The Effects of the Affordable Care Act on Small Business

Studies | Health

No. 356
Thursday, June 12, 2014
by Devon M. Herrick

Whereas large corporations typically self-insure - paying their employees' medical bills and hiring insurers to administer health benefits - small businesses purchase group health coverage from insurers and face cost-increasing regulations as they go through the annual ritual of renewing their coverage. Over the next few years, as regulations and mandates are finally implemented, Obamacare will affect how businesses operate - including hiring, employee compensation, growth and so forth.

The Mandate on Employers. Though media attention has focused on the federal and state health exchanges, much of the burden of complying with the Affordable Care Act will fall on business. Nearly two-thirds of Americans with health coverage have employer-sponsored health insurance - approximately 171 million people.

Health benefits are a significant expense for U.S. employers and a substantial portion of workers' total compensation. The Congressional Budget Office (CBO) estimates that the required coverage for an individual will cost $5,800 a year or more in 2016 - the equivalent of an additional $3 an hour "minimum health wage." Family coverage could cost more than twice that amount. For instance:

The cost of employee health benefits averages $2.70 per hour, according to the Bureau of Labor Statistics, representing 8.5 percent of private industry workers' total compensation.

The Kaiser Family Foundation's annual survey of employer health benefits found the average cost of an employee family plan was $16,351 in 2013.

The ACA includes an employer mandate designed to force firms to provide full-time employees with comprehensive health insurance. The mandate took effect January 1, 2014, for employers with more than 99 full-time employees. Firms employing from 50 to 99 full-time workers have until 2016 to comply. Businesses with fewer than 50 employees will not be penalized. Employers are also required to limit the amount of premiums some employees pay as a percentage of their wage income. For example, health plans are considered "unaffordable" if workers earning less than 400 percent of the federal poverty level (about $46,680 for an individual) must pay a premium that is more than 9.5 percent of their income.

Health Insurance Mandate on Firms with 50 or More Employees. Employers with fewer than 50 full-time workers are exempt from penalties. The fiftieth worker, however, could be a very expensive hire. Firms that employ 50 or more workers and don't provide health insurance will be subject to a tax penalty of $2,000 for each uninsured employee beyond the first 30.

Furthermore, firms with 50 or more workers will be required to contribute at least 60 percent of the cost for individual minimum essential coverage.

"Grandfathered" Health Insurance Plans. Many small firms were able avoid the costly mandated benefits and new regulations by renewing less-expensive (non-conforming) coverage prior to January 2014. When these plans expire in 2014, firms will be forced to purchase more highly regulated plans.

In theory, firms could retain their current health plan by claiming "grandfathered" status, insulating employers from cost-increasing regulatory burdens. However, only a few small businesses will have grandfathered plans. The status is lost if a firm makes any substantial plan change, such as switching to a new insurance carrier. According to official documents, two-thirds to as many as 80 percent of employer plans will likely lose their grandfathered status.

Effect of Obamacare on Premiums. The conse-quences for employers (and individual workers) who must purchase coverage are already becoming apparent. A 2014 survey of 148 insurance brokers by the investment firm Morgan Stanley found that rates in the small group market have risen substantially. For instance:

Premiums for firms renewing in 2014 jumped 11 percent in the small group market.

For firms with coverage through BlueCross, the year-over-year renewing contract premium hike is nearly 16 percent.

For individuals, the increase was similar - about 12 percent.

However, premium increases were much higher in some states than others. The survey found that since December 2012, rates for small employers grew 588 percent in Washington state, though this astounding increase is likely due to the small sample size and additional state regulations. Premiums rose 66 percent in Pennsylvania, 37 percent in California, 34 percent in Indiana, 30 percent in Kentucky and 29 percent in Colorado.

Employers Are Responding. Some employers are reducing their costs by passing on more of the cost to workers. Some employers are raising copayments for workers; others are boosting costs for dependent coverage, according to Mercer, a benefit consulting firm.

The Affordable Care Act is also affecting personnel decisions. A survey of more than 600 small business owners by the Society for Human Resource Management found that more than four-in-10 small business owners have delayed hiring due to uncertainty about the effects of the ACA. One in five reported they have cut the number of workers they employ. Employers are not required to offer coverage for employees who work less than 30 hours per week. Those employees are eligible for subsidized coverage in the health insurance exchange. Mercer reports that 12 percent of employers nationwide plan to reduce workers' hours as a result of Obamacare.

