Letting Go Of Employer-Based Health Insurance

Other than the egg-laying exercise surrounding the ACO regulations, 2011 was a quiet year among Washington health policy experts until June 6 when McKinsey released the results of a survey of employer plans under the Affordable Care Act. The McKinsey study found that roughly 30 percent of employers were considering dropping their employee insurance coverage and encouraging their employees to receive federally subsidized health insurance through the Exchanges created in the Affordable Care Act. This compared to low- to mid-single digit estimated drop rates based upon economic modeling by the Urban Institute, Lewin and, importantly, the Congressional Budget Office (CBO).

To judge by the storm of angry political reaction, you would have thought that McKinsey had advocated mass psychedelic drug use. Senator Max Baucus (D-MT) sent McKinsey a letter demanding that the firm disclose its methods and questioning its motives. There followed a flurry of hostile press coverage of the study, echoed in the progressive blogosphere. Horrified, McKinsey released its study methodology, survey instrument, and tabulations of responses.

Why such a sharp reaction? If McKinsey turns out to be right about employer intentions, the cost estimates of the federal subsidies for individuals to purchase coverage through the Exchanges (roughly $777 billion from 2012 to 2021 according to CBO’s March, 2011 analysis) are far too low, making the program even more vulnerable to Republican efforts to cancel it. And if a third of employers drop coverage, President Obama’s pledge that “if you like your health insurance coverage, you can keep it” won’t look so great either.

But these two problems are not the whole story. The larger problem is that the struggle for public support for health reform is not going well. Fifteen months after passage, only about a third of the American public thinks health reform will be good for the country (according to the June Kaiser Family Foundation Tracking Poll). The Democratic base does not love the ACA, believing that too much was given away to the health insurance industry. It’s a politically sensitive time for an influential firm like McKinsey to be questioning the administration’s economic assumptions.

On my review, McKinsey’s survey seemed both thorough and workmanlike, a typically high quality work product by the elite consulting firm. A surprisingly large percentage of the survey’s respondents were not aware of many specific features of the legislation that will directly affect them. Indeed, most seemed only to have begun to analyze its economic impact on their firms or workers. Absent the regulations to implement the insurance reforms, this is probably sensible.

McKinsey’s Findings Hit The Mark On Employer Thinking

However, based on what I’ve learned in my not-entirely-random walk through the health insurance market, McKinsey’s findings accurately reflect current employer thinking. The ACA’s incentives to move toward a consumer market and away from employer-provided health insurance could prove to be far stronger than its drafters intended. I was surprised that only 37 percent of employers under fifty employees “probably or definitely” intended to drop coverage, since there are no penalties for doing so and the subsidies for their workers to get Exchange-based coverage are so compelling. If anything, McKinsey’s survey understates the likely employer abandonment of the small group market.

According to Urban Institute’s Eugene Steuerle, a family of four with cash income of $30,000 a year is almost $14,000 to the good by going through the Exchange and picking up the premium subsidies rather than getting coverage from their employer. Even at $42,000 in family income, the Exchange advantage is close to $7000 a year. On this point, my employee benefit friends are virtually unanimous: except for high wage employers like law firms or consultants, it doesn’t make sense, for small employers or their workers, for small employers to continue offering coverage given these incentives.

How large employers will respond is a conundrum. The angry reaction to the McKinsey study was clearly intended to tamp down a stampede for the exits (as well as to deter further studies which reached a similar conclusion). There is no consensus among the employee benefits community about what large employers should do. Some analysts rightly point to corporate inertia, the “malign paternalism” of corporate human resources managers, and collective bargaining agreements as supporting continued provision of employer sponsored health benefits. There is also the “what is my competitor doing?” factor. McKinsey’s study findings probably significantly overstate, (in the mid 20 percent range) the number of large employers that will ultimately drop coverage. Far more likely is a shift to some type of defined contribution model.

What If McKinsey Is Right?

The controversy over McKinsey’s survey begs a question: what if McKinsey is right about the ultimate employer response? The forces sustaining the employer-based system are already weakened by the economic crisis and the eclipse of labor unions’ influence. After all, if consumers choose their own health benefits, they can make President Obama’s pledge about not being forced to switch plans a reality.

