Part of the rationale behind the Affordable Care Act has been that the misfortunes of birth, or even most of the unhealthy habits acquired thereafter, should not greatly affect the terms on which individuals can acquire health insurance. Unfortunately, that egalitarian philosophy is not sustainable in a market in which the purchase of health insurance is voluntary and in which the insured can accurately foretell their likely expenses. An adverse-selection death spiral that shrinks or kills the market is the almost sure result. This tension between egalitarianism and freedom underlies the various compromises one sees in many ACA provisions that have gained prominence since passage of the Act in 2010: an “individual mandate” that isn’t particularly mandatory for the first two years or, apparently, mandatory at all for people victimized by President Obama’s broken promise that one could keep one’s health plan; diluted age rating; the opportunity to choose between levels of benefits; and the inability to enroll during most months of the year even if one’s health has seriously deteriorated through no fault of one’s own.
We could be about to see the same clumsy reconciliations of egalitarianism and freedom ensnare the nation’s 6 million or so small businesses, the 40 million–plus people they employ, and the millions more spouses and children who depend on those employees. If only because the number of people involved is so much larger, the consequences and the stresses created could be even more serious than those we have seen playing out over the past few months in the individual market. The major points of tension here are (1) the prohibitions in section 1201 of the ACA on experience rating and medical underwriting in policies sold to small employers; (2) the requirement, also in section 1201, that, if a small business purchases group health insurance from a state-regulated insurer, it must provide the same sort of generous protections (including “essential health benefits”) as do individual policies; and (3) the effective tax that section 1421 of the ACA (section 45R of the Internal Revenue Code) places on wage increases and hiring by some small businesses that choose to offer health insurance.
Section 1201 of the ACA extends its prohibition on medical underwriting to insurers selling policies to small employers (usually meaning ones with fewer than 101 employees). Just as in the individual market, premiums in the “small-group market” may now depend on nothing more than the metal tier of the policy (bronze to platinum), the geographic region in which the policy is sold, and a small subset of the characteristics of the persons protected by the plan — age and relation to the employee. The idea, of course, is that just because a particular employer has some sick employees or dependents, that should not affect its ability to provide health-insurance coverage for those individuals. The ACA does not mandate, however, that employers with fewer than 50 employees ever purchase such coverage. Moreover, President Obama has by administrative order purported to delay for one year a requirement that employers with more than 50 employees either purchase coverage for their employees or pay a substantial tax. There is no limited “open enrollment” period in the government-sponsored insurance marketplaces (SHOP exchanges) created by the act for small businesses; unlike the situation for individuals, a small employer can, without penalty, apply for coverage through a SHOP exchange at any time — as, for example, when it discovers that a dependent covered by its policy has been afflicted with some expensive-to-treat form of cancer.
This combination of provisions is a Petri dish for an adverse-selection death spiral in the small-group insurance market. The average medical expenses of employers’ work forces varies greatly, particularly among small employers, where the “law of large numbers” fails to provide statistical protection. Studies by the Kaiser Family Foundation indicate that, among the 5 million–plus employers with fewer than 20 employees and the 22 million or so employees working for them, the percentage of employers whose work forces have substantially higher-than-average medical expenses is greater than 22 percent. What that means is that there are an awful lot of employers who, if they want to provide health insurance to their employees and dependents, will now be able to purchase those policies at prices that do not take into account their abnormally high projected medical expenses.
A large number of these employers are likely to do so; even now 35 percent of employers with 50 or fewer employees provide some form of health insurance. Many small employers with lower-than-average projected health costs will strive to avoid being lumped in with their colleagues or competitors with higher costs. Instead, they will, if financially possible, “self-insure”: The section 1201 requirement of uniform premiums does not apply to arrangements whereby the employer (or union) itself nominally provides the medical benefits but throws off much of the financial risk onto reinsurers and many of the headaches of running a health plan onto “third-party administrators.” This option becomes even more attractive if employers can get away with the now-bandied-about “dumping strategy” of offering to pay their sickest employees enough so that they can purchase platinum health insurance in the individual exchanges and have money left over. Still other small employers may simply decide not to insure at all — reserving perhaps the delicious option of entering the exchange if some crucial employee or his dependents develop expensive medical conditions.
This self-segregation of small employers based on the projected health-care expenses of their employees will pressure small-group health insurers to raise prices. It would not be surprising to see prices jump by upwards of 25 percent after insurers endure one year of high claims, and to see further price hikes in the years to follow. Yes, this pressure will be relieved somewhat by various provisions in the ACA that have the federal government and other insurers subsidizing small-group insurers who lose money selling these non-underwritten policies, but it will exist nonetheless. As even some proponents of the ACA recognize, by letting a small business refuse to insure its employees at all and by providing a loophole that lets the ones with low projected medical expenses avoid the exchanges and self-insure instead, the system is in grave jeopardy of imploding even more swiftly and more decisively than the individual market. There is a serious risk that, even if the implementation problems that have thus far limited enrollment in the SHOP exchanges get worked out — and if you think the individual exchanges were dysfunctional, read up on the travails of the various SHOP exchanges — the promise of egalitarianism contained in the ACA will be mooted by the unraveling of the small-group market. Yes, employers will face prices that are wonderfully “equal,” but they will be so high that almost no one can afford them.
