $2,500, which represents about a 6 percent annual rate of growth over four years. Health costs are likely to grow much faster than that, so the penalty could look more and more appealing compared to ESI costs over time.

3. Should employers offer less-generous health coverage?

Most employers offer insurance with an actuarial value well above the requirement to pay at least 60 percent of benefit costs, to avoid employer penalties. The baseline actuarial value level for Qualified Health Plans in the exchanges will be 70 percent. Employers might ask themselves whether it is worth it to continue offering plans with benefits well above those standards.

The so-called “Cadillac tax” is another reason for employers to consider less-generous ESI plans. Starting in 2018, the the ACA imposes a tax on employers of 40 percent for health benefits worth more than $10,200 for an individual and $27,500 for a family.

4. Cost of employer sponsored health insurance will grow substantially under ACA

Milliman’s brief has an interesting hypothetical analysis of the ACA’s effect on ESI costs in 2014. In addition to the penalties and the Cadillac tax described above, the ACA has the potential to increase the cost of employee health care in a few ways:

In its cost estimate for a hypothetical employer, Milliman finds an expected increase in employer costs of 43.7 percent in 2014, compared to this year. 23.2 percentage points of the increase are attributable to the ACA. Most of the additional ACA costs come from the increase in ESI enrollees and the employer mandate penalties.

You can read details about cost projections in the full Milliman brief, here.