What the President addressed is only a problem if the employer continues to limit health plan choice. Rather than twist ourselves in knots to keep the employer in the game, federal policymakers should consider nudging employers toward the exit and moving more aggressively toward a consumer-driven health insurance marketplace.

Little appreciated in Washington is that the large employer’s influence on benefit design has been a major enabler of escalating premiums. The main influence hasn’t been first dollar coverage, but rather their preference for open access, point-of-service plans, which replaced more accountable “closed panel” or HMO-type health plan products. The open access products markedly reduced health plan bargaining leverage and rewarded provider cartel behavior. Individuals in the Exchanges won’t care if every provider in their region is covered by the health plan they choose; they will only care about the narrow network they already use (and they will love the significantly lower premiums).

A formidable barrier to encouraging employers to exit health benefits is the potential cost to the federal budget. If employers are voluntarily contributing north of $800 billion a year to health insurance costs, it is troublesome fiscal strategy to substitute borrowed federal dollars for these corporate funds. By way of comparison, the 2020 premium subsidy cost estimate for ACA is $130 billion a year, according to CBO’s March, 2011 report. Wyden Bennett’s orphaned alternative to ACA included an employer maintenance of effort provision in its first few years, replaced by an explicit payroll tax, to control this substitution.

Some way must be found to assure that employers pass through a significant fraction of their current premium outlays to their workers in increased cash compensation to justify the increased federal subsidy cost. Perhaps penalties for dropping coverage could be increased if employers don’t increase cash compensation and are waived if they do. Encouraging employers to get out of the health benefits business would be a compelling fiscal stimulus if, as is possible, the US dips into a “double dip” recession – the equivalent of a huge corporate tax reduction that also raised worker pay.

If Employers Exit, How Could Greater Subsidy Costs Be Financed?

If McKinsey’s study is even close to predictive, policymakers need to begin searching now for the resources to finance the higher subsidy expense needed to cover a more vigorous employer exit. The tax subsidy to private firms and individuals for the health benefit is the largest “tax expenditure” in the current tax code (larger than the mortgage interest deduction) – more than a trillion dollars over the next five years. Markedly reducing this subsidy is scary, but it’s the most attractive revenue source to finance the shift. Phasing out the employer’s tax subsidy over a decade and capping the individual’s tax subsidy are desirable elements of a responsible tax policy.

Possible alternative funding mechanisms are to accelerate the Cadillac tax to 2014, or broaden ACA’s premium tax to non-profits and self-funded benefits plans, or institute a consumption tax on soft drinks or transfats. The premium subsidies could also phase out at 250% or 300% of poverty. A final, and more complex, cost-saving possibility is making the “minimum essential benefit” in ACA truly “minimum” and “essential”, rather than a somewhat skinnier version of today’s comprehensive benefit, by covering catastrophic costs plus ambulatory services and prescription drugs, and encouraging employers to offer only supplementary coverage.

Not all employers would elect to drop coverage even with these changes. How many employers ultimately elect to drop coverage is a huge uncertainty about the future cost of the program. The employer’s decision to offer health benefits is a business decision, not a policy decision. Employers will examine the incentives and financial impact of whatever structure ACA has created, and make decisions that are right not only for their workers but also for their customers and equityholders. Right now, the prudent business decision for most small employers and larger ones with a lot of low wage workers is to exit the direct provision of health insurance coverage, and give their workers both additional cash compensation and full control over health plan choice.

Right now is not a good time to broach changes in ACA. The two political parties are locked in a futile struggle over outright repeal, whose main purpose appears to be to mobilize their respective electoral bases for the 2012 election. Outright repeal of ACA would be a disaster for citizens as well as the care system. Other than the disillusioned “progressive” wing of the Democratic party, that continues grieving for the lost “public option”, the rest of the country might look favorably upon a modification of ACA’s insurance reforms that reduced employers’ health benefits paperwork, increased worker’s cash compensation and truly empowered consumers to determine their own health benefits needs.