The Affordable Care Act’s employer shared responsibility, or “pay-or-play,” rules require “applicable large employers” (generally employers with 50 or more full-time and full-time equivalent employees) to offer group health plan coverage (i.e., “play”) or face the prospect of having to pay money to the government (i.e., “pay”). These provisions are included in a new section of the Internal Revenue Code, Code § 4980H, as implemented by final regulations issued earlier this year, and the IRS has provided a useful summary of the rules in a set of Questions and Answers.

The impact of the Act’s employer shared responsibility rules varies widely from employer-to-employer. Employers with stable workforces to whom they have traditionally provided broad-based, robust, major medical coverage—e.g., banking, finance, and information technology—will have little difficulty satisfying the Act’s pay-or-play rules. In contrast, employers with large cohorts of variable and contingent workers to whom robust coverage was not previously offered will find these rules daunting. Examples of affected industries and sectors include staffing, restaurants, retail, franchise, and hospitality. It is this latter group of employers that is scrambling to find solutions that enable them to limit their exposure to penalties (or in the parlance of Code § 4980H, “assessable payments”). “Solutions” for this purpose means, simply, inexpensive group health plan coverage. And there is some urgency since the Act’s pay-or-play requirements take effect January 1, 2015 (or 2016 for certain employers with between 50 and 100 full-time and full-time equivalent employees).

I.  Background

The mechanics of the pay-or-play rules are by now generally familiar to affected employers and their advisors. The following explanation is provided for convenience. Readers already familiar with the rules are encouraged to skip to the next section – Managing Code § 4980H Liability.

Each applicable large employer is subject to an assessable payment if any full-time employee is certified as eligible to receive a low-income premium tax credit or cost-sharing reduction from a public insurance exchange and either:

• Code § 4980H(a) Liability

The employer fails to offer to all its “full-time employees” (and their dependents) the opportunity to enroll in “minimum essential coverage” under an “eligible employer-sponsored plan.” Under this prong, if an employer fails to make an offer of coverage to its full-time employees, an assessable payment is imposed monthly in an amount equal to $166.67 multiplied by the number of the employer’s full-time employees, excluding the first 30.

- or -

• Code § 4980H(b) Liability

The employer offers its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan that, with respect to a full-time employee who qualifies for a premium tax credit or cost-sharing reduction, either is (i) “unaffordable” or (ii) does not provide “minimum value.” If the employer makes the requisite offer of coverage, the assessable payment is equal to $250 per month multiplied by the number of full-time employees who qualify for and receive a premium tax credit or cost-sharing reduction from a health insurance exchange. The amount of the Code § 4980H(b) Liability is capped at the Code § 4980H(a) Liability amount. As a result, an employer that offers group health plan coverage can never be subject to a larger assessable payment than that imposed on a similarly situated employer that does not offer group health plan coverage.

“Minimum essential coverage” includes coverage under an “eligible employer-sponsored plan.” An “eligible employer-sponsored plan” includes “group health plans offered in the small or large group market within a state” but does not include “excepted benefits” as defined and described under the Public Health Service Act, e.g., stand-alone vision or dental benefits, most medical flexible spending accounts, hospital indemnity plans, etc.

Employer-provided health insurance coverage is deemed “unaffordable” if the premium required to be paid by the employee for self-only coverage exceeds 9.5% of the employee’s household income. Final regulations issued under Code § 4980H offer three safe harbors—W-2, rate-of-pay, and Federal Poverty Limit—under which affordability may be determined.

Coverage is deemed to provide “minimum value” if it pays for at least 60% of all plan benefits, without regard to co-pays, deductibles, co-insurance, and employee premium contributions. Final regulations establish rules for determining minimum value which include the use of an on-line calculator.

If an employee accepts an employer’s offer of coverage, despite that it is unaffordable or that it fails to provide minimum value, he or she has minimum essential coverage. As a consequence, he or she cannot qualify for a premium subsidy, even if he or she otherwise satisfies the applicable income requirements. Nor can the employer be subject to an assessable payment with respect to the employee.

II. Managing Code § 4980H Liability

A.  Code § 4980H(a) Liability

The least expensive way to eliminate exposure for assessable payments under Code § 4980H(a) is to use a “minimum essential coverage” or “MEC” plan. (These plans are also referred to alternatively as “skinny” or “sub-minimum value” plans, and for a description of these plans, including their evolution, please see our prior posts here and here.) Because MEC plans address only the penalty under Code § 4980H(a), they are better suited to employers with relatively smaller numbers of low- and moderate income employees. These employees are eligible for subsidized coverage from a public insurance exchange, which means they are in a position to cause the employer to incur penalties under Code § 4980H(b).

An employer cannot foreclose the possibility of penalties by providing MEC plan coverage to all its full-time employees at no cost. The regulators anticipated this strategy in the preamble to a May 3, 2013 proposed regulation dealing with minimum value. Here’s what they had to say (78 Fed. Reg. 25,909):

“Any arrangement under which employees are required, as a condition of employment or otherwise, to be enrolled in an employer-sponsored plan that does not provide minimum value or is unaffordable, and that does not give the employees an effective opportunity to terminate or decline the coverage, raises a variety of issues. Proposed regulations under section 4980H indicate that if an employer maintains such an arrangement it would not be treated as having made an offer of coverage. As a result, an applicable large employer could be subject to an assessable payment under that section. See Proposed § 54.4980H–4(b), 78 FR 250 (January 2, 2013). Such an arrangement would also raise additional concerns. For example, it is questionable whether the law permits interference with an individual’s ability to apply for a section 36B premium tax credit by seeking to involuntarily impose coverage that does not provide minimum value. (See, for example, the Fair Labor Standards Act, as amended by section 1558 of the Affordable Care Act, 29 U.S.C. 218c(a).) If an employer sought to involuntarily impose on its employees coverage that did not provide minimum value or was unaffordable, the IRS and Treasury, as well as other relevant departments, may treat such arrangements as impermissible interference with an employee’s ability to access premium tax credits, as contemplated by the Affordable Care Act.” (Emphasis added).

