Federal contactors face significant cost increases from impending health insurance reform. The Patient Protection and Affordable Care Act (PPACA or Act) was signed into law by President Obama on March 23, 2010.1 Beyond the politics that has surrounded it, the Act raises significant cost and compliance implications for federal contractors. As the changes brought by the Act approach, many Federal contractors are standing on the tracks, so to speak, unaware of the Act’s potential cost increases bearing down on them. Following affirmation by the Supreme Court, with enrollment in exchanges starting in October 2013, and key provisions of the Act becoming effective on January 1, 2014, change is coming. Federal contractors must focus on how the Act may soon affect their bottom line. This article discusses six ways that the Act may increase work force related costs for federal contractors, and how contractors can prepare for the impact of those potential cost increases before the Act takes effect in January 2014.
- The Act’s Health Care Obligations
The Act imposes new requirements on individuals, employers, and health plans, restructures the private health insurance market, and sets minimum standards for health coverage. It also provides financial assistance to certain individuals.
The Act does not specifically require employers to provide health benefits. However, as detailed below, certain employers may be required to pay a penalty if either (1) they do not provide insurance, under certain circumstances, or (2) the insurance they provide does not meet specified requirements. These penalties may be assessed against “applicable large employers,” defined as firms that employ more than 50 full-time employees on business days during the preceding calendar year.1 The Act defines a “full-time employee” as individuals employed “on average at least 30 hours of service per week.”2 It is important to note that the 50 employee standard is but one of many different size thresholds applied to various Act provisions. This article focuses on the 50 employee size threshold because it relates to potential employer penalties, as discussed below.
One of the most significant features of the Act requires the creation of governmentsponsored Health Benefit Exchanges (Exchanges).3 The intent of the Exchanges is to provide a venue where insurance companies may sell their insurance products and purchasers can shop from multiple options available to them.4 Exchanges can be located at a physical location and/or be virtual, operating online.5 The Exchanges do not issue insurance, but contract with issuers who will make insurance products available for purchase through the Exchanges.6 Some have compared the operation of Exchanges to buying car insurance online.
The Act requires that Exchanges be established in every state by January 1, 2014.7 States can establish their own Exchanges, partner with the federal government in operating an Exchange, or default to a federally facilitated Exchange.8 A federally facilitated Exchange leaves the work of operating the Exchange within the defaulting state to the federal government.9 In order to help individuals purchase coverage, individuals of certain income levels may qualify for a tax credit toward their premium costs and a subsidy that will be available through an Exchange.10 Employers are expected to make information about Exchange plans available starting in October 2013. The implementation of coverage under these Exchanges has potential cost implications for many employers.
Open enrollment for the Exchanges is scheduled to begin on October 1, 2013.11 Before this date, employers will be required to provide formal notice to their employees that the Exchanges are available. These deadlines are coming fast, and additional employer costs may be close behind. Federal contractors operating with slim margins and under tight budget constraints should plan carefully to ensure compliance with the Act and assess potential cost impacts under it
- Six Potential Cost Impacts on Federal Contractors
- “Play or Pay” Penalty Costs
Starting on January 1, 2014, the Act establishes two possible penalties for large employers: one for not offering health care coverage, and the other for offering coverage that is unaffordable and/or fails to provide minimum value. When assessing their options, employers must consider whether they will “play” ‒ provide insurance coverage to their employees under the Act ‒ or “pay” a penalty.
Applicable large employers (employing more than 50 fulltime employees in the prior calendar year) may face a monthly penalty if the employer: (1) fails to offer full-time employees (and their dependents) the right to enroll in minimum essential coverage for any month, and (2) has at least one full-time employee that has been certified to the employer as having enrolled for the month in a qualified health plan offered by an Exchange to which a premium tax credit or cost sharing reduction is allowed or paid. In such cases, the employer will be charged a monthly (non tax-deductible) penalty of US$2,000 per full-time employee for all except the first 30 employees.12
As detailed above, the “play or pay” penalty calculation applies to large employers with employees eligible for premium tax credits or cost sharing. Thus, employers must be aware of their employees’ eligibility for tax credits, and employers must carefully assess whether the firm qualifies as “large.” Again, this size threshold is driven by the Act’s definition of full-time employee. While many currently consider “full-time” employees as those working 40 hours each week, the Act defines “full-time employees” as individuals working 30 or more hours per week.13 The Act also includes exceptions for new employees, seasonal employees and variable hour employees.14
Under the Act, an employer’s size will be assessed monthly. Thus, employers near the 50 full-time employee threshold may want to determine recurrently the size of their workforce under the Act, whether they may be subject to the penalty, and if so, whether the overall penalty exceeds the cost of providing coverage. While certain employers may decide to reassess yearly, others closing in on large status may decide to reassess more often. The difference between 49 employees and 50 could be the difference between no penalty and a penalty of over US$40,000, calculated by multiplying 20 employees (50 minus 30) times US$2,000. Only with current information regarding their employees and their size can companies make a business decision when and whether to “play or pay.”
