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Not so fast: Terminating employee health plans may not be cost-effective

Not so fast: Terminating employee health plans may not be cost-effective

WASHINGTON—At first glance, the health care reform law would seem to open the door for employers to terminate their health care plans.

Employers choosing to go that route simply could bump up salaries of employees to help offset the premiums they would pay to buy coverage in state health insurance exchanges that the reform law authorizes and are supposed to be set up by Jan. 1, 2014.

Employees buying coverage through the exchanges could not be denied policies due to pre-existing medical conditions. In addition, health insurers authorized to provide exchange would be limited in how much they vary rates based on age.

In the case of lower-income employees—those making up to 400% of the federal poverty level—federal premium subsidies would be available that would reduce the premiums they would pay.

In turn, employers would be free of the hassle and expense of offering coverage, dealing with insurers and third-party claims administrators and could reduce the size of their benefit departments.

But in many cases, the theory is sharply different from the reality, benefit experts say. And, in fact, survey after survey has found that only a small percentage—under 10%—of employers say they are actively considering terminating their health care plans when key provisions of the reform law kick in starting in 2014.

“The vast majority of companies we have spoken to have concluded that the risk is too great,” said Steve Raetzman, a partner with Mercer L.L.C. in Washington.

As to potential savings resulting from terminating their health care plans, those savings “evaporate” when employers calculate the costs associated with plan termination, Mr. Raetzman said.

Employers that do not offer coverage must pay to the government an annual non-tax-deductible $2,000 penalty for each full-time employee that is not offered coverage.

Then there is the cost to employers of bumping up employees' salaries to offset premiums they would pay for coverage in the exchanges.

If employers intend to keep employees whole—that is, employees would not pay any more for coverage after their employers terminate coverage compared with before—potential savings would quickly evaporate.

That is because under current tax law, the premiums employers pay are excluded from employees' taxable income. By contrast, if employers terminate their plans and increase employees' salaries to enable employees to buy coverage in the exchanges, that additional cash employers would be giving their workers would be considered taxable income.

Take the case of a group health care plan in which family coverage costs $12,000, with employees paying $3,000. Assume the same coverage also costs $12,000 in an exchange. Depending on the employee's tax bracket, an employer would have to give the employee considerably more than $9,000 to keep him or her whole—plus the employer would be paying the $2,000 penalty for not offering coverage.

“When you bump up salaries, you can see how quickly the savings evaporate,” Mr. Raetzman said.

“The economics in many cases are not in favor of plan termination,” said Ed Fensholt, a senior vp and director of compliance services for Lockton Benefit Group in Kansas City, Mo.

Then, there are the unknowns associated with plan termination. For example, it is impossible to predict—at least not yet—the premium rates insurers will charge for exchange coverage and how those rates will compare to the premiums employers now pay or, in the case of self-funded employers, their claims' costs.

Mr. Raetzman predicts that premiums in many cases will be higher in exchanges than for comparable coverage offered by employers.

That is because those buying coverage through exchanges will be more likely to have health insurance problems.

“It is almost certain that there will be adverse selection, and that will drive up premiums compared to employers' plans,” he said.


Even though the health care reform law imposes penalties on individuals who are not enrolled in a qualified health care plan, those penalties, at least initially, are modest and pale in comparison with premiums individuals would have to pay for coverage.

As a result, the cost of keeping employees whole by boosting their salaries to purchase exchange-based coverage for employers terminating coverage could be more expensive than anticipated, experts say.

Yet another disincentive to terminating coverage could be the state of the economy. If the economy over the next couple of years strengthens significantly, far more employers will have to aggressively compete for employees.

“Today, the economy is down. But at some point, it will cycle back,” notes Dan Levin, a principal with Buck Consultants L.L.C. in Chicago.

At that point, companies that don't offer coverage could find themselves at a competitive disadvantage in recruiting and retaining employees compared with those that do, Mr. Levin said.

“You can't judge the economy by how it is now,” he added.

Yet another unknown is whether the $2,000-per-employee penalty on employers that do not offer coverage will remain at that level. For example, if the cost to the government of expanding coverage proves to be far higher than originally calculated, the penalty might have to be significantly increased.

“What if $2,000 becomes $6,000? That is a risk employers” would not be willing to take, Mercer's Mr. Raetzman said.

Still, in certain situations—and putting certain risks, like Congress later jacking up the $2,000 premium, aside—terminating coverage may be economically attractive, Lockton's Mr. Fensholt said.

This would be true in industries such as retail and hospitality, where a very high percentage of the workforce is made up of low-wage employees who would be eligible for federal premium subsidies. Employers in such situations, due to the availability of the federal premium subsidies, would incur relatively modest costs to make employees whole.

“Financially, there are situations, where some will come out ahead” if they terminate coverage, Mr. Levin said.

“There are a lot of dials to turn in doing the analysis,” Mr. Fensholt said.