The health care reform bills signed into law last month by President Obama (together, the "2010 Act") radically change the way health, accident and sickness insurance is to be bought, sold and provided in the United States.
The 2010 Act principally does so by reorganizing the commercial health insurance marketplace, generally starting June 21, 2010, and ending December 31, 2013. Then, effective January 1, 2014, the 2010 Act will require most employers to provide employment-based health insurance coverage -- or pay a potentially substantial penalty. For all but the largest employers, providing health insurance coverage will involve purchasing group coverage from a newly-reorganized health insurance marketplace. In the interim, employers must cope with a number of transitional issues and coverage changes without losing sight of the bigger changes headed everyone's way in 2014.
This Advisory provides a series of assessments and identifies key issues employers should address to avoid being caught out of position. Its focus is on what employers need to do before 2014 arrives.
Issues Employers Should Address Before 2013
Most of the changes required by the 2010 Act to be made over the next 3½ years are intended to transform the commercial health insurance marketplace and, in some cases, supplement the marketplace with government-facilitated programs and coverage options. A handful of those initiatives require employers to take specific action in the next couple of years. The pre-2014 changes that employers should pay particular attention to are as follows (generally, listed in the order they take effect):
- The Early Retiree Reinsurance Program. (Effective June 21, 2010.) A special early retiree "reinsurance" program, to subsidize plans and programs that provide coverage to retirees that are not yet Medicare-eligible (and their families), will become available June 21, 2010. Employers that currently maintain a plan or program that provides coverage to early retirees should consider applying and qualifying for the program, because it generally reimburses up to 80% of plan-incurred benefit costs between $15,000 and $90,000 so long as the reimbursed amounts are used to lower plan costs or provide relief for covered retirees. The funding for this special subsidy is limited ($5 billion), and plans must meet certain conditions. However, those that qualify and apply could meaningfully benefit from it.
Remove Certain Limiting Coverage Provisions By 2011. (Effective for plan years commencing after September 23, 2010.) Potentially important changes will have to be made to all group health plans, including: removing lifetime benefit limits on core benefits (also known as "essential benefits"); removing the right to rescind coverage (other than for fraud or intentional misrepresentation); eliminating overly restrictive annual limits; extending coverage to adult children who have not yet attained age 26 (generally, if they have no other employer-sponsored coverage options); and eliminating pre-existing condition exclusions for dependent children under age 19.
- Special Note: "Grandfathered" Plans. A provision in the 2010 Act provides "grandfathered" plans with relief from some of the new requirements. (A "grandfathered" plan is one in effect when the first of the two laws comprising the 2010 Act was signed on March 23, 2010.) While the relief provided during the transition period (2010-2013) is limited, having a "grandfathered" plan nonetheless may come in handy in 2014 when the more comprehensive changes take effect. Accordingly, employers that have "grandfathered" plans should not simply terminate or discontinue them without considering the relief they are likely to provide in 2014. For example, "grandfathered" plans will have the ability to avoid having to satisfy all of the "essential benefits" requirements which will then take effect.
- Preventative Benefits Without Cost Sharing. (Effective for plan years commencing after September 23, 2010.) Generally, beginning in 2011, group health plans (other than "grandfathered" plans) will be required to offer certain preventive services, such as immunizations and preventative screenings, without requiring any employee cost sharing.
- Health Insurer Rebates. (Effective for plan years commencing January 1, 2011.) Health insurers will be required to maintain comparatively high medical loss ratios (MLRs) to ensure that most premiums collected are spent on benefits and not used to quickly build up reserves or put to other corporate uses. For large group health plans, the company-wide MLR is 85%; for individual policies and small group health plans, the company-wide MLR is 80%. Insurers that violate this standard will be required to provide a pro rata rebate to "enrollees." Because most employer-provided plan coverage is contributory, employers should clarify in their plan documents that any rebate paid will stay in the plan, subject (if necessary) to an offsetting credit for contributing employees. (Less-than-clear plan documents have spawned litigation in similar situations, such as when mutual insurance companies de-mutualize.)