- Inadequate Insurance Penalty Costs
The Act also subjects employers to financial penalties for a different reason – failure to provide adequate insurance. Starting in 2014, an employer will not be treated as meeting the Act’s requirements and will be subject to penalties if the employer’s offered insurance is either “unaffordable” or fails to provide “minimum value,”15 and at least one full-time employee receives a premium tax credit and is enrolled in one of the subsidized health insurance Exchange plans.
To be considered “affordable,” the employee’s premium cost for employee-only coverage can be no more than 9.5% of household income (several alternative “safe harbors” can be used to measure income, including using employee W-2 wage reports). To meet the “minimum value” requirement, employer plans must provide at least a 60% actuarial value of their workforce – essentially, cover at least 60% of covered health care costs.16
Employers without adequate insurance will be notified that an enrollee is eligible for a premium tax credit because the enrollee’s employer does not provide minimum essential coverage through an employer-sponsored plan or that the employer’s offered coverage is not affordable.17 Employers without adequate insurance face a monthly penalty of onetwelfth of US$3,000 (or US$250) per month for any applicable month for each full-time employee who receives a premium credit.18 After 2014, the penalty amounts will be indexed by a premium adjustment percentage for the calendar year.19
The Act also imposes a penalty on large employers with waiting periods to enroll in any minimum essential coverage under an employer-sponsored plan. The Act imposes a penalty of US$400 for plans with a waiting period between 30 and 60 days and US$600 for waiting periods beyond 60 days.20 The definitions of “minimum coverage” are beyond the scope of this article; employers will have to seek actuarial assistance in assuring adequate coverage.
Employers providing health care benefits also face administrative reporting requirements under the Act. Such employers must file a return providing the name of each individual for whom they provide the opportunity to enroll in minimum essential coverage, the length of any waiting period, the number of months that coverage was available, the monthly premium for the lowest cost option, the employer plan’s share of covered health care expenses paid for, the number of full-time employees, the name, address and tax identification number for each full-time employee, and any other information required.21 Employers are also required to provide information about the plan for which the employer pays the largest portion of the costs (and the amount for each enrollment category).22 These administrative requirements may subject employers to additional costs, including compliance costs.
- Part-Time Employee Coverage Costs
Employers typically provide health care for all full-time employees working 40 or more hours per week. Some employers currently are able to minimize benefit costs by hiring part-time workers, as health care coverage was not generally required for part-time workers working less than 40 hours per week. This too will change on January 1, 2014, when the Act requires that large employers offer coverage to employees working on average at least 30 hours per week, or face monthly financial penalties.23
Large employers who fail to offer adequate benefits to parttime employees will be subject to the penalties described above for failure to provide coverage. The new definition of part-time workers is a significant change in the breakpoint for employee benefits coverage. This change could dramatically alter federal contractors’ insurance costs and in turn generate increased overhead costs, thus affecting the contractor’s competitive pricing strategies.
- Excess Health Benefits (Cadillac) Tax
High cost employer-sponsored health care coverage may also face increased costs, as the Act will soon penalize high cost benefit plans. Some employers may offer a rich benefit package in order to attract or retain highly skilled employees. However, beginning in 2018, the Act will impose a 40% nondeductible excise tax on employers offering a “high cost” employer-sponsored health benefit plan, defined as plans with annual premium equivalents of US$10,200 for individuals and US$27,500 for other than individual coverage. Many within the insurance industry refer to this as the “Cadillac Tax.”24
Under the Act, employers offering self-funded benefit plans will be required to calculate annual premium equivalents for purposes of a “Cadillac Tax” calculation. The “coverage provider” is responsible for the tax. This could be the employer, insurer, or third-party administrator. Although the “Cadillac Tax” does not take effect until 2018,25 federal contractors facing multi-year procurements and out-year acquisition plans should carefully examine health coverage offering “excessive” benefits. Health insurance benefits traditionally offered to employees may, after the Act takes effect, be viewed as “excessive.” “Applicable large employers” will have to analyze existing benefits under the Act and project cost trends into 2018 and either avoid paying the Cadillac Tax, or be prepared to pay it and absorb consequent increases in overhead rates.
- Potential Penalties for Service Contract Act Employers
Contractors with Service Contract Act (SCA)26 employees face even more significant consequences under the Act than those described above. Generally speaking, SCA employers can offer service contract employees benefits as fringe dollars, as defined by prevailing wage determinations. These benefits costs are a direct charge to a federal contract. The SCA currently allows contractors to pay employee fringe benefits in cash, and many employers take advantage of this simple way to comply with the SCA.27 Starting in January 2014, the Act eliminates this simple “cash in lieu of benefits” approach and establishes the more complicated regime under which large employers must offer “an affordable plan that meets minimum value” for their employees, or face steep penalties.