Introduction

Four years after President Barack Obama signed the Affordable Care Act (ACA) into law, there is still uncertainty regarding its effects, due to delays and exemptions granted by the Obama administration and challenges still pending in the courts. So far, however, there is plenty of evidence that the ACA, or Obamacare, is raising the cost of health insurance to employers and individuals.

The effects on business vary - by state, firm size and the composition of firms' workforces - but the impact on small businesses is especially acute. Whereas large corporations typically self-insure - paying their employees' medical bills and hiring insurers to administer health benefits - small businesses purchase group health coverage from insurers and face cost-increasing regulations as they go through the annual ritual of renewing their coverage. Over the next few years, as regulations and mandates are finally implemented, Obamacare will affect how businesses operate - including hiring, employee compensation, growth and so forth.

The Role of Employer-Sponsored Health Plans

Though media attention has focused on the federal and state health exchanges, employers are responsible for much of the growth in the number of insured. And much of the burden of complying with the Affordable Care Act will fall on business. From September 2013 to mid-March 2014, according to RAND Corporation estimates, a net 9.3 million Americans gained health coverage.1

The majority of the gains during this period came from employer-sponsored coverage: 8.2 million people enrolled in employer plans rather than purchasing individual coverage in an exchange.2 These new enrollees include individuals who previously declined employers' offers of insurance but are responding to the individual mandate to obtain coverage or face a tax penalty. Only 1.4 million were newly insured by exchange plans. (Though 3.9 million people enrolled in exchange plans, most were previously insured.)

Why Do Employers Provide Health Benefits? The practice of getting health coverage through the workplace began with a series of laws that originated during World War II.3 In a tight labor market with wage and price controls, the War Labor Board ruled wage controls did not apply to fringe benefits. Thus, employers could provide health coverage in lieu of higher cash wages.4 A few years later, in 1954, Congress and the Internal Revenue Service agreed that the value of health coverage provided by an employer could be excluded from taxable income.5 Today, as a result of this policy, most Americans get health insurance through work:

Nearly two-thirds of Americans with health coverage have employer-sponsored health insurance - approximately 171 million people.6

Slightly less than three-fourths (71 percent) of firms that employ 10 to 24 workers offered coverage in 2011.

In contrast, only 48 percent of firms employing three to nine workers offered coverage in 2011.7

The proportion of small employers offering health coverage has been declining for years. Under the Affordable Care Act, many firms will find it in their self-interest to abandon their company health plans.

Employer Costs for Health Insurance. Health benefits are a significant expense for U.S. employers and a substantial portion of workers' total compensation:

The cost of employee health benefits averages $2.70 per hour, according to the Bureau of Labor Statistics, representing 8.5 percent of private industry workers' total compensation.8

The Kaiser Family Foundation's annual survey of employer health benefits found the average cost of an employee family plan was $16,351 in 2013.9

Health benefits substitute nearly dollar-for-dollar for cash wages.

The Value of Employer-Provided Insurance Varies by Employees' Incomes. The cash value of excluding employee health coverage from taxable income is substantial. This is the major reason why most Americans have health coverage tied to their employment. For example:

To a middle-income couple with a marginal federal income tax rate of 25 percent, payroll taxes add another 15.3 percent and state and local taxes could add another 5 percent to their tax burden.

Thus, at an effective tax rate of 40 percent to 45 percent, the tax exclusion is worth nearly half the cost of coverage. For instance, a family in an employer health plan costing $16,351 would only experience a reduction in take home pay of $8,993 [$16,351 x (1-0.45)] - a tax savings of $7,358.

Furthermore, because the value of the tax subsidy increases with income, high-income families receive a greater benefit than low-income families. For instance, a family with an income of $150,000 or more receives about $4,436 in tax relief, compared to only about $147 for families earning less than $10,000 annually. [See Figure I.]

Lower income workers are less willing to use scarce wages for health benefits. Thus, small employers that predominantly hire low-income workers are far less likely to offer health benefits than firms with higher average wages. As the cost of health coverage rises, firms like these are the most likely to drop employee health plans altogether.

