The new health care reform law offers companies with more than 50 full-time equivalent employees a choice: They can play by offering their employees affordable employer-sponsored health care, or they can pay a penalty not to.
It sounds straightforward, but making that decision involves complexities and factors that vary depending on the size of the company and the type of workforce. Since the Supreme Court upheld the Patient Protection and Affordable Care Act (PPACA) in June, many employers have been weighing their options and preparing for the consequences of paying or playing. Others are waiting to see the outcome of the Nov. 6 election because Republicans, should they gain control of both the White House and Congress, have pledged to repeal or at least overhaul the PPACA.
But time is running out. The so-called “employer mandate” takes effect Jan. 1, 2014, meaning employers who currently offer health care coverage but need to make changes in order to comply with the law, or who want to drop health care and pay a penalty instead, have just a few months to put those plans in place. The situation is even more critical for employers who currently do not provide health care benefits but will be required to do so, or face penalties, under the new law. For all, the decision goes beyond a simple cost analysis.
“The answer to whether it makes sense to pay or play is not something you can paint the answer to with a broad brush,” says Sheldon Blumling, a partner at Fisher & Phillips. “Most employers would say, ‘If I pay $2,000 per employee in penalties and I am paying a lot more per employee for health care coverage, it looks like a no-brainer.’ But the devil is in the details.”
On the following pages, we look at some of those details that are driving employers’ play-or-pay decisions.
Large employers traditionally have offered health care coverage, and most will continue to do so, at least in the short run. A General Accounting Office review of 19 employer surveys on the topic found the percentage of employers who said they planned to drop coverage ranged from 2 percent to 20 percent, with many studies indicating the smaller the employer, the greater the chance of abandoning coverage.
“That’s not surprising because most large employers have never considered leaving their employees without health care coverage,” says Steven Friedman, a shareholder at Littler Mendelson. “Even if they are considering it, no one wants to be the first one. There may be a cat-and-mouse game going on, where employers in certain industries are waiting for the first company to drop coverage, or waiting for it to become commonplace.”
Patricia Cain, a partner at Neal, Gerber & Eisenberg, summarizes the factors that go into the play-or-pay decision as the three Cs: culture, cost and competitiveness.
The culture issue involves the employers’ view of his responsibility to provide employee benefits. “For many, health care is a core benefit,” she says.
The cost analysis gets more complicated. First, the penalty imposed for not offering health care coverage is not tax deductible for the company, while the cost of providing benefits is. The penalty is $2,000 per employee (excluding the first 30 employees) if coverage is not offered to anyone, including executives. Second, the law contains a nondiscrimination provision, meaning if coverage is offered to some employees, the same coverage must be offered to all. If some employees can’t afford that coverage, the employer must pay a $3,000 per employee penalty for everyone who goes to the state-run exchange for insurance and qualifies for subsidized coverage. Under current regulations, to be considered affordable, individual coverage under the plan cannot cost an employee more than 9.5 percent of his household income, defined as his W-2 wages for the year, regardless of whether there are other wage earners in the household. That might be an easy standard to meet for executives, but a tough one for low-wage workers.
“A lot of employers are trying to project costs going forward and looking at their contribution to see if they will be able to provide coverage that is affordable,” says B. David Joffe, a partner at Bradley Arant Boult Cummings. “If you provide coverage with minimum value and the employee does not have to contribute more than 9.5 percent of household income, you don’t have to worry about the penalty.”
Joffe adds that the nondiscrimination provision will be problematic for employers with an array of employees at different salary and responsibility levels. “It’s hard to do one-size-fits-all,” he says.
One example is the restaurant industry, in which management typically has health care coverage but waiters and kitchen staff don’t.
“You can get out of the $2,000 per employee penalty by offering everyone access to coverage, but to get out of all penalties, you have to offer it at 9.5 percent of household income. That’s a pretty low threshold for servers or shift cooks,” says John McGowan, a partner at BakerHostetler. “The business will incur some meaningful costs it doesn’t have in the budget right now.”
Cost considerations also are tricky because while an employer can calculate current costs versus the penalty, no one knows how the law will impact the future cost of health care coverage. To qualify, plans must fully cover the cost of preventive care and contraceptive services for women, eliminate lifetime caps on benefits and remove pre-existing condition exclusions. Free preventive care is intended to eliminate the need for costly treatment later, and new regulations on providers aim to reduce the soaring costs of health care, but some are skeptical about the law’s overall impact on costs.
“[The PPACA] mandates certain types of coverage be provided and mandates preventive coverage be provided at no cost, all of which are good for employees. But it doesn’t appear to take an aggressive stand toward lowering costs, and that’s what troubles employers,” Friedman says.
If health care costs rise substantially after the new health care system takes effect in 2014, the incentives for dropping employee coverage will grow. “Everyone thinks they will keep health care, but it certainly is feasible if we are still in an era where companies are struggling to make a profit that they will see no other way,” [than dropping coverage] Friedman adds.
The competitive environment is another major factor in the pay-or-play decision. Large employers in industries such as high tech, where competition for highly skilled employees is fierce, have a much stronger incentive to maintain health care benefits than those in industries with unskilled workforces that are easier to replace. The economy may play a role: A continuation of high unemployment would make it easier to drop health care coverage without worrying about finding good job candidates. But Cain points out there are still predictions of a labor shortage going forward that could prompt employers to maintain health care coverage in order to attract the best employees.
Unions also will play a role: Management of a manufacturing plant in which a union is seeking a foothold may well decide that keeping health care is an important element in keeping out a union, and those with unions may find removing employer-based health care is a deal-breaker in negotiations.
