by William G. (Bill) Stuart
Director of Strategy and Compliance
September 29, 2016
The so-called Cadillac Tax, the levy on high-premium medical coverage scheduled to go into effect January 1, 2018, is dead, right? Not exactly.
Late last year, Congress delayed implementation of the controversial tax for two more years until 2020. Most elected officials and the two major-party candidates for president support a permanent repeal. Its most ardent supporter will leave the presidency in less than four months. The remaining defenders of the law fall into two contradictory camps. First, some economists believe that businesses and unions will choose not to pay the tax by adjusting their benefits packages to increase members’ out-of-pocket expenses, which in turn will enhance consumerism that will in turn lead to a reduction in services that patients demand. Second, some elected officials believe that businesses and unions will retain their rich benefits, pay the increased taxes and bring an additional $90 billion in to the federal treasury during the law’s first decade
The tax as written and interpreted includes not only medical insurance premiums, but other costs of coverage as well, including:
- Contributions to HRAs (only employers can fund HRAs)
- Employee pre-tax payroll contributions to a Health FSA.
- Employer contributions to a Health FSA (which aren’t common).
- Employer contributions to an HSA.
- Employee pre-tax payroll contributions to an HSA.
Grass-roots efforts by trade associations, like this one, are trying to eliminate or modify the tax. Other efforts focus directly on legislation exempting particular items from the tax, particularly employee elections to Health FSAs and employee contributions to HSA. Their rationale: These elections/contributions reflect employees’ decisions to accept a portion of their pay in the form of tax-free funds that they can use to reimburse eligible expenses. They aren’t premiums in any sense of the word.
Because the Cadillac Tax is no longer looming, many employers are renting it space in the back of their minds as they craft their benefits strategies for 2017 through 2019.
Here’s why they’re making a mistake by not factoring in the tax as they make plans:
First, it’s not dead. Even though most Americans (particularly unions and residents of areas where medical costs – and therefore medical premiums – are higher) and most members of Congress oppose the tax, it’s still on the books. It’s been delayed four times, but not eliminated.
Second, politicians who want to kill the tax must identify areas to make up the tax shortfall that eliminating the Cadillac Tax will create. Unfortunately, the current models projecting revenue are flawed as they assume that everyone who has access to a Health FSA or HRA will fund the account to the maximum – a projection that doesn’t reflect current experience, particularly with HSAs. Finding an alternative source of revenue is sure to be a divisive issue that may breathe life back into the tax.
Third, the treatment is more extreme the longer it’s delayed. If employers spend the next two years making decisions with the assumption that the Cadillac Tax will be repealed and it isn’t, they will face a dilemma of a high tax (40% tax on all benefits above a yet-to-be-established adjusted threshold) or dramatic changes in benefit strategy. It’s much easier introducing changes over several years to smooth the impact on employees and begin the process of compounded savings.
Fourth, whether the Cadillac Tax looms or not, employers should be challenging themselves to find creative ways of managing benefits costs. And many employers are. Employers’ actual premium increases are lagging the increases that medical insurers are proposing. The reason: Employers are passing more costs to employees in the form of higher deductibles, introduction of coinsurance after the deductible is met, higher prescription drug cost-sharing and more excluded non-essential benefits.
Here are some approaches that employers can take now to prepare for the Cadillac Tax and control their total benefits spend:
- Adopt defined contribution. A majority of employers still aren’t giving employees a flat-dollar contribution to spend on whichever health plan they wish to choose. Let’s say an employer offers an HMO with a monthly premium of $500 and a PPO with a monthly premium of $700. In a defined-benefit model, the employer pays 75% of the premium. Employees who place a value of more than $50 (their 25% share of the $200 premium difference) choose the PPO, which increases the employer’s spend from $375 (75% of the $500 HMO premium) to $525. By contrast, if the employer gave each employee $400, employees would pay the entire $200 premium difference and triple their insurance costs ($100 to $300 per month), leading most to choose the lower-premium plan. Learn more about the power of defined contribution here.
- Introduce a private exchange. Private exchanges offer employees more products with a wider range of premiums than a company (or insurer) typically offers in a traditional distribution model. Most exchange operators report that employees, when faced with a flat-dollar employer contribution to premium (a key element in a successful private exchange program), buy down on medical and buy up on ancillary plans. The private exchange gives employees more options to make the buy-down less or more dramatic, depending on their preferences. Every dollar that they reallocate from medical to other coverage is a dollar that’s not included in the Cadillac Tax formula.
- Switch from an HRA to an HSA. HRAs are subject to the Cadillac Tax – and the value of the HRA for Cadillac Tax purposes is the value of the HRA, not the amount of reimbursement that an individual employee – or employees as a whole – receive. Employer and employee pre-tax payroll contributions are also factored into the total cost of coverage for purposes of calculating the Cadillac Tax. The difference between the HSA and an HRA (and a Health FSA) is that employees can benefit from the program without an impact. Employees can make post-deductible contributions to their HSAs. A sharp employer will eliminate employer HSA contributions; not allow employees to make pre-tax payroll contributions; bump employee pay to reflect the former value of the HSA contribution; and encourage employees to make personal post-tax contributions to their HSAs through the payroll system. These employees can then deduct their contributions on their personal income-tax return. They’ll receive credit for federal and (in most states) state income taxes paid. They (and the employer) won’t be able to escape FICA taxes, but the higher income reported to the Social Security Administration may have a positive impact on the size of their future Social Security payments.