As set forth above, the Act mandates coverage of employees working over 30 hours per week. The Act’s “affordability” provision further seems to override the individual employee’s fringe offered under the SCA test (9.5% of payroll) with a new definition of “60% of the actuarial value of the contractor’s costs.”28 T hus, t he e mployer w ill n ow h ave t o h ave a n authoritative actuarial analysis of all of such SCA benefit costs in order to comply with the Act and thus, at the same time, with the SCA.
Under the Act, beginning January 1, 2014, “large applicable employers” who continue to pay cash for SCA fringe benefits in lieu of providing health care coverage will pay a penalty equaling the lesser of US$3,000 annually for each full-time employee receiving a cash subsidy or US$2,000 per fulltime employee (starting after the first 30 employees). For contractors heavily dependent on SCA-covered employees and paying cash for their fringe benefits, these penalties can be hefty. These penalties may also be subject to increases in the future.
The decision for SCA employers simply to pay the US$2,000 penalty for not having health care insurance for employees is probably not an option because contracts utilizing SCA employees generally have thin margins and the US$2,000 per employee penalty may exceed the profit margin for SCArelated work. The conversion of SCA employees to health care plan coverage and working out actuarial calculations for a company based on its costs imposes administrative burdens upon government contractors heavily dependent on SCA employees to keep costs down. As the January 1, 2014 date approaches, SCA-covered contractors are advised to seek actuarial assistance well in advance.
Absent an actuarial analysis, a contractor may also risk a finding of noncompliance with the SCA and may run the risk of automatic debarment under the SCA if its plan is found “unaffordable” or of “minimal value,” and thus noncompliant with the SCA, as well as with the Act. This potential for noncompliance with the Act, and therefore the SCA, has not yet been ruled on, but the risks of being found noncompliant with the SCA are high because such failure can lead to automatic debarment.29 Because no one would want to be the test case on this point, the costs of an actuarial analysis would seem justified.
- Potential Employer Costs Under the Exchange System
Exchanges are intended, in part, to help keep health care costs down. These Exchanges may, however, also subject employers to additional business and administrative costs.
- Administrative Costs
If employees or individuals cannot afford health insurance individually, or through employer plans, they can presumably seek coverage on a less expensive basis through the Exchanges. The Act requires Exchanges to be established in every state by January 1, 2014. Exchanges are to be available for enrollment on October 1, 2013, at which time the public can go online, compare insurance plans, and sign up.
The Act provides general direction regarding the actual establishment and administration of the Exchanges.30 The Act provides federal standards for a state Exchange to meet that are administered by the Department of Health & Human Services (DHHS) Secretary.31 If a state refuses or fails to establish an Exchange, the federal government will establish a federally-facilitated Exchange in the state.32 A state can also establish a “partnership” with a federally-facilitated Exchange.33 However, the promise of Exchanges opening for business on October 1, 2013, is an open question. First, while Exchanges are to be established at the state level, only 17 states and the District of Columbia have declared an intent to create state-run Exchanges, and approximately 26 states have opted not to establish Exchanges, mostly for political reasons.34
In addition, the Act grants significant latitude in how Exchanges can operate. In some states, an Exchange may serve largely an administrative role, facilitating the sale and purchase of health insurance. Other state Exchanges may be responsible for implementing regulatory standards, such as requiring standardization of all products offered through it or imposing requirements on Exchange participants.35
The variation in Exchanges could impose another administrative and financial burden for national employers, as employees working in different states resort to Exchanges in different states with different rules. Federal contractors may need human resources (HR) and other staff trained in the differing state-run, federally-facilitated, or federallypartnered Exchanges across the 50 states and the District of Columbia merely to answer basic employee questions.
- Exchange Effects on Employer Benefit Costs
Second, and of much greater consequence, the “3 to 1 rule” could have a significant cost impact on health insurance plans generally, possibly increasing them for federal contractors. Starting January 1, 2014, the “3 to 1 rule,” or “3:1” limits the age rating band to 3:1.36 The premium rate charged by an issuer for non-grandfathered health insurance coverage for an individual or small group may vary by age, except that the rate variance may not exceed 3:1 for adults.37 That is, premium rates for older adults may not exceed three times the premium rates for younger adults.
The net effect of the 3:1 constraint may be to increase the cost of health insurance for employers, or at least affect them in ways that are difficult to predict. Older adults tend to be more costly to insure (because they may have more health problems on average) than younger adults. If the 3:1 rule has the effect of raising younger workers’ premiums, they may disproportionately leave their employers’ plans, possibly opting for Exchange coverage, leaving a larger share of older, higher cost insurance workers behind. Insurers will have to charge premiums sufficient to pay the costs to cover these older employees (and still make a profit), and premiums for non-Exchange plans may rise.38 To the extent this effect occurs, health insurance costs for federal contractors may rise well above where they were pegged in long-term contract proposals. This is another reason that SCA employers should consider seeking an actuarial analysis of their workforce to predict and calibrate these effects.
