The PPACA is a complicated set of new rules and regulations but most employers just want to know, “How does it effect me?”.  One change that effects the great majority of employers, and is often overlooked with all the bigger discussions around health care reform is the change to W-2 reporting that starts with 2012 tax year reporting (the reporting done in early 2013).  Specifically, Section 6051(a)(14) of the tax code requires that employers include the aggregate cost of employer sponsored health coverage on Form W-2, Box 12, using code DD.

As per the interim guidance published by the IRS in Notice 2011-28, the amount to be reported is based on the “applicable premium” for employer sponsored group health coverage, not including policies that cover dental or vision services only.   It also does not include policies for disability income, life, workers compensation, auto or any other coverage in which medical care benefits are a secondary or incidental part of the policy.  Essentially this means only group medical and prescription drug coverage are to be part of this new reporting.  However, the amount to be reported also does not include HRA, HSA or FSA contributions by either the employer or employee.  What it does include, for employers with insured group health plans, is the premiums paid by both the employer and employee toward the group health plan sponsored by the employer.  For self funded employers the amount reported is based on COBRA applicable premiums.  For more details you can read the interim guidance here www.irs.gov/pub/irs-drop/n-11-28.pdf.

This may seem like just another demand put on HR departments or another cost to those that use payroll service companies to produce W-2s.  However the intent of this portion of the legislation is to make employees more aware of the cost of the benefits they receive.  It is not overly complicated to produce the aggregate cost for each employee and I think the information can be powerful.  One of the problems with our healthcare system is that so many people have very little idea of the cost associated with their health benefits.  This is a good step towards making everyone aware of those ever increasing costs that we all like to complain about.

As a follow up to my last article, I thought I’d discuss the decision making process a group should go through when deciding whether or not to change its health benefits from a fully insured product to a self funded plan.  As I mentioned there are many reasons self funding saves money for most groups with the biggest one being the reduction in cost associated with transferring less of the risk associated with claims variability.  In other words, if you retain more of the risk and accept the variability in claims, your expected cost will be less.  There are other reasons to support self funding including increased plan flexibility and better claims data for use in wellness programs but most employers are going to focus primarily on the financial aspects.

So how does a group go about making this decision and how do they know how much additional risk they are taking on?  The simple method employed by many brokers and consultants is to show the employer the expected and maximum cost calculated by the reinsurance carrier.  There are a few problems I have with this method.  First, the reinsurance carrier is concerned with its risk not yours.  They are adequately pricing for the individual and aggregate stop loss that you are transferring to them.  Their concern is not a reasonable picture of the risk retained by the employer.  So there is going to be a slight bias towards conservative (high) estimates in the numbers produced by a reinsurance carrier.  This method also leaves little room for examining different potential programs as a reinsurer will quote you one or a few options and leave you to choose.  None of these might be the best fit for the employer’s risk tolerance but it is hard to know that if the options aren’t presented.

The method that I have used in the past, and that I now help brokers and consultants to provide to their employer clients, is a third party analysis of funding options.  This involves a review of historical claims to determine appropriate trend assumptions, modeling of large claims at the individual level, and modeling of aggregate claims retention by the employer.  Not only does this provide an unbiased estimate of expected and maximum cost under different self funding arrangement options, it also provides additional information including the probability of hitting the maximum cost and confidence intervals of where total cost will fall.  This type of analysis also provides for comparison to what the reinsurer says the cost should be and a basis to determine if their pricing is reasonable.  The analysis gives employers information on what it means to retain more risk and shows them the tradeoff in lower expected costs for increased claims volatility.  Then an employer can decide whether fully insured or self funding makes sense because they have a true picture of what exactly the differences are.

For many employers, self funding employee health benefits is an opportunity to save substantially on the cost of those benefits.  There is a tradeoff to the expected saving in that the employer is giving up knowing exactly what the benefit costs will be.  Variability and volatility are the price one must pay to reap those expected savings.  So why is self funding cheaper on average than a fully insured plan?  As is the case with any investment or financial instrument, there is a tradeoff in risk and return.  This is as true in interest rates of debt and prices of equity as it is in the insurance industry.  So part of the reason self funding is cheaper on average is because less of the risk is being transferred, hence less of a risk charge is paid.  That is obvious perhaps, but there are some other reasons self funding is less expensive and I want to talk a little about some of these.

The first such reason is premium tax.  By paying a portion of claims directly, and not paying a carrier to pay those claims for them, employers avoid paying the premium taxes that carriers undoubtedly pass along to the consumer.  This is not an unsubstantial amount as premium taxes can be as high as 5% depending on the state you are in and the state your carrier is domiciled in.  Another large savings area is flexibility of plan design.  Increased flexibility is achieved because the employer is not dependent on an insurance carrier to offer the plan they want and because state mandated coverage is avoided through ERISA.  This increased flexibility allows employers to take on the cost of only the benefits they want to offer.

Another area where the cost of self funding can be much less than it is with fully insured plans is administrative costs.  This is partly because the administrative costs are known when purchased from a third party administrator (TPA) or on an administrative services only (ASO) contract with an insurer while they are mostly hidden in an insurer’s premium rates.  It is also partly the result of how insurers load for administrative costs.  Most, if not all, insurers load their administrative costs as a percentage of premium which doesn’t very well match up actual cost with priced charged.  Larger groups and those with richer benefits, even with sliding administrative loads, will most of the time subsidize the true administrative costs of smaller volume groups.

