How US health care reform will affect employee benefits

By Shubham Singhal, Jeris Stueland, and Drew Ungerman
McKinsey Quarterly, June 2011

US health care reform sets in motion the largest change in employer-provided health benefits in the post–World War II era. While the pace and timing are difficult to predict, McKinsey research points to a radical restructuring of employer-sponsored health benefits following the 2010 passage of the Affordable Care Act.

Many of the law’s relevant provisions take effect in 2014. Our research suggests that when employers become more aware of the new economic and social incentives embedded in the law and of the option to restructure benefits beyond dropping or keeping them, many will make dramatic changes. The Congressional Budget Office has estimated that only about 7 percent of employees currently covered by employer-sponsored insurance (ESI) will have to switch to subsidized-exchange policies in 2014. However, our early-2011 survey of more than 1,300 employers across industries, geographies, and employer sizes, as well as other proprietary research, found that reform will provoke a much greater response.

Overall, 30 percent of employers will definitely or probably stop offering ESI in the years after 2014.

Among employers with a high awareness of reform, this proportion increases to more than 50 percent, and upward of 60 percent will pursue some alternative to traditional ESI.

A transformed employer market

Health care reform fundamentally alters the social contract inherent in employer-sponsored medical benefits and how employees value health insurance as a form of compensation. The new law guarantees the right to health insurance regardless of an individual’s medical status. In doing so, it minimizes the moral obligation employers may feel to cover the sickest employees, who would otherwise be denied coverage in today’s individual health insurance market. Reform preserves the corporate tax advantages associated with offering health benefits—except for high-premium “Cadillac” insurance plans.

Starting in 2014, people who are not offered affordable health insurance coverage by their employers will receive income-indexed premium and out-of-pocket cost-sharing subsidies. The highest subsidies will be offered to the lowest-income workers. That reduces the social-equity advantage of employer-sponsored insurance, by enabling these workers to obtain coverage they could not afford on today’s individual market. It also significantly increases the availability of substitutes for employer coverage. As a result, whether to offer ESI after 2014 becomes mostly a business decision.

What the law says

Reform requires all employers with more than 50 employees to offer health benefits to every full-timer or to pay a penalty of $2,000 per worker (less the first 30). The benefits must provide a reasonable level of health coverage, and (except for grandfathered plans) employers will no longer be able to offer better benefits to their highly compensated executives than to their hourly employees. These requirements will increase medical costs for many companies. It’s important to note that the penalty for not offering coverage is set significantly below these costs.

The subsidies will cap the amount lower- and middle-income individuals and families will have to spend on health coverage, to 9.5 percent of household income for those at 400 percent of the federal poverty level and less for those at lower income levels. The subsidies will keep the cost of insurance coverage from the exchanges below what many employees now pay toward employer-sponsored coverage, especially for those whose earnings are less than 200 percent of the federal poverty level.

A bigger effect than expected

As we have seen, a Congressional Budget Office report estimated that only 9 million to 10 million people, or about 7 percent of employees, currently covered by ESI would have to switch to subsidized exchange policies in 2014. Most surveys of employers likewise show relatively low interest in shifting employees from traditional ESI.

Our survey found, however, that 45 to 50 percent of employers say they will definitely or probably pursue alternatives to ESI in the years after 2014. Those alternatives include dropping coverage, offering it through a defined-contribution model, or in effect offering it only to certain employees. More than 30 percent of employers overall, and 28 percent of large ones, say they will definitely or probably drop coverage after 2014.

Our survey shows significantly more interest in alternatives to ESI than other sources do, for several reasons. Interest in these alternatives rises with increasing awareness of reform, and our survey educated respondents about its implications for their companies and employees before they were asked about post-2014 strategies. The propensity of employers to make big changes to ESI increases with awareness largely because shifting away will be economically rational not only for many of them but also for their lower-income employees, given the law’s incentives.


Getting Insurance at Work

Posted by Nancy-Ann DeParle
The White House Blog, June 8, 2011

You might have seen reports about a study from McKinsey and Company claiming that a significant number of employers will stop offering insurance to their workers in 2014. Unfortunately, the study misses some key points and doesn’t provide the complete picture about how the Affordable Care Act will strengthen the health care system and make it easier for employers to offer high quality coverage to their employees.

The McKinsey Study is an Outlier

The Rand Corporation: “The percentage of employees offered insurance will not change substantially, but a small number of employees in small firms (defined as those with under 100 employees in 2016) will obtain employer-sponsored insurance through the state insurance exchanges.”

The Urban Institute: “Some have argued that the Patient Protection and Affordable Care Act would erode employer-sponsored insurance (ESI) by providing incentives for employers to stop offering coverage. Others have claimed that most businesses would face increased costs as a result of reform. A new study finds that overall ESI coverage under the ACA would not differ significantly from what coverage would be without reform.”

Mercer: “In a survey released today by consulting firm Mercer, employers were asked how likely they are to get out of the business of providing health care once state-run insurance exchanges become operational in 2014 and make it easier for individuals to buy coverage. For the great majority, the answer was ‘not likely.'”

The Bottom Line

A central goal of the Affordable Care Act is to reduce the cost of providing health insurance and make it easier for employers to offer coverage to their workers. We have implemented the law at every step of the way to minimize disruption and maximize affordability for businesses, workers, and families.  And we agree with experts who project that employers will continue to offer high quality benefits to their workers under the new law.  This one discordant study should be taken with a grain of salt.

(Nancy-Ann DeParle is the Assistant to the President and Deputy Chief of Staff.)

Republicans contend that this new McKinsey study shows that the provisions of the Affordable Care Act (ACA) will cause a massive transfer of employee health coverage from employer-subsidized plans to new government-subsidized plans that will be made available through the state insurance exchanges. Democrats contend that the ACA program design will prevent this shift. This either/or debate misses the point. The massive shift to government-subsidized private plans will occur under ACA. The uncertainty is only in how fast that will be.

This discussion is important because one of the main strategies was to establish policies that would ensure the perpetuation of the employer role in funding health care, thereby avoiding the necessity of infusing yet more taxpayer funds into health care. Ultimately, a taxpayer-financed system would be more equitable and efficient, but, until we have that, the employer funds are an important transitional resource to help fund our health care.

As the financing responsibility shifts more to the government, there is also a responsibility for the government to demand greater value in its health care purchasing. That will be difficult under ACA since a government-managed exchange of private health plans does not provide effective means of eliminating the administrative and clinical waste that typifies our dysfunctional U.S. system of financing health care.

The rate of employer-sponsored coverage continues to decline. The quality of employer-sponsored health plans continues to deteriorate as more and more costs are shifted to employees, making the plans less desirable. The opportunity offered to employers by the safety-valve of the state insurance exchanges will cause an acceleration in the decline of employer-sponsored coverage as employers realize that shifting to a government-financed program simply represents a wise business decision for them.

Once the government is stuck with the bill for these private exchange plans, maybe the light will finally go on. Why are we paying so much for these inadequate and wasteful plans when we could have a more efficient and effective program with better benefits – a single payer national health program? Fortunately, the emergence of this epiphany will not be a matter of whether, but how soon.