Indeed, one can already see a battle brewing in this area. Proponents of the ACA are seeking to preserve real egalitarianism by restricting freedom even further. They seek to make self-insurance more difficult through state and federal reinsurance regulation. HHS secretary Kathleen Sebelius has indicated that she is not ruling out such regulatory attempts. Interest groups have responded by supporting bills such as the Self-Insurance Protection Act (S. 1735), which attempts to preserve the freedom of low-medical-expense businesses to self-insure. The bill does so by making sure that the reinsurance on which such protection depends is not defined as health insurance subject to ACA mandates.
We have seen already the storm created by requiring most health insurance sold to individuals to be more generous in its benefits than was frequently the case before, and by requiring individuals to be rated, not on the actual health risks they face or even an approximation thereof, but on the basis of a metric based on the Obama administration’s ideas about equality. Individuals have seen their policies canceled only to find that replacement policies on the exchanges are far more expensive and, sometimes, offer no better benefits. Even when the individual situations end up being resolved in a satisfactory way, enormous stress has been generated. Moreover, when the dust settles, it may well end up, notwithstanding the promises and huge expense, that the net number of people with individual insurance failed to increase much if at all in 2014 once the ACA took full effect.
The same storm is brewing in the small-group market. Indeed, the only reason the storm has been delayed is that clever insurance advisers had small employers preemptively renew their policies in late 2013 so that the new requirements would not kick in until late in 2014. Although no one knows for sure, there appears to be a consensus that many of the policies now sold in that market fail to provide all the “essential health benefits” required by the ACA, particularly as interpreted by the Obama administration, or have overly burdensome cost-sharing requirements. In some instances — such as a failure to provide pediatric vision benefits — the departures will be inexpensive and easy to fix; in others, however — such as “excessive” cost sharing, a failure to provide adequate behavioral health benefits, or (for employers who have fewer than 15 employees and thus are exempted from the federal Pregnancy Discrimination Act) a failure to cover at least some maternity expenses — the departures may be quite expensive to remedy.
Small business is thus likely to find itself in the same predicament as individuals, in which cancelation notices abound and immediate answers are unclear or unsatisfactory. For example, if a low-health-cost business purchased a policy that did not cover several of the items required by the ACA, it might find itself forced to choose between a more expensive “better policy” or none at all; and if it does purchase a new policy, it may find itself treated as an average-cost business rather than (correctly) as a low-cost one. While federal tax credits the ACA provides may undo the damage for some small businesses, or even improve their situation, that will not help the hundreds of thousands of small businesses that have too many employees or that pay their employees too much to be eligible for the tax credit. Result: Hundreds of thousands or even millions of small businesses and surely millions of their employees and dependents will have their health-insurance coverage seriously jeopardized.
The wage and hiring taxes imposed by the ACA on small business have not been widely advertised, and that is in part because, like the premium tax credits and cost-sharing reductions made available to less wealthy individuals purchasing policies on the individual exchanges, the provision is described not as a lump-sum benefit with a tax but as a phased-out tax credit. In effect, however, just as new section 36B of the Internal Revenue Code imposes on premium-tax-credit recipients and beneficiaries of cost-sharing reductions a significant tax on income (sometimes over 100 percent), new section 45R of the Internal Revenue Code imposes a 9 percent tax on incremental wages (such as giving employees a raise). The effective tax exists because the tax credit otherwise bestowed phases out under many circumstances as the employer’s average wages increase. Moreover, if an employer with between 10 and 25 employees who purchases health insurance through a SHOP exchange hires a new worker and that new worker does not want the health insurance offered by the employer, the employer will see its tax credit decline. The cost of hiring such a new worker is thus effectively increased by 3 to 5 percent, depending on various circumstances. While these effects are not enormous, at the margin they are likely to deter at least some of the nation’s thousands of businesses that might otherwise pursue the section 45R tax credit from engaging in such productive economic behavior. This, along with the other burdens created by now having to comply with the ACA, is likely to retard economic growth.
Of course, the curious thing about the looming debacle in the small-group market is that its possible contraction might be the one thing that could rescue the individual market from the probable death spiral. Right now, the individual markets are in danger as a result of lower-than-predicted enrollment and disproportionate enrollment of those over age 50. If small employers actually stop offering coverage — either because the costs of ACA-compliant policies prove too high or because of a death spiral in the SHOP exchanges (or both), they may end up just sending people to the individual exchanges. That won’t do much for President Obama’s promise that people could keep their health plans, and it won’t constitute a “silver lining” for people who want to reduce government’s role in health insurance, but it will do what many conservatives have wanted to do for years: undo the ideology that has previously tied the labor and health-insurance markets together.
— Seth J. Chandler is a professor of law at the University of Houston, where he specializes in insurance law, and the author of acadeathspiral.org.