The last area of potential savings I’ll talk about only applies to some groups and that is capturing good experience that an insurance carrier does not give credit for.  One instance of this is when multiple years of consistent claims experience that demonstrate a group’s good experience is more credible than traditional credibility formulas would give it.  Most carriers, when experience rating, will look only at the most recent twelve months of experience and apply credibility based on just those twelve months of experience.  So a group with good experience in many past years will be getting the short end of the stick in experience rating.  Another example would be if a group’s experience warrants a reduction in rates, which will often lead to the carrier holding rates but not reducing them.  The last instance I’ll mention where a carrier won’t give credit for good experience is when they don’t know about it.  In other words, a company may know things about its usage of benefits that those outside of the company do not.  For example, decision makers may know that pregnancies are expected to drop off, or that a high cost employee is about to retire, and an insurance carrier obviously wouldn’t take that into consideration.  Often times having more information, means knowing costs will be lower than in the past and self funding presents a way to take advantage of that.

Over the last month or so I have been asking the question on LinkedIn groups and in a poll (view my profile) of what is most important to controlling the cost of healthcare in the future.  Answers included tort reform, eliminating errors and wasteful procedures, wellness initiatives, and a lot of political opinions of course.  But the one subject that came up more than any other was the idea of consumerism.  Empowering us as consumers to make good decisions about our healthcare purchases seems to be something most agree on as a staple to improving our healthcare system here in the U.S.  Better information, better aligned incentives, and a system that allows us as consumers to make the right decision is all part of the solution.  Of course, this alone won’t solve our healthcare cost crisis, all of the methods to improve our system I mentioned will be important to fixing our problems.  But a lot of it depends on big changes that will take time, effort and resources to make any impact.

One small step that can be taken towards better consumerism today is the use of consumer driven health plans (CDHPs).  It isn’t the solution to the problem, but it is a move in the right direction that any employer can make right now.  Most commonly this means the coupling of a high deductible insurance plan along with a health reimbursement account or health savings account.  Regardless of which is chosen, and they each have their benefits and negatives, the idea is to have consumer directed funds to close some of the gaps of the high deductible plan. 

In my opinion the best designed CDHPs today provide three major things to employees.  The first is the incentive to make good decisions, which properly designed CDHPs provide because the consumer is making purchasing decisions with money that is, to some degree, their own.  The second thing needed is good information to make these decisions.  This is an area where I believe we have failed as a society so far.  The information available to make informed decisions is sparse, confusing and sometimes completely wrong.  Little information is available on the cost of services at a hospital or other provider and providers themselves are rarely well equipped to help a patient make a decision that properly takes into account cost.  The final thing I feel is important to a good CDHP program is some sort of wellness program.  It could be as simple as periodic communication on healthy habits, but once you have employees involved financially in the cost of their healthcare decisions they will better see the repercussions of their lifestyle choices and be more incentivized to improve their own health.  A wellness program gives them even more incentive and opportunity to act on it.

I am a big proponent of CDHPs as I described them, because I think they are an immediate change an employer can make today that saves them and their employees money, and gets their workforce involved in the issue of rising healthcare.  As I said, it isn’t the end of the story, and as the debates go on in public forums of all types around what we need to do to fix our nation’s healthcare crisis, it seems like a small drop in a huge bucket, but why not take a baby step that can do a lot of good.  Healthcare consumerism doesn’t work as well as it can, and a big reason is the lack of information available to consumers, but the article linked to below is a great example of the fact that it can work, even before we make the drastic changes needed to the system.

It is not easy being a patient-consumer, but it can be done

Everywhere you turn these days people are talking about healthcare reform and the PPACA.  Most of the talk is about the Constitutionality challenges to the mandate on coverage or other aspects of the act.  What I haven’t seen too much discussion about is preparation for one of the most impactful changes under the PPACA; the state run exchanges coming in 2014.  Sure, some or all of the PPACA might be overturned or rewritten, but it seems inevitable that public exchanges, private exchanges or both are around the corner. 

What are companies doing to prepare for this huge change and what are brokers and consultants doing to educate and prepare their clients?  Many struggling companies and those in industries that don’t need to worry about employee retention will take this as an opportunity to drop coverage.  The only formula they care about is penalties < cost of coverage.  They see this as an opportunity to reduce total compensation to their employees and book the difference.  However, most employers are not going to take this simplistic view of the decision to “Pay or Play”.  Many companies face competition to attract and retain employees even in a down market, and who knows what the job market will look like two years from now.  Other employers realize that even in the absence of intense competition for employees, a happy and healthy employee is a more productive one.  

So what can a broker or consultant do?  The first step is to educate yourself and co-workers on what is involved in the decision to Pay or Play.  You can only then start to educate your clients on the many inputs and considerations to this decision.  Cost of coverage, out of pocket costs, employer penalties, subsidies and taxes are the major considerations.  Employers will want to consider the total impact to their cost as well as their employees and the most prudent employers will seek out the option that offers the best value and lowest cost for their company and employees in aggregate.   Complicating the issue further is the fact that the effect to employees of sending them to the exchanges will vary, sometimes greatly, employee to employee.  Fairness and effect to key employees are also considerations of the prudent employer.