Does Employer-Sponsored Health Insurance Have a Future?

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Mark Pauly discusses the ACA's impact on employer-sponsored health insurance

When the Affordable Care Act (ACA) was first introduced, some critics claimed it would erode employer-sponsored health insurance. Many companies would find it cheaper to discontinue in-house plans, knowing their workers could simply move onto public exchanges, the argument went. And to the extent the shift involved low-income workers, there was concern that the government would end up subsidizing many new entrants. It has not turned out that way – at least so far. But Mark Pauly, a Wharton professor of health care management, says the long-term picture is “murkier, and depends greatly on how creative workers and firms are in responding to the incentives of the ACA.” In this Knowledge@Wharton video interview, he looks at how many workers may eventually get shifted onto public plans.

An edited transcript of the conversation appears below.

Knowledge@Wharton: The title of your new briefing paper asks, “Is There a Future for Employer Sponsored Health Care?” It has to do with the idea that there may be incentives for employers to give up some health insurance plans because of the way that Obamacare affects some people in companies of a certain size, generally smaller companies.

Pauly: Right. Before the passage of the ACA, if you were not a poor person eligible for Medicaid, you basically could only get help from the government to get health insurance by getting insurance through your job. And although you may not think of it this way, that actually is potentially a way to provide substantial help because the fraction of your compensation that you would get as your employer’s premium payment would not be subject to taxes. Then as most of us pay an explicit premium as well, usually — it’s about a quarter of the total premium — that’s also excluded from taxation. And if you have a creative enough employer that has set up a flexible spending account, you can exclude up to $2500 of spending not covered by insurance from taxation as well.

Before the ACA, only people who got insurance through their job could get help from the government [via tax breaks] from private insurance. What the ACA did was to set up a system of subsidies related to income — of up to 400% of the poverty line income — that a person could get if they got insurance through the exchanges that were set up by the law. And the reaction to that, in part, was to say, “Well, this may be the end of the world as far as employment-based insurance would go,” especially if you’re willing to believe, despite evidence to the contrary, that these exchanges will be terribly efficiently run and offer wonderful choices.

Don’t get me wrong. There are some good exchanges, but they’re more the exception than the rule….

“… It would seem like a money losing proposition all around for a large firm to contemplate dropping health benefits.”

And then some employers said — or even some consultants told them — “Look, you’re now paying, let’s say, an average of about $4,000 per worker for insurance. There’s a penalty if you’re a large employer for not making that payment but the penalty is only $2,000. [Since] $2,000 is less than $4,000, why not drop insurance coverage and tell your employees to go to exchanges?”

Knowledge@Wharton: Explain the $2,000 penalty.

Pauly: There’s an explicit penalty in the law for employers — it’s called the employer mandate, which says that if you’re an employer of a certain size, you have to provide insurance to your workers and contribute a certain fraction of their premium. But if you don’t — it’s complicated like everything in the law — roughly speaking, you would be subject to a penalty of $2,000 per worker. But the calculation was, “Well, $2,000 is less than what I’m paying now. Would I come out ahead by dropping insurance coverage?” A point that I make in this article is, “Well, it’s not quite so easy.”

There are some employers and their workers who would come out ahead. I guess the key issue here is not what’s in the interest of the employer, but what’s in the interest of workers? Twitter  Can workers, on balance, be better off by, in effect, taking the money that employers were spending on them for insurance and going to the exchanges?

The answer would be, if you were a worker in a small firm with mostly low-wage workers, there would be an advantage: You weren’t getting much of a tax break before, because your taxable income is not that high. But now with the same amount of money [if the employer paid workers in extra wages instead of paying for health premiums], you could go to an exchange and [for example] if your income was 200% of the poverty line (about $24,000 per person), you could get a 50% subsidy. So, that’s a much bigger break than you were getting before.