Employer Mandate and Subsidies

The ACA includes an employer mandate designed to force firms to provide full-time employees with comprehensive health insurance. The mandate took effect January 1, 2014, for employers with more than 99 full- time employees.The mandate does not penalize businesses with fewer than 50 employees for failing to offer coverage. The Obama administration announced it will not enforce the mandate on mid-sized employers - those employing from 50 to 99 full-time workers - before 2016.10

Cost of Employer Coverage. The Congressional Budget Office (CBO) estimates that the required coverage for an individual will cost $5,800 a year or more in 2016 - the equivalent of an additional $3 an hour "minimum health wage." Family coverage could cost more than twice that amount. Employers will be fined if they drop their health insurance plans altogether or if their health plans are deemed "unaffordable" to any of their employees. If the fines do not encourage employers to offer health insurance, the federal government is likely to respond by increasing them.11

New Small Business Subsidy for Firms with Fewer than 26 Employees. The ACA includes a temporary health insurance tax credit for small employers with moderately-paid workers. The credit is only available for six years, and the only firms that qualify are those with 25 or fewer employees and whose average wage is less than $50,000.

Most businesses will not meet the strict (and complex) criteria for claiming the credit. In fact, fewer than one-third of small businesses qualify, according to the National Federation of Independent Business.12 The credit is not available to sole proprietors and their families.

Health Insurance Mandate on Firms with 50 or More Employees. The ACA requires employers to offer health coverage to workers or face a fine. Employers with fewer than 50 full-time workers are exempt from penalties. The fiftieth worker, however, could be a very expensive hire. Firms that employ 50 or more workers and don't provide health insurance will be subject to a tax penalty of $2,000 for each uninsured employee beyond the first 30. Thus, growing from 49 to 50 uninsured workers would subject employers to a fine of $40,000 [(50 - 30) x $2,000] for adding the last worker. The fine, however, is much smaller than the cost of providing 50 employees with insurance.

Employers have three ways to reduce the burden of the employer mandate: 1) limit the workforce to fewer than 50 workers; 2) limit the hours worked per week by some employees to fewer than 30 hours; or 3) fail to offer coverage and, thus, pay a $2,000 per (full-time) worker fine. These perverse economic incentives will cause many firms to avoid growing beyond 49 employees.

Employer Contribution for "Essential Benefits." Firms with 50 or more workers will be required to contribute at least 60 percent of the cost for individual minimum essential coverage.13 Federal law now requires health plans to cover a package of "10 essential benefits," including ambulatory patient services; emergency services; hospitalization; maternity and newborn care; mental health and substance use disorder services, including behavioral health treatment; prescription drugs; rehabilitative and habilitative services and devices; laboratory services; preventive and wellness services and chronic disease management; and pediatric services, including oral and vision care.

These new plans are likely to be more generous and more costly than what many firms previously offered. For instance, essential health benefits include preventive services, on the assumption that prevention and early detection of disease will decrease the cost of care. But research has found this assumption is wrong: Preventive medical services are sometimes beneficial but increase total costs about 80 percent of the time, according to Louise Russell of Rutgers University.14

Access to Exchanges for Firms with Fewer Than 100 Employees. The Affordable Care Act contains financial incentives for states to establish health insurance exchanges where qualifying individuals and small businesses can purchase subsidized, individual health insurance. Employers with fewer than 100 employees will be able to purchase coverage in a health insurance exchange rather than buy insurance in the small group market. This so-called SHOP exchange (Small Business Health Options Program) is behind schedule in the 33 states that will not be running their own health exchange. The federal government announced that the rollout of the SHOP exchanges will be delayed until 2015.15 In the SHOP exchanges, however, workers will not be eligible for the subsidies individuals receive when they buy their own insurance. Also, just as insurers selling in the exchange will not be allowed to charge premiums based on health status, neither will small group health insurance policies sold outside the exchange. Thus, there does not appear to be a financial advantage to using the exchange.

"Grandfathered" Health Insurance Plans. Many small firms were able avoid the costly mandated benefits and new regulations by renewing less-expensive (non-conforming) coverage prior to January 2014.16 When these plans expire in 2014, firms will be forced to purchase more expensive plans.17

In theory, firms could retain their current health plan by claiming "grandfathered" status, insulating employers from cost-increasing regulatory burdens. However, only a few small businesses will have grandfathered plans. The status is lost if a firm makes any substantial plan change, such as switching to a new insurance carrier - even though changing insur­ers is the main way small firms keep premiums down. For instance, according to official documents:

Under a "mid-range" estimate, two-thirds of small business employees will lose their grandfathered status this year and will no longer be able to keep the plan they now have.18

Under the worst case scenario, as many as 80 percent will lose their grandfathered status.19

By contrast, a self-insured, large company plan or union plan is free to change its third-party administrator as often as it likes and still keep its grandfathered status.20

With the exception of firms that employ mainly high-income people, many companies - especially those employing fewer than 50 workers and those primarily employing moderate-income workers - will find it less costly to drop health insurance and pay the fine.