- Potential State, Local Attempts To Tax Benefits. (Effective for taxable years beginning January 1, 2011.) Employers will be required to report to the IRS the cost of the health, accident and sickness coverage(s) provided to covered employees. Because information provided to the IRS routinely is shared with most state and local tax authorities under information sharing arrangements, state and local governments anxious to expand tax collections to close fiscal deficits can be expected to act on this new information.
- Loss Of The Medicare Part D Tax Benefit. (Effective for taxable years after December 31, 2012.) The 2010 Act eliminates the ability of employers who receive the Medicare Part D prescription drug subsidy to claim an allowable federal income tax deduction for the Part D subsidy they or their plan(s) receive. (This is the change that has prompted numerous public companies to announce that they must adjust their balance sheet obligations and take a current charge against their 2010 earnings.)
- Legacy Costs. Not all employers have "legacy costs" (i.e., the contractual obligation to provide retired employees and their dependents with health, accident, sickness and similar benefits). Those that do often find the costs extremely burdensome. The 2010 Act does not encourage employers to offer retiree medical benefits. While efforts were made to discourage employers from abandoning retirees wholesale (see the Early Retiree Reinsurance discussion, above), employers able to unilaterally modify or eliminate retiree medical benefits should review their present arrangements between now and 2014 and consider whether the new coverage opportunities becoming available to retirees allow both employers and retirees to come to some other arrangement. Even employers that need consent to do so (e.g., union consent in the case of non-vested benefits, individual retiree consent in the case of benefits that are contractually vested, etc.) should consider whether to propose mutually beneficial changes between now and 2014. For example, an employer might consider substituting a "defined contribution" program in 2014 which would provide retirees with an allowance they could then use to purchase individual coverage.
Addressing the 2014 Employer Mandate In 2013
While the 2010 Act requires an employer to make further changes for plan years starting in 2013, most are comparatively minor (e.g., restricting amounts capable of being contributed under a cafeteria plan, etc.). More importantly, an employer should position itself to strategically respond to the substantial changes set to take effect in 2014. For employers, the "employer mandate" is the predominant concern.
What the Employer Mandate Is
Much has been written about the "employer mandate" that takes effect in 2014. For those employers subject to it (more on that, below), the proposition is straightforward and has two important components:
- If you don't offer "minimum essential coverage" to all your full-time employees (either by providing them with a "grandfathered" plan, a self-insured plan that meets the new federal standards, a governmental plan (for governmental employers), or one of the certified "qualified health plans" available for purchase through one of the to-be-established exchanges), you will face a tax penalty of $166.67 per month for each full-time employee you have ($2,000/full-time employee per year) until you do so (subject to an exemption for the first 30 full-time employees you have).
- Even if you offer "minimum essential coverage" to all your full-time employees (as described in (1), above), to the extent some of your full-time employees turn down that offer of coverage and instead purchase their own "qualified health plan" coverage through an exchange, you will face a separate tax penalty of $250 per month ($3,000/year) for each of those opting-out employees whose independent purchase coverage is eligible to be taxpayer-subsidized. (In no case would your total penalty exceed the maximum penalty you would pay if the tax penalty described in (1), above, were to apply.)
The $2,000 tax penalty ((1), above) is comparatively easy to understand: the tax penalty only affects employers that have more than 30 full-time employees, but it could generate a staggering penalty for an employer with a very large employee population. For instance, a foreign manufacturer with 100,000 full-time employees, only 200 of which are employed in the United States, could face a $199.94 million penalty per year if the manufacturer simply chose not to comply with the mandate. Likewise, a national restaurant chain with 50,000 employees that operates through "company stores" but permits its local stores to purchase coverage locally could face a $99.94 million penalty if just one store failed to properly comply with the mandate (e.g., misclassified an employee as part-time, improperly used independent contractors, etc.).