The news is there would be some workers in some firms where there would be an advantage. And if this were a small firm — under 50 workers — there would be no penalty for the employer. The only reason why that doesn’t necessarily signal a revolution is that the fraction of workers who work in small, homogenous, low-wage firms who currently get health insurance is actually quite tiny — less than 5% of the overall workforce. So, although those people would gain a lot, there aren’t a lot of them. And at the other extreme, if you are working in a large firm — and you’re an upper-middle-income worker and most people in that firm are — if that employer cancelled their insurance, then you as workers could go to the exchange, but you would have to pay the full premium without a subsidy and you wouldn’t get the tax break anymore.

Knowledge@Wharton: From the employer’s point of view — let’s say I’m a large employer — and I think you said the average premium is $4,000 — even for a large firm, is that after the tax breaks that I get from providing it?

Pauly: No. That’s before.

Knowledge@Wharton: So, it’s actually not costing me $4,000, it’s costing something less because of tax advantages?

Pauly: Yes. So, it depends of course which marginal tax bracket you’re in. But if you were in a 30% tax bracket, it’s costing you $1,200 less than $4,000.

Knowledge@Wharton: So, then the employee would not want their employer to drop insurance coverage and send employees to the exchanges because it would be like a pay cut?

Pauly: Effectively, it is like a pay cut. Let’s take the simple case, where the employer drops insurance but gives you back the money, the $4,000 they were spending. Well, you’re now going to have to pay $1,200 more in taxes because you’ve got $4,000 more in taxable income. You go to the exchange, you say, “Where’s my subsidy?” They say, “Sorry, you earn too much to be eligible for a subsidy. You get zero subsidy.” You’re out $1,200. And at least in my simple example, the employer was neutral because they just transferred the money from paying for benefits to cash compensation.

Knowledge@Wharton: But it doesn’t take into account the idea that an employer could in theory say, “I’m not providing insurance,” which would be like a pay cut, and “Oh, and I’m not giving you the $4,000.”

Pauly: Well, they could of course say, “And I’m not giving you the money, either.” But then that would be like a pay cut, and you’d [think], “You’re kind of a sorry excuse for a capitalist, because you must have been overpaying me in the first place if I continue to work for you after this big pay cut.”

“And that’s the main economic message here — that employers don’t give you health insurance, they just either pay you in the form of cash or in the form of benefits.”

Knowledge@Wharton: Because now you’re less competitive, workers want to work someplace else.

Pauly: Right. So, we usually assume — and it is probably easier to assume in the current labor market than in the labor market that prevailed in 2010 when the ACA passed – [that] labor markets are pretty competitive. Workers are not being overpaid, but if their compensation takes a big hit, the employer that does that is actually going to lose rather than win because the workers will no longer want to work there.

Knowledge@Wharton: So, whether your pay is cut or your health care benefits are cut, it feels the same to the worker?

Pauly: It feels the same. And that’s the main economic message here — that employers don’t give you health insurance, they just either pay you in the form of cash or in the form of benefits. And one advantage of getting paid in the form of benefits is that you get a tax break. Whereas if you get paid in cash, you would pay tax on it.

Knowledge@Wharton: As does the employer.

Pauly: As does the employer for the Social Security part.

Knowledge@Wharton: The big split seems to be between bigger companies and smaller companies. I think you’re saying that the percentage of smaller companies doesn’t add up to a very big percentage overall.

Pauly: That’s right, or at least if you look at the fraction of people who are getting private health insurance through their job, which was more than 90% of all people getting private health insurance, the great bulk of those people are not working in small, homogenous, low-wage firms. They’re working in large firms that either have high average wages, which was the story I was telling a few minutes ago, or there are some low-wage workers, but the great bulk of the workers are not low-wage. So, if the firm cancels the whole deal, it’s going to do more harm to the larger number of high-wage workers than it’s going to benefit the small number of low-wage workers.

And then if you add on top … there’s this $2,000 penalty, it would seem like a money losing proposition all around for a large firm to contemplate dropping health benefits.