- Introduce a high-performance network plan. “Narrow” network plans have gained a bad reputation because they’re usually policies offered on public exchanges that offer Medicaid-level reimbursements to providers. They typically aren’t representative of the provider community, with teaching hospitals and specialty practices refusing to participate for lower reimbursements. By contrast, high-performance network plans consist of a subset of an insurer’s total network based on objective cost and quality measures. Individuals covered on these plans have access restricted to the providers who deliver quality at the lowest cost – precisely the behavior that an employer (and an insurer) wants to encourage. When individuals are responsible for the entire premium (individual market) or the difference in full-network vs. high-performance network plans (defined contribution), they disproportionately choose the plan with a lower premium and a smaller network.
Large employers who self-insure their benefits have some other levers that they can pull in addition to the options listed above (all of which work equally well across all group sizes):
- Build a best-in-class product. Large self-insured employers can carve out certain benefits form their insurer’s standard plan and contract separately with a pharmacy-benefits manager, behavioral-health supplier, disease-management firm and other specialty companies. If activity is coordinated efficiently, sewing a quilted offering composed of best-in-class vendors may reduce costs.
- Introduce medical tourism. A growing number of companies are catching the medical tourism wave. Many providers around the world – from as close as Canada and Central America to Asia – are achieving results equal or superior to US hospitals’ quality of care at substantially lower cost. In many cases, it’s possible to send a patient and relative to someplace like Thailand for two weeks for an operation and recovery at a lower cost than having the same procedure in the United States. And sometimes patients don’t have to travel as far – certain facilities in the United States are specializing in very specific treatments and can provide superior results at lower costs when they design their facility, staff and processes around one particular treatment (example: hernia surgery or colonoscopy) rather than utilizing general staff and standard facilities to conduct a wide range of treatments.
- Adopt reference-based pricing. In a reference-based pricing plan, patients can receive care at any facility, but the insurer sets a maximum payment. In a fascinating experiment earlier this decade, CALPERS, the California retiree program, found that covered retirees were spending more than $100,000 at some facilities for knee and hip replacements. CALPERS looked at the provider market and selected 41 hospitals that delivered the service at a cost of no more than $30,000. It set that figure as the upper limit that it would reimburse, with patients responsible for 100% of the remaining provider charges. Something amazing then happened: Patients flocked to lower-cost facilities, CALPERS saved money (estimated at about 26% or $7,000 to $9,000 per procedure) and patients paid less in cost-sharing ($700 savings on average). Oh, and the expensive facilities set a maximum reimbursement of $30,000 for CALPERS patients.
Employers of all sizes can introduce some (or in the case of larger, self-insured employers) all of the solutions listed above. Not only will these blunt the impact of the Cadillac Tax, but they make good sense for employers who want to manage costs and achieve the greatest value for dollars spent.
Avoid last-minute changes
Employers who don’t act sooner rather than later will miss out on opportunities to begin to save on benefits costs – savings that compound over time. In addition, if the Cadillac Tax isn’t repealed, they’ll face the prospect of a 40% surtax on benefits above the threshold or dramatic reductions in benefits. In most cases, they’ll have to adopt the latter approach for financial reasons. The low-hanging fruit to reduce the total cost of coverage at the 11th hour aren’t attractive and include the following:
- Eliminate Health FSA at renewal, leaving middle-income families (those who use this benefit) with a tax increase of $600 to $800 annually if they elect to the maximum ($2,550 in 2016).
- Eliminate the HRA at renewal, leaving employees exposed to the entire deductible rather than a portion of it.
- Eliminate employer HSA contributions, leaving middle-class employees with $500, $1,000 or more less spendable income as they personally pay the portion of their out-of-pocket expenses that the employer contribution covered.
- Eliminate employee payroll contributions to HSAs. Employers can shift those contributions from pre-tax to post-tax to encourage employees to continue to contribute regularly, but most employers won’t understand that option and instead will leave employees to make personal contributions with any leftover personal funds. Imagine how successful that approach would be to retirement savings if employers didn’t allow payroll deductions.
- Reduce medical premiums by stripping benefits where possible (limited to Affordable Care Act requirements and state mandates) and increasing employee cost-sharing (higher deductibles, more coinsurance, higher out-of-pocket costs for prescriptions) without any employer pre-tax reimbursement assistance.
The message to employers – and their benefits advisers – is simple: Be proactive now. Take action immediately. Review all benefit offerings. Develop a five-year plan (something that almost no employers do). Adopt a general approach to gaining value for your benefits dollars and a contingency plan to tweak that approach if the Cadillac Tax is implemented. Follow this approach every year.
What we’re reading
In recent months, the mass media have begun to appreciate and report the role of HSAs in retirement. Finally, consumers are receiving independent advice about how to allocate retirement savings strategically between qualified retirement accounts and HSAs. Read more here, here and here.
While private insurers negotiate – either directly or through pharmacy benefit managers – prices for prescription drugs with pharmaceutical companies, government programs aren’t allowed to do so. Should Medicare and Medicaid, the largest purchasers of prescription drugs, be allowed to negotiate? It’s a complicated issue, since the pharmaceutical trade association was the first corporate backer of the Affordable Care Act after negotiating a deal with the Obama administration that included taxes on the industry and no negotiations. The magazine Health Affairs provides information in this article.