Employers facing penalties may also face additional costs to appeal such penalties. The Act requires the Secretaries of the Treasury, Homeland Security, and Social Security to establish procedures by which the government hears and makes decisions with respect to appeals of any determination. The Secretaries must also establish an appeals process for employers who are notified that they are liable for a tax determination that the employer does not provide minimum essential coverage through an employer-sponsored plan or that the employer does provide coverage but it is not affordable with respect to an employee. The procedures additionally must provide employers an opportunity to (i) present information to the Exchange for review of the determination either by the Exchange or the person making the determination, including evidence of the employer-sponsored plan and employer contributions to the plan; and (ii) have access to the data used to make the determination to the extent allowed by law.39 These processes will cost money and increase overhead for federal employers.
- What Can Contractors Do Now?
The Act imposes numerous requirements and standards on employers and imposes significant penalties.40 Starting on January 1, 2014, employers will face multiple compliance and business decisions. The coming months are thus essential to plan and prepare for these changes. Taking proactive steps in the coming months may help companies minimize costs and compliance risks going forward, including:
- Calculating company size. The Act sets forth specific calculations to determine if a company is defined as an “applicable large employer” subject to coverage under the Act. These calculations can be affected by common ownership, and also depend on how the number of employees is calculated. In addition, companies considering mergers or acquisitions in the coming months should carefully examine additional costs if the resulting transaction renders them an “applicable large employer” under the Act.
- Assessing Play or Pay Costs. Large companies facing the Act’s new requirements will retain the option to comply with Act’s requirements for employee coverage or pay a monthly penalty. Determining the most costeffective solution is a unique business decision for each employer. To make this business decision, companies near the threshold should be prepared to (1) make a regular assessment of their size status (whether they are an applicable large employer under the Act); (2) determine if any employee has enrolled in a federallysubsidized plan offered on an Exchange; and (3) assess the number of “full-time” employees, as the US$2,000 penalty cost is assessed on a per-employee basis (for in excess of 30 employees).
- Examining employer health benefits. To a void penalties, employers must ensure their offered coverage is affordable and above minimum value. This type of preventive actuarial assessment looks forward at the contractor’s costs in terms of the Act’s requirements.41 The timing of this assessment is important. It will be too late to find out in December 2013 that an employer’s plan offers “unaffordable” or “minimal” coverage. Additionally, an actuarial analysis will help to assess the most beneficial amount of coverage ‒ and whether the Act would consider the health benefits offered excess coverage and subject the upcoming “Cadillac Tax.” The employer has to know this for purposes of long term contracts.
- Conducting an actuarial review. The Act defines coverage according to “actuarial value.” Such actuarial analyses are based on different assumptions and data which measures the generosity of a plan for the employer’s specific workforce population. Different actuarial values will drive different plan structures for each employer. Because actuarial analyses are complex, employers should consider engaging actuarial experts to ensure employer plans are compliant with the Act’s requirements.
- Examining part-time employee headcount. Large employers relying on significant numbers of part-time employees may be the hardest hit by the Act, as these employers may soon have to offer coverage to many part-time employees who work (on average) over 30 hours per week, or face steep penalties. Because firms currently are not required to pay benefits to part-time employees, firms relying on part-time workers versus full-time employees will have to assess their workforce under the 30 hour work rule to assess the costs of their work force as constituted.
- Reviewing Service Contract Act Contracts. As set forth above, the Act will limit employers abilities to pay certain employees cash in lieu of benefits. As such, contractors performing SCA-covered work should immediately assess the cost impact of this upcoming change, and also examine how to ensure compliance with existing SCA obligations, and the Act’s new benefit requirements. Failure to comply with the Act may also implicate failure to comply with the SCA, with potential consequences for debarment.
- Training and/or increasing corporate HR resources. Within each company, HR personnel are generally responsible for managing employer health benefits and compliance with federal employment laws. The Act’s new requirements and upcoming changes may increase the administrative burden on HR personnel and require additionally trained HR personnel to ensure compliance. Companies should ensure current HR personnel receive the requisite training and orientation regarding the Act’s requirements and understand their critical role in corporate compliance.
- Updating internal compliance policies. As with other federal laws, the Act includes reporting obligations, and employers may be subject to federal reviews and audit to assess compliance. Contractors should update their written compliance policies to reflect changes imposed by the Act. As part of this policy update, contractors should revise record retention plans to preserve documents associated with any changes to their benefit plans and administration, including any notices issued to employees.