Knowledge@Wharton: There’s another intriguing line in your brief, which says that there could be some incentive for some large companies to create a separate company for lower-wage workers in order to eliminate some health care insurance.

Pauly: My view is that in the short run — let’s say over the next five years — I don’t see a massive reduction in the provision of health insurance by employers just for the reasons I mentioned. That the great bulk of workers now getting health insurance through their jobs are in these large heterogeneous firms where there isn’t going to be a net gain from dropping coverage…. There are some low-wage workers, but a lot of high wage workers.

“If it’s possible to separate out the low-wage workers into a separate entity with separate management and still have production take place efficiently, that would be an industry where … [employers might create a separate company to cut health insurance costs].”

But with enough time and with enough ingenuity on the part of Americans, which we definitely have an adequate amount of, a large firm could see — although it might not be politically correct — a way to make it possible for their low-wage workers to get this juicy tax subsidy that they could get in an exchange.

What they would have to do, at least in the most straight-forward way, would be to reconfigure how the firm is organized — spin off the tasks performed by low-wage workers into a [preferably small] firm hiring only low-wage people. And then there wouldn’t be a penalty. And those workers could potentially claim a fairly hefty tax break. My assumption is that it would take a while for that change to happen, but I guess it could eventually happen, because in some ways saying, “Well, if you’re a low-wage worker who worked for a small firm or if you were a self-employed low-wage person, right now you’re eligible for this quite generous subsidy. But if you’re the janitor at Microsoft, you’re not eligible for this subsidy — that’s sort of intrinsically unstable in addition to being unfair.

Knowledge@Wharton: Are there any industries where the separation between the two groups might be more natural?

Pauly: If it’s possible to separate out the low-wage workers into a separate entity with separate management and still have production take place efficiently, that would be an industry where that would happen. Now, thinking of the industry I work in, which is the higher education industry, we have [people who earn less] … and they’re literally our partners. It would be hard for me to think of handing over my calendar planning or preparation of materials for my classes to somebody who works for a separate company other than the University of Pennsylvania….

Knowledge@Wharton: What about an assembly line operation, where you’ve got thousands of workers and then a smaller management?

Pauly: It comes back to [the question], can you carve out the tasks? In a manufacturing firm, a lot of the low-wage workers are — because of their seniority — just workers who haven’t been there as long. And it would be hard to say, “We’ll have a separate firm for the starting workers and then for the permanent workers.” But … I think there’s a reason why firms are heterogeneous, why they employ high-wage and low-wage workers: because it’s more efficient to manage them collectively rather than managing them separately.

But if there’s enough of a carrot dangled in front of people to switch the method of organization, somebody’s always on the margin, somebody might do it. I guess I’m programmed to say, “But that doesn’t sound like a good idea for society, because you are in effect subsidizing an inefficient way of organizing production if it really was more efficient to have workers high- and low-wage as part of the same firm.”

Knowledge@Wharton: What haven’t we covered in our discussion that would be important to know?

Pauly: There is a way to make it advantageous for low-wage workers to be spun out or to be separated. And that is — and there’s a considerable debate about this — the law penalizes firms when they don’t provide health insurance to full-time workers but not when they don’t provide health insurance to part-time workers…. One of the adverse incentives present in the law is to say to an employer, “Look, if you can split your work into twice as many part-time workers instead of full-time workers, and if they are also low-wage … there’s no penalty for sending them off to the exchange.”

Now, I’m back again on my sermonette about how that doesn’t sound like a good way to organize production because usually it doesn’t make as much sense to have a lot of part-time workers as a smaller number of full-time workers if you’re producing things in an ordinary kind of production setting. Although of course we know for some things like fast food and things like that, it may not be so inefficient.

Some companies are saying, and they’re probably right, that this incentive will cause us to emphasize part-time work more than full-time work. There’s no intrinsic merit to full-time or part-time work, but having the reason why you choose to employ people as part-timers is because of this subsidy is not a good reason from the point of view of overall efficiency.

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