B.  Code §§ 4980H(a) and (b) Liability

In order to eliminate exposure to both the Code § 4980H(a) and Code § 4980H(b) penalties, the employer must offer coverage that is both affordable and provides minimum value. As a result, the aggregate cost of the premium for self-only coverage is an important variable: The lower the aggregate cost; the lower the cost to the employer of providing affordable coverage. One obvious approach for employers that did not previously offer coverage to all or most of their full-time employees is to simply extend the offer of coverage under their existing, major medical insurance plan. But that strategy has proved to be expensive in instances where the take up rate of the newly eligible employees is expected to be low, e.g., restaurants and staffing firms. While the Act imposes some new limits on a carrier’s ability to impose minimum participation and contribution requirements, carriers are not constrained from increasing the price of coverage, or varying the price based on the take-up rate. As a result, the aggregate premium cost of self-only coverage has risen significantly in many instances.

III.  Alternative, Emerging Strategies

With the extension of coverage under an employer’s existing, major medical insurance plan off the table, there have evolved a handful of alternative strategies, many of which are self-funded, which seek to drive down the top-line, aggregate premium cost of group health coverage. These strategies include the following:

A.  Reference pricing models

In a “reference pricing model” an employer or insurer establishes a maximum payment it will make for a specific service, e.g. knee surgery. We explained the reference pricing model in a previous post. The downside of reference pricing is, of course, that providers may be unwilling to accept the coverage, or the covered employee or his or her dependent might be liable for the balance in states where balance billing is permitted.

In a recent set of Frequently Asked Questions, the Department of Labor (joined by HHS and the Treasury Department) gave voice to concerns over reference pricing in connection with the Act’s rules imposing caps on maximum out-of-pocket limits, saying:

“Reference pricing aims to encourage plans to negotiate cost effective treatments with high quality providers at reduced costs. At the same time, the Departments are concerned that such a pricing structure may be a subterfuge for the imposition of otherwise prohibited limitations on coverage, without ensuring access to quality care and an adequate network of providers.”

The Department of Labor invited “comment on the application of the out-of-pocket limitation to the use of reference-based pricing.”

B.  Major medical plans without inpatient hospital coverage

Coverage is deemed to provide minimum value if the “percentage of the total allowed costs of benefits provided under a group health plan” is at least 60% of all plan benefits, without regard to co-pays, deductibles, co-insurance, and employee premium contributions. Under a final rule issued by the Department of Health and Human Services (HHS), the “percentage of the total allowed costs of benefits provided under a group health plan” is defined as—

1. The anticipated covered medical spending for essential health benefits (EHB) coverage … paid by a health plan for a standard population,

2. Computed in accordance with the plan’s cost-sharing, and

3. Divided by the total anticipated allowed charges for EHB coverage provided to a standard population.

EHB includes a list of 10 categories of coverage that individual and small group plans must cover. While self-funded groups and large fully insured groups are not required to cover all EHBs, whether they provide minimum value is determined by comparing the benefit provided to a benchmark set of EHBs. (For a detailed, though slightly dated, explanation of how these rules work, please see our previous post on this issue).

Among other methods, HHS permits employers to determine minimum value using an on-line calculator. Employers can input a set of standard plan design parameters, for which the calculator will return a value. If the value is 60% or greater, the plan is deemed to provide minimum value.

Certain plans offered on a self-funded basis have been able to remove inpatient hospital services from coverage and still get to a calculator-determined value of greater than 60%. This design results in an aggregate premium cost of less than half of that charged for traditional, major medical coverage. But the approach has others scratching their heads. In an earlier notice (Notice 2012-31), the Treasury Department and the IRS proposed that, for an employer-sponsored plan to provide minimum value, it would be required to cover four core categories of benefits: physician and mid-level practitioner care, hospital and emergency room services, pharmacy benefits, and laboratory and imaging services. This requirement was not carried over into the final rule, which instead relied on a comparison to EHB benchmarks. So, for now at least, these arrangements do appear to provide minimum value.

While there is every reason to believe that the regulators are fully aware of these plans, there is no indication as of the date of this post that they consider them abusive or otherwise see a problem. This could change, of course.

NOTE: There is a variant of this design that seeks to replace inpatient hospital services with a hospital indemnity feature that would pay a set dollar amount per day of inpatient hospitalization. Hospital indemnity arrangements are generally “excepted benefits” that are not subject to the Act. But this is true only when the benefit is not coordinated with other major medical coverage. So it’s hard to see how such a feature would not run afoul of the bar on annual limits, for example.

C.  Limited network arrangements

While the reference pricing models and the plans that dispense with inpatient hospital services are generally self-funded plans, this last approach is usually offered on a fully-insured basis. As the title implies, these plans are in most ways indistinguishable from any other major medical plan, except the covered individuals are restricted to a narrow set of in-patient providers.