ACA: Employers, Non-Discrimination Rules And The ‘Cadillac Tax’

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A version of this article was originally published in the January 2014 issue of The HR Specialist. It is reprinted here with permission.

For most employers, the substantive provisions of the Patient Protection and Affordable Care Act (the PPACA) have been implemented. Almost all plans cover an employee’s child until that child reaches the age of 26, fully cover preventive services, and have eliminated pre-existing condition exclusions. Perhaps it’s finally time to sit back, relax with friends and family and begin planning for the employer mandate that will become effective January 1, 2015.

If only life was that simple.

Starting this year, in addition to plans that may be offered by an employer, all individuals will have the ability to shop for health care coverage through newly formed health care exchanges, also referred to as health insurance marketplaces. The exchanges are organizations set up to facilitate the purchase of health insurance as required by the PPACA and are designed to offer government-regulated and standardized health care plans for individuals to purchase (with certain individuals eligible for federal subsidies in connection with that purchase).

The economic viability of the exchanges depend on a critical mass of individuals receiving coverage through the exchanges. If only those individuals who were prevented previously from securing coverage for their medical issues enroll in the exchanges, the cost of coverage in 2015 and later years will need to increase, significantly. Increases will be inevitable because this group of enrollees are likely to consume more health care than their collective premiums cover. Insurance carriers can’t be required to participate in the exchanges and can’t sustain losses indefinitely. At some point, someone must cover the cost.

To that end, there are two lingering requirements of the PPACA rules that have yet to be implemented: (1) the non-discrimination rules for fully insured health care plans and (2) the “Cadillac tax” for all health care plans.

The Non-Discrimination Testing Issue

Historically, and for the moment, employers sponsoring health plans that are insured (as opposed to self-insured) have enjoyed broad discretion in fashioning the way that health care benefits are provided. Until the enactment of the PPACA, only self-insured health care plans had been subject to the onerous non-discrimination rules imposed by Section 105(h) of the Tax Code. The PPACA seeks to impose the Section 105(h) rules to insured plans as well.

The problem is that is the existing Section 105(h) regulations are unclear at best, to say the least. It’s difficult to imagine how the IRS will interpret these existing “rules” to regulate insured arrangements. Take a simplistic example: Imagine an employer that sponsors a health care plan with two choices for employees – a very expensive point-of-service option (low co-pays and no referrals for specialists) and a low-cost HMO – and subsidizes 50 percent of the monthly cost for each employee. On the one hand, if all employees are eligible for either form of coverage and receive the same subsidy percentage (e.g., each employee must pay 65 percent of the cost of the premium of the coverage he or she selected), the plan would appear non-discriminatory.

But, consider an employer with two distinct groups – a high-paid group and a low-paid group. Under this plan, it would not be unusual for the high-paid group to choose to enroll in the much more expensive option. Because the cost of that program is higher, the subsidy results in the employer paying more, in the aggregate, for coverage for each high-paid employee. Can employee choice result in the failure of the yet-to-be issued non-discrimination rules? It remains unclear.

Now, step back and compare (A) the simplistic example of only having two distinct employee populations and two health care coverage choices against (B) the more typical, complex employee demographic and multiple health care offerings. The more complex the employee and plan demographic, the harder it may be to understand, let alone satisfy, the pending non-discrimination rules.

Cadillac Tax Issue

Assuming that the PPACA isn’t modified, beginning in 2018, all employer plans (whether fully insured and self-funded) will be assessed a 40 percent excise tax on the dollar amount of the cost of coverage that exceeds annual limits of $10,200 for individual employee coverage and $27,500 for family coverage. As a practical matter, the excise tax will present employers who wish to sponsor plans with two alternatives: (a) incorporating the tax into their pricing – by increasing employer and/or employee contribution – or (b) by cutting benefits to avoid the tax – by increasing co-payments or co-insurance paid by the employees.

Starting in 2015, abandoning coverage altogether costs an employer who is subject to the PPACA rules $2,000 per year per full-time employee. Most employees can’t purchase coverage on an exchange on a tax-free (meaning deductible) basis. Thus, for any given employer, solving the problem of dropping coverage without disadvantaging the employees is, at a minimum, complex algebra.

Math is difficult enough. But, when you add to that the unknown of the non-discrimination rules and the applicability of the Cadillac tax, it is not surprising that some employers are considering abandoning the traditional employer-plan model in favor of the exchanges.