The $3,000 tax penalty ((2), above) is more disarming; it essentially penalizes any employer that offers coverage so inadequate, or so expensive (in terms of the cost the employee is charged), that the employer's own lower-paid employees would rather purchase taxpayer-subsidized coverage in the marketplace. As such, the $3,000 tax penalty is designed to be Darwinian: it weeds out those employer-provided plans (and in particular, "grandfathered" plans) that the employer's own employees consider inadequate or too pricey (or both).
Most important, the tax penalties are triggered if any of the employer's full-time employees purchase coverage through an exchange and qualify for a taxpayer-subsidized coverage. Most employers are surprised to learn how many of their employees can qualify for taxpayer-subsidized coverage. In general, taxpayer-subsidized coverage is available to anyone with an income lower than 400% of the Federal Poverty Level (FPL); currently, that level is set at $88,200/year for a family of four and $43,320 for an individual.
Which Employers Are Subject to the Mandate
Not all employers will be subject to the employer mandate, Rather, the 2010 Act sharply differentiates between different employers based on the size of their employee populations. The larger an employer's employee population, the more financial and regulatory responsibilities the employer will have in 2014. The following examples illustrate how the size of an employer's employee population dictates its opportunities and obligations (including the mandate):
- An employer with less than 25 full-time employees and average annual wages of less than $50,000 will qualify for a small business tax credit if it provides subsidized coverage that meets minimum standards. (Larger tax credits are available to smaller, lower-wage employers.)
- An employer with 25-49 full-time employees (including full-time-equivalent (FTE) employees) will receive no tax credit, but also will not be penalized for not providing subsidized coverage that met minimum standards.
- An employer with 50 or more full-time employees (including full-time-equivalent (FTE) employees) will be subject to the "employer mandate" described above.
- An employer with more than 100 full-time employees will have the same obligations -- and face the same potential tax penalties -- as an employer with 50 or more full-time employees (above). However, an employer this size will not be able to purchase coverage for its employees through the new exchanges prior to 2017, even if it is too small to self insure, and despite having an employer mandate capable of generating a meaningful tax penalty.
- An employer with more than 200 full-time employees will have the same obligations -- and face the same potential tax penalties -- as an employer with 50 or more full-time employees (above). Also, like employers with more than 100 full-time employees, these large employers will not be able to purchase coverage through the new exchanges prior to 2017 -- although many likely will be in a position to self-insure (which should provide some control over plan design). However, in addition to the above requirements and conditions, an employer with more than 200 full-time employees will be required to automatically enroll all of its new full-time employees in one of the plans it maintains. A special Fair Labor Standards Act (FLSA) exemption (notably, not available to smaller employers) protects such an employer from the wage payment problems normally associated with mandatory withholding.
Finally, it is important to understand that employers which find themselves subject to the employer mandate will not simply be able to play the "audit lottery." Those subject to the employer mandate will be required to report to the IRS whether they are providing the requisite coverage to their full-time employees, along with details enabling regulators to enforce the mandate.
Calculating Size of Employee Population
Some employers may see the employer mandate rules as a "numbers game" and be tempted to try to avoid them. That strategy would be short-sighted. Technical rules, used to determine the size of an employer's employee population, limit an employer's ability to manipulate the numbers. Employers that do not pay proper attention to these anti-manipulation rules may be in for an unwelcome surprise. The following rules are used to determine the true size of an employer's employee population:
- The employer mandate rules are based on the number of full-time employees an employer has employed, on average, during the calendar year preceding the year to which the mandate(s) otherwise are to apply. Thus, an employer's employee population in 2013 will determine whether it will be subject to the employer madate in 2014. When making these determinations, a "full-time" employee is one who works 30 hours per week, based on a monthly average. Hours worked by part-time employees also count towards determining whether the 50+ employee threshold is met, by totaling the number of hours worked for a given month by all of the employer's part-time employees and dividing by 120, to determine how many FTE employees the employer has.
- Non-employee workers, such as independent contractors and leased employees (especially those provided through "payrolling" arrangements) also count as employees if they could be reclassified as employees of the business receiving their services. Reclassifying workers as "employees" can materially change the size of the employee population.