Michael Sheehan, a partner at DLA Piper, sees dropping health care as a “huge employee-relations issue,” particularly for less-educated workforces who would feel insecure with the idea of buying health care on their own, even if pay is increased to help cover the cost.
“Think about a plant in the middle of Iowa where there have been union-organizing drives,” Sheehan says. “The leaders of the union may seize on employer-provided health care coverage in their campaign. Even if dollar-to-dollar it made sense for the rank-and-file employee [to buy his own coverage], the employer would have to look carefully at whether this could become an issue.”
Beyond the three Cs, employers are concerned about whether the new health care system will offer viable alternatives to employees who lose company-sponsored insurance. Because the law’s individual mandate requires everyone to have health insurance or pay what the Supreme Court dubbed a tax, those employees would likely buy coverage through one of the new health care exchanges, which the states are supposed to run. But no one knows yet how the exchanges will work, what providers will participate and how much the coverage will cost.
State governments have a Nov. 16 deadline for submitting their exchange plans, but in some states where opposition to the PPACA is high, officials are refusing to develop exchanges. The law calls for the federal government to run exchanges where the states fail to do so.
“The big unknown is whether the exchanges will be a viable alternative to employer coverage,” says Michael Tomasek, a partner at Freeborn & Peters. “How good will the quality be? Will they function well? Will they be administered well? We just don’t know that yet. Until we know what the alternative to employer coverage is, it’s impossible for employers to make a rational choice about play or pay.”
Multistate employers may find significant differences in what is offered from one state’s exchange to the next.
“In some states, the exchange may function perfectly well, and in some it may be highly dysfunctional, if it is functional at all,” McGowan says. “So I don’t know what I am going to be seeing if I am a multistate employer.”
These exchange uncertainties are a major reason why some employers considering dropping health care coverage are taking a wait-and-see attitude. They are concerned that even if they give employees a raise or subsidy to help them purchase coverage on the exchange, employees will be unhappy with the choices offered.
“There may be a whole second wave of employers who decide to pay [the penalty] a year or two [after 2014], once we see how exchange coverage works and what it looks like,” Blumling says. “It may only take one to make the bold move, and everyone will feel empowered to do it.”
Sears Holding Corp. and Darden Restaurants Inc. appear to be paving the way for large employers to drop coverage. They announced in late September that they are replacing their self-insured health plans with a defined-contribution plan, giving their employees money to buy group insurance on a private, online exchange. Private exchange operators say they offer employers more predictable costs, as well as potential savings gleaned from workers’ voluntary choice of lower levels of coverage than the employer was offering and competition among insurers offering plans on the exchanges.
The defined contribution approach and the private exchanges aren’t part of the PPACA’s design. But they could provide a model for employers once the public health care exchanges go into operation in 2014.
The Patient Protection and Affordable Care Act’s (PPACA) biggest impact will be on employers who traditionally have not offered health care to their workers, or who have offered mini-med plans with very limited benefits that don’t qualify as minimum essential coverage under the new law.
The PPACA’s requirements that employers with more than 50 full-time employees offer coverage or pay a penalty will hit particularly hard in the service sector, according to John McGowan, a partner at BakerHostetler, because those high-turnover industries haven’t felt the need to offer health care in order to attract employees.
“This changes the economics of those businesses substantially,” McGowan says, estimating that the cost will be the equivalent of a $2 per hour increase in the minimum wage. He notes that single outlet restaurants, motels and retail stores with fewer than 50 full-time employees will be exempt from the PPACA and therefore will gain a competitive advantage over their competitors that are part of national chain and bound by the law’s requirements and penalties.
The law also hits the service sector by defining full-time employment entitling employees to health care benefits as 30 or more hours a week, whereas most employers previously have defined it as 35 or more hours per week. Industries including hotel, restaurant and retail chains rely heavily on part-time employees who don’t receive benefits.
“The problem arises when you have a workforce where your criteria [for receiving health care benefits] was 35 hours per week, and now the threshold is 30,” says Patricia Cain, a partner at Neal, Gerber & Eisenberg. “If you have a lot of employees working 30-plus hours but less than 35, your choices are to cut them back to under 30 hours, pay the penalty tax or offer coverage. That is the area where the greatest concern is expressed.”
That is leading some companies to consider restructuring their workforces to avoid the costs of playing or paying. As a result, “the day of the 32-hour-a-week waiter may be gone,” Blumling says. “He may have his hours capped at 25 hours per week and work two jobs.”
Small Company Considerations
Employers big enough to fall under the employer mandate—those with 50 or more full-time equivalent employees—but with fewer than 100 employees who currently offer health care coverage have different considerations than large employers.
Sheldon Blumling, a partner at Fisher & Phillips, says companies with 50 to 100 employees have fewer options for health care coverage than those with more than 100 employees, who can often shop around for a better deal based on the demographics of their employee population. If the small employer pays a higher cost per person to provide employee coverage, dropping coverage and paying the penalty becomes more attractive.
Another factor is that the $2,000 penalty does not apply to the first 30 full-time employees, a provision that makes the per employee cost much less for the small employer. For example, an employer with 60 full-time employees would only pay the penalty for 30 employees, making the penalty effectively $1,000 per full-time employee.
In certain industries such as financial services, companies with a small but highly educated workforce may find the option of dropping health care while increasing compensation palatable to employees, according to Michael Sheehan, a partner at DLA Piper.
“I could see a small office of a private equity group, hedge fund or trading company where the workforce is acclimated to making cost-benefit decisions not being offended or unsettled” by the idea of shopping for their own health care coverage on a state exchange, Sheehan says.