Limits on Employee Premiums. Employers are required to limit the amount of premiums some employees pay to a percentage of their wage income. For example, health plans are considered "unaffordable" if workers earning less than 400 percent of the federal poverty level (about $46,680 for an individual) must pay a premium that is more than 9.5 percent of their income. The premium for an employee with an income of $32,000, for example, would be deemed unaffordable if the premium was higher than $3,400. For firms with more than 49 workers, employing a worker whose premiums are unaffordable may result in a $3,000 fine. However, employers do not have to subsidize the premiums of workers with incomes 400 percent or more of the poverty level.21

The affordability threshold is an employee's wage income compared to the cost of single-only employee coverage. However, an employee health plan is not deemed unaffordable if the employee's share of family coverage exceeds 9.5 percent of family income.22

Restrictions on Defined Contribution Health Plans. The federal government has essentially prohibited so-called defined contribution health plans for individual coverage.23 Defined contribution is an arrangement where employers provide a fixed sum of money toward employee benefits, which workers then use to pay for individual coverage.

The Affordable Care Act bans health plans that limit annual or lifetime coverage of a package of essential health benefits. The ACA also limits employee cost-sharing, which makes it more difficult for employee health plans to feature high-deductible insurance compatible with a Health Savings Account (HSA). For instance, small employers cannot require a deductible that exceeds $2,000 unless it is accompanied by an HSA account that reduces the deductible to $2,000. For instance, an employer could offer a plan with a $3,000 deductible but provide an HSA with $1,000 in it.

Elimination of Limited Benefit Plans. The Affordable Care Act removes much of the discretion employers once had to tailor health benefits to workers' unique health needs. Prior to the ACA, workers had the option of choosing health plans that featured limited benefits in return for lower premiums. The ACA has banned this type of plan. Under current law, health plans cannot cap benefits.

In other words, when an employer provides health coverage, the potential liability is unlimited. By its very nature, insurance is underwriting an individual's health risk in return for a premium payment. The greater the risk, the more an insurer has to charge in premiums. By requiring health insurers to take on unlimited risk, the Affordable Care Act renders health coverage far less affordable.

In addition, the Affordable Care Act doesn't allow insurers to vary premiums by such factors as health status of the employer group, size of employer group or industry. Thus, firms that employ predominantly young workers will likely see their costs go up.24 All told, the ACA will increase premiums for about two-thirds of employers with fully-insured employee health plans.25

Effect of the Affordable Care Act on Health Insurance Premiums, by State

A 2009 analysis of claims data by Oliver Wyman, a national consulting firm, estimated that the new Affordable Care Act regulations would boost small group premiums by about 20 percent.26 More recently, a 2014 survey of 148 insurance brokers by the investment firm Morgan Stanley found that rates in the small group market have risen substantially as a result of new regulations.27

Premiums for firms renewing in 2014 jumped 11 percent in the small group market.

For firms with coverage through BlueCross, the year-over-year renewing contract premium hike is nearly 16 percent.

For individuals, the increase was similar - about 12 percent.

However, premium increases were much higher in some states compared with others. The survey found that, since December 2012, rates for small employers grew an astounding 588 percent in Washington state, though some of the increase is likely due to the small sample size and additional state-level regulations. For instance, Washington state officials were opposed to overly-restrictive narrow networks. Also, more than half of enrollees were ages 45 to 64.28 Premiums also increased 66 percent in Pennsylvania, 37 percent in California, 34 percent in Indiana, 30 percent in Kentucky and 29 percent in Colorado.29 [See Figure III.]

A number of states experienced above-average hikes in premiums when individual policies were renewed in the first quarter of 2014.30 [See Figure IV.] For instance:

Premiums for renewing policies doubled in Delaware.

Californians' premiums rose 53 percent.

Georgia and Kentucky both saw premiums rise 29 percent.