- Finally, common ownership rules (frequently called the "controlled group" rules) are used to determine (a) whether an employer is subject to the employer mandate, and (b) how to calculate any tax penalty that may apply, such as the $2,000 per full-time employee penalty (which applies if an employer provides no coverage and one or more full-time employees purchases coverage from an exchange and qualifies for taxpayer-subsidized coverage), or the $3,000 per opting-out full-time employee penalty (which applies if a full-time employee independently purchases coverage and qualifies for taxpayer-subsidized coverage).
How The Mandate Actually Works
The following example illustrates how the employer mandate actually functions in the "real world" in which many small businesses operate:
A married couple own two businesses: a financial planning business/insurance agency (with 14 full-time (FT) employees and 6 part-time employees, in 2013), and a two-store McDonald's franchise (with 18 FT employees and 50 part-time employees, again, in 2013). The businesses are considered a single employee population because they are commonly-owned. Assuming the part-time employees each work an average of 20 hours per week, they collectively count as 37 FTEs; that will cause the combined business to be subject to the employer mandate once it takes effect in 2014 (at 32 FT employees and 37 FTEs, for a total of 69).
First, if the businesses do not provide all of the FT employees of both businesses with coverage that meets the new standards, the combined businesses will be subject to a comparatively modest $4,000/year penalty because (a) while the businesses are subject to the employer mandate, the penalty is calculated on the basis of FT employees only (a total of 32), and (b) there is a 30-employee exemption. Second, even if the businesses provide the minimum possible coverage and charge the highest possible employee contribution, the penalty will not exceed $4,000/year even if one or two (or more) FT employees opt out of the coverage, purchase their own coverage on an exchange, and qualify for taxpayer-subsidized coverage (because their family incomes fall below the applicable federal thresholds) because the overall penalty is limited to what it would be if the employers provided no coverage at all.
The more substantial challenges to the couple's businesses are likely to come from other factors, such as the individual purchase mandate (which will provide some individuals with an incentive to find jobs with competitors who provide coverage or better coverage).
It has never been more important for employers to engage in careful workforce planning because the costs of miscalculation are rapidly rising. Employers thus are well-advised to consider the following essential lessons when deciding how best to plan for 2014:
- Do what you need to do now, and in 2011 and 2012, but remain focused on what is coming in 2013 and 2014.
- Recognize some key business realities. First, the employer mandate clearly falls unevenly and is based on the size of an employer's overall employee population. Second, at the margins, the employer mandate is not a huge deterrent. Third, in any business sector where the competitive landscape is populated by both large and small organizations, direct competitors could have significantly different labor costs once the mandate rules take effect, which are potentially disruptive. Accordingly, employers that operate in markets in which profit margins are narrow or which are populated by both large and small employers (e.g., restaurants, motels, commercial retail, etc.) should consider whether their existing business model allows them to compete effectively.
- Bear in mind that the new rules place no independent value on providing health coverage to retirees and other former employees and dependents -- and in 2014 such individuals will be able to purchase their own coverage. Employers in a position to curtail, convert or eliminate their post-employment benefit obligations may find it appropriate -- and perhaps, even necessary -- to do so.
- Watch out for -- and avoid -- easy traps. Employers will be tempted to minimize their insurance costs by maintaining large part-time employee populations without providing them with health insurance. However, part-time employees count towards determining whether an employer is subject to the mandate, and even part-time employees can be organized. Such employers that maintain large part-time employee populations should watch out for organizing efforts.
- Do not try to avoid the employer mandate penalty through employee "communication." The Fair Labor Standards Act (FLSA) has been modified to prevent employers from firing, coercing or disciplining employees who are in a position to purchase health insurance and qualify for tax subsidies.
Employers generally will not have to respond immediately to all of the changes now headed their way as a result of the 2010 Act. But that situation will change, as incremental modifications will need to be made as early as 2011. It is not too early for most employers to now begin to plan for 2014 and determine whether they need to change more than just their health insurance coverage to function effectively. For those who conclude that more significant changes in operations are needed, the time to plan for change and implement change is 2013 -- before the 2014 rule changes take effect