When I emigrated to the United States in 1975 from the UK, I was shocked to discover that my health insurance would be chosen and controlled by my employer. No other major country organizes health coverage in this way. I soon discovered why the United States is different. Employer-sponsored health insurance (ESI), which is actually part of my paycheck my employer earmarks for coverage, is treated by the IRS as tax-free compensation. If I use the same money to buy insurance myself, I pay tax on it.
This ESI “tax exclusion” reduces the after-tax cost for workers and their families. But as a way of encouraging coverage, it has long been criticized by health economists of all stripes. For instance, it is a costly strategy. The exclusion is the largest tax break in the individual tax code (about $250 billion each year in lost federal revenue). But the lion’s share of the benefits go to the highest paid employees, who are in the highest tax brackets and usually have the most generous coverage, while very little goes to lower-paid workers with low marginal tax rates. Moreover, until the Affordable Care Act (ACA) provided subsidies to some households buying plans in health exchanges, few families without ESI received any help towards the cost of coverage. In addition, the illusion that ESI is “paid for” by employers – although it actually comes out of the compensation package – causes many employees to think little about value for money. This encourages the overuse of insured care, raising the cost of ESI and thus reducing what’s left in the compensation package for cash wages. This pattern of overuse has led many employers to shift more of the cost of coverage to employees, so that they have more “skin in the game.”
What is the future of ESI? One of the most comprehensive annual surveys of employer health benefits shows that it is declining, albeit not precipitously. Although 68% of firms offered coverage in 2000, just 55% did last year. While almost all large firms (200 or more employees) still offer ESI, the fall has been pronounced among smaller firms.
Some critics of the Affordable Care Act (ACA) argued it would accelerate the trend away from ESI. Since employers who offered insurance would face a mandate to provide comprehensive benefits, and subsidies for exchange plans would make non-ESI coverage much more affordable for modest-income families, it was thought that many firms would avoid providing coverage. But the first major study of the impact of the ACA on employer coverage does not show any significant change in the underlying trend as yet because of the law. Still, it is early, and firms are increasingly concerned about the impact of the ACA’s tax on expensive ESI plans (the “Cadillac Tax”), which is scheduled to be imposed in 2018. The prospect of that tax is now causing many larger employers to re-examine their coverage.
Yet even if large companies do not follow smaller firms by declining to offer coverage, their pattern of coverage is changing. About 20% of enrollees are now in some form of high-deductible plan. These leaner plans were virtually unknown just 10 years ago. Another pattern is for more and more large employers to turn over the management of health benefits to “private exchanges” operated by insurance companies or brokers. Just this March, Starwood Hotels announced it was moving its 26,500 employees into a private exchange run by professional services company Towers Watson. A survey by the Private Exchange Collaborative (consisting of four leading business coalitions) found 47% of employers have implemented a private exchange or plan to consider one before 2018. According to some estimates, private exchanges could soon explode, with as many as 40 million employees and dependents rerolled in them by 2018, up from 3 million last year.
What we may see, then, is not the end of any role of the employer in health coverage but a profound change in the nature of that role. It could be that in the future the place of work will continue to be the location where health insurance transactions take place, with employers making payroll deductions on behalf of their employees and sending the money to a plan administered by a private or ACA exchange. But with the Cadillac Tax’s squeeze on ESI, and the availability of subsidized plans in the ACA exchanges, it seems likely that fewer and fewer employers will actually select and run plans, and be exposed to the insurance risk. I sketched out such a hands-off scenario in a proposal almost 10 years ago, in which tax reform with tax credits for non-ESI coverage would lead to a major change in the employer role. I wrote that employers play a similar purely bookkeeping role today in the collection of federal taxes. And I noted that traditional defined benefit pensions run by employers are being eclipsed by payroll deductions for 401(k) plans administered by independent brokers and mutual funds.
So within a few years, an immigrant much like me, arriving in the United States, will be able to pick the plan that suits his family and get the same tax breaks of subsidies whichever plan he chooses. His employer will handle the paperwork and send his premium payments off to his chosen plan – but not control his choices. Now that would be a big step forward.