The Decline Of Employer-Sponsored Coverage Under Health Reform: Good, Bad Or Ugly?

This post appeared in Kaiser Health News on 27 May 2010 and was cited in the 10 June 2010 edition of Health Wonk Review.

One of the latest criticisms of the new health overhaul law is that it will encourage employers to stop offering health insurance. In fact, it will.

We should welcome this, provided the decline in employer coverage is gradual and good alternatives exist. There are several advantages to the way in which the new law promotes severing the connection between employment and health insurance. One of them is that it will make more visible the biggest looming health care problem: costs.

The erosion of employer-sponsored health insurance is not new. Employers have been dropping coverage for years. According to the 2009 Kaiser/HRET Employer Health Benefits Survey, over the last decade employer offers of health insurance have declined by 10 percent. That’s been a problem because affordable coverage has not been readily available for many consumers outside of employer groups. For far too many, the only viable alternative to employer-sponsored insurance has been no insurance.

That will change in 2014 when coverage becomes available on exchanges, along with federal subsidies — depending on income – to buy it. That same year, Medicaid will expand to cover all individuals with incomes below 133 percent of the federal poverty level. As these non-employer options become available, the incentive and need for employer-sponsored insurance will decline.

A few years later, in 2018, another incentive for employer-sponsored health insurance – its preferential tax treatment – will begin to erode. A 40 percent excise tax (the “Cadillac tax”) will be levied on a gradually increasing portion of employer-based premiums. Right now, in contrast to insurance bought by individuals, premiums on employer-provided coverage are not taxed. That tax subsidy causes employer plans to be about 40 percent cheaper than they otherwise would be and encourages 26 percent more health spending than would otherwise occur. The excise tax will gradually recapture the foregone tax revenue, reduce the health care costs encouraged by the tax subsidy and drive down the incentive for employees to seek employer-sponsored coverage and for employers to offer it.

So, the deck is stacked against employer-sponsored coverage. The only things in the new health care law that encourages it are small-business subsidies for offering coverage and large-employer penalties for failing to do so. The former are scheduled to sunset after 2016 and the latter are small relative to a typical insurance premium. In the long run, they’re no match for the forces against employer-sponsored coverage.

But we need not fear the loss of employer-sponsored insurance if good, reasonably-priced options exist in the individual market. It’s essential that exchanges with fair subsidies to purchase coverage function properly.

Breaking the connection between insurance and employment solves other labor market problems too. It would reduce “job lock” (keeping a job for the insurance only) and enhance employment mobility. It would increase the insurance options available to most workers, an effect estimated in a recent National Bureau of Economic Research working paper to be valued at over $2,000 for a family of four. And, it would permit the reallocation of dollars spent by employers on health care premiums to wages, giving workers greater control over how the money is spent.

Meanwhile, as our health care system undergoes this change, health care costs will continue to rise faster than GDP, a clearly unsustainable rate. This isn’t a result of the new health care law (health care costs would soar nearly as rapidly without it), and it isn’t likely to be fully resolved by it (despite some provisions that can help).

One thing the new health care law will do is make us more aware of those costs. The same features that will contribute toward reduction in employer-sponsored coverage will also more fully reveal the cost of care.

A growing portion of largely obscure employer-based insurance tax subsidies will be replaced with explicit income-based subsidies. Higher-income individuals who switch from employer-sponsored to individually-purchased coverage will directly pay the full cost of premiums. For such individuals the hidden contribution their employers had made toward premiums as well as their own implicit payments via payroll deduction will be fully revealed. No longer will health insurance premiums be out of sight, out of mind. Cost increases will be easy to observe and harder to accept.

As the full impact of those cost increases becomes apparent, there may be a temptation to interpret them as a consequence of the erosion of employer-sponsored coverage. That would be a mistake. Some will likely confuse the distributional consequences of the new law with the absolute changes in underlying costs. That would also be incorrect. There may be calls for rollbacks of the high-premium excise tax, reductions in low-income subsidies, or higher employer penalties. Providers and the insurance industry may encourage such measures as means of putting off painful changes to their business models. That would be a shame.

The mechanisms that will contribute toward reduction of employer offers will make costs more visible and play a role in the redistribution of their burden, but they will not be responsible for cost increases. Weakening those mechanisms may temporarily push cost increases back below the radar, but it will do nothing to reduce them.

The ultimate consequence of the decline of employer-sponsored insurance depends on how we respond. Good, bad or ugly? It’s up to us.

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