Employment Effects of the Affordable Care Act. The Affordable Care Act will have profound effects on labor markets. Not only will many firms find it advantageous to drop their health plans, many workers who stayed in their current positions in order to qualify for health coverage (so-called "job lock") may quit their jobs because subsidized coverage is available through a health exchange. Families earning 133 percent of the federal poverty level without access to an employer-provided plan will pay no more than 3 percent of their income in premiums for policies in the exchange. Families earning up to 400 percent of the poverty level will pay no more than 9.5 percent. In all, more than 2 million people are expected to leave the labor market because they can get subsidized coverage.32

Subsidies for Exchange Plans Vary by State and Age of the Insured. Because health care costs vary widely among regions, exchange policies in states with higher health care costs will be more heavily subsidized. Furthermore, older workers will receive larger subsidies than younger workers. Consider [see Figure V]:

In the exchange, a family headed by a 25-year-old worker earning $31,168 (133 percent of the federal poverty level in 2013) and living in a low-cost region would receive a health insurance subsidy worth $6,376.

A family headed by a 40-year-old earning $31,168 and living in a high-cost region would receive a federal subsidy of $13,620, meaning he would be charged only $936 (about 3 percent of his income) for a health plan with a $14,500 annual premium.

A family headed by a 55-year-old worker living in a high-cost region and earning $93,700 (400 percent of the poverty level in 2013) would get an exchange subsidy worth $14,799 and pay just $8,901 toward the premium annually.

By contrast, a worker with employer-based insurance earning $31,168 would receive benefits equivalent to a tax subsidy of about $2,800, or $7,231 less than the same family in the exchange.

Employer Responses to the Affordable Care Act

A 2014 report from the Obama administration admitted that two-thirds of small employers could see a jump in premiums due to provisions in the health care law.33 And more employers will face insurance cancellations (and possible premium hikes) in fall 2014 as they are forced to replace lower-cost health benefits with more comprehensive plans that comply with the Affordable Care Act.34 [Note: The Appendix provides details on premium increases in seven typical states.]

Increasing Employee Cost-Sharing. The media tends to focus on individual insurance (nongroup coverage), but the cost of phasing out caps on benefits and the new coverage requirements is affecting employers, who are looking for ways to reduce their costs. One way is for employers to pass on as much of the cost to workers as they can. Some employers are raising copayments for workers; others are boosting costs for dependent coverage, according to benefits consultant Mercer.35 For instance, United Parcel Service (UPS) decided to stop covering employees' spouses who had access to coverage through their own employer.36 The consulting firm Aon Hewitt found that more than two-thirds (69 percent) of firms are considering increasing cost-sharing for adult dependents and 54 percent are considering reducing subsidies for all dependents.37

A few firms no longer offer spousal coverage.38 A 2011 report by McKinsey, a benefits consulting firm, found nearly one-third of employers (30 percent) would likely stop offering health insurance as an employee benefit. Among employers who are knowledgeable about the Affordable Care Act, this figure rose to half or more.39

Reducing the Number of Workers and Delaying Hiring. A survey of more than 600 small business owners by the Society for Human Resource Management found that more than four-in-10 small business owners have delayed hiring due to uncertainty about the effects of the Affordable Care Act. One in five reported they have cut the number of workers they employ.40

Reducing Employee Hours. The Society for Human Resource Management also found about one in five small businesses are reducing workers' hours to part time because they are not required to offer coverage for employees who work less than 30 hours per week.41 Those employees will be eligible for subsidized coverage in a new health insurance exchange. Thus:

The human resources consultancy Mercer reported that 12 percent of employers nationwide plan to reduce workers' hours as a result of the Affordable Care Act.

In the retail and hotel sector, Mercer reported that about one in five employers plan to reduce employee work hours.42

An informal survey of small business owners across the country by NBC News found that almost all have cut the hours of some employees due to the law.43

Investor's Business Daily recently documented 401 employers that have similar stategies and are reducing part-time workers' hours to avoid the costs of the mandate - including not just businesses, but also public sector employers.44 Indeed, the list included 320 public sector employers.45

Researchers at the University of California - Berkeley estimate 2.3 million part-time American workers could lose hours of work due to the Affordable Care Act.46 As the leaders of three major unions wrote to congressional Democrats, the ACA as currently written could "destroy the foundation of the 40-hour work week that is the backbone of the middle class."47

Conclusion

The Affordable Care Act contains sweeping changes to the employer-sponsored health insurance market. Though it was promoted as a way to lessen the problems small businesses experience in providing health coverage, many business owners report that the law is increasing their burden.48 Indeed, the Obama Administration itself says that two-thirds of small employers could see a jump in premiums due to provisions in the health care law. This trend is likely to continue.


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