Taking a Closer Look at Health Exchanges

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1 Fidelity Perspectives Spring 2012 Taking a Closer Look at Health Exchanges Soon, the U.S. Supreme Court will determine whether, in the words of Justice Elena Kagan, it is better to preserve the whole loaf, half a loaf, or alternatively, to decide that the entire issue of health care reform should be debated again in the halls of Congress. Although uncertainty is rampant, employers are pragmatically analyzing their response to various Affordable Care Act (ACA) provisions as they take effect. A key component of ACA is its provision for public health exchanges, which hold the potential to significantly impact the current employer-sponsored health care benefit insurance delivery model. The anticipation of public exchanges has led the industry to explore the creation of private exchanges (typically run by an insurance carrier, administrator, or other private entity). This presents large employers currently ineligible for the soon-to-be-introduced public exchanges with another option to consider. Key Takeaways Most employers are interested in the concept of exchanges, yet believe it is too early, and that there is too little available information, to determine whether they represent a viable option. Lack of certainty, negative employee perception, and anticipated lack of control over benefit plan design are employers chief concerns about exchanges. It is prudent to focus first on creating the right defined contribution (DC) health benefit strategies, before making plans to participate in a private or public health care exchange.

2 Earlier this year, Fidelity polled clients 1 (all with >1,000 employees) to gauge their understanding of health exchanges. While both public and private exchanges understandably generate a high level of interest among respondents, plan sponsors wanted more information to confidently decide on whether or not to pursue an exchange strategy as the foundation for their health care benefit program for their active employees. In short, most employers are interested in the exchange concept. Yet they also feel it is too early, and that they lack sufficient information, to determine whether exchanges represent a viable strategy going forward. One basic building block for any successful employer exchange implementation (public or private) is for a shift to a DC health benefit financing model. Interested employers can focus on preparing their organization and their employees for an environment in which the employer sets its obligation in a formula-based contribution amount, even as exchange models evolve in the market and the U.S. Supreme Court considers constitutionality of fundamental aspects of the ACA. Most employers are interested in the exchange concept. Yet they also feel it is too early, and that they lack sufficient information, to determine whether exchanges represent a viable strategy going forward. Meanwhile, employers are closely watching how their competitors are shifting their benefits strategies to attract and retain a productive workforce, while keeping benefit costs in check. A DC model aligns with the need to tame escalating health care costs by encouraging employees to assume greater responsibility for their own health and health care purchasing decisions. This approach is in keeping with the growth of consumer-driven health benefit designs which assume that financially motivated employees will use their fixed employer healthcare purchase subsidies to buy economical coverage that best meets their needs. Regardless of the outcome of the most contentious dispute surrounding the ACA the individual mandate many employers now realize that shifting to a DC model is a basic first step in the direction of utilization of health exchanges, whether public or private. Funding Comes First While private or public health exchanges may offer an alternative means to access insurance, plan sponsors today are more concerned about their own costs for providing health coverage, regardless of the mechanism by which employees ultimately receive health benefits. In Fidelity s survey, more than one-third (37%) of respondents report that they are either somewhat likely or likely to move toward a DC/fixed dollar subsidy health benefit design. Under one such model, an employer allocates a set dollar amount to all similarly situated employees. For example, all single employees might receive $5,000 to allocate toward the cost of their coverage, and $8,000 would be allocated to employees seeking family coverage, regardless of which plan option they select. Because the employer assumes full discretion over the amount of its contribution from year to year, it is not directly subject to changes in the underlying costs of health care. Under this approach, employees pay the marginal cost of any richer plan option, and, depending on the options they select, they may also have strong incentives to manage cost at the point of care FMR LLC. All rights reserved.

3 A DC Approach to Health Care In the DC approach to health care financing, as with the DC retirement plan model, specific employer contribution levels not the benefit ultimately to be received by a participant or employee is explicitly defined. A variety of DC approaches exist, and finding the most appropriate approach will depend on such variables as the competitive environment of the labor market, tax implications, corporate culture, and workforce demographics. Some sponsors may choose to adopt a DC strategy more gradually, with a phase-in to minimize disruption and provide the highest odds for a successful transition. From a tactical perspective, premium contributions, plan designs, vendor partners, employee contributions, and participant communications are among the areas impacted by the change. The operational, financial, and employee relations ramifications of moving to a DC strategy are, predictably, significant. But making the move to a DC model is essential before considering an exchange strategy for at least two reasons: 1. Depending on the number of options available in the chosen exchange, it may be impractical to set varying price tags and subsidy amounts for all the choices available to employees. 2. The employer may decide to suspend providing the same proportional health benefit subsidy, regardless of the richness of a plan option. For example, if an employer has subsidized all plans at 80%, that policy may have had the effect of motivating employees to over-insure. A fixed dollar contribution, in contrast, makes a richer plan more costly to the employee and conversely allows a frugal employee to reap savings by selecting a leaner plan. Addressing Access to Public vs. Private Exchanges Public Exchanges Once employers have chosen to move toward the DC model, they can begin to focus on specific access options. Those choices will increase in the future as exchanges are developed and offer a competing channel to the traditional employer-sponsored plan approach. The public exchanges under ACA will open up in 2014 to small employers 2 (up to 100 employees) and individuals who do not have qualified access to employer-sponsored coverage. In 2017, states will be allowed (but not immediately required) to open their exchanges to larger employers. A key feature distinguishing public exchanges from private ones is that they are the only mechanism through which the federal government (via the tax system) will provide premium subsidies and costsharing relief to moderate or low-income individuals. The subsidy threshold begins at income below 400% of the federal poverty level. By one estimate, 40% of employees nationwide will be eligible for some level of subsidy. Nevertheless, 80% of Fidelity s survey respondents do not anticipate providing benefit coverage through public exchanges, should they become eligible. 3 (One percent of employers surveyed view the prospect as very likely, and the balance, 19%, as somewhat likely. ) 2012 FMR LLC. All rights reserved. 3

4 As of May 2012, 13 states and the District of Columbia had established exchanges, three more were in the process of doing so, 20 states were mulling their options, 12 had shown no indication of moving in that direction, and two had affirmatively chosen not to create exchanges. 4 Though plan sponsors can begin to contemplate the implications of using public exchanges as the vehicle for making health benefits available to their workers, most of the important variables that will dictate such a decision are yet unknown. These include the nature of the risk pool (and thus costs), the cost structure relative to employer-sponsored plans, and the number and quality of participating provider networks. Nearly three-fourths (74%) of survey respondents across all company sizes stated they have not much at all of the information they would need to make a sound decision on whether to take advantage of a public exchange (see Figure 1). Figure 1: Employers of All Sizes Lack Information to Assess Viability of Public Exchanges Number of Active Employees Small <1,000 Mid 1,000 5,000 Large >5,000 6% 26% 68% 2% 5% 22% 14% 81% 76% Sufficient information Some information, but need more Not much information at all Unless a plan sponsor has already reached a decision to stop providing health benefits entirely and incur the $2,000 per-employee penalty for doing so, it is premature to make an informed decision on whether to utilize public exchanges. Private Exchanges Private exchanges are seen as a potential access option (available to large employers immediately, unlike public exchanges as noted above), with hopes resting on a better risk pool than in the public exchange. As Figure 2 illustrates, many survey respondents believe the private exchange option holds the promise of reducing administrative burdens and lowering costs. Some also view private exchanges as laying the path for a transition to a DC health care benefit model. (Under most scenarios, however, utilizing a private or for that matter, public exchange would represent a de facto switch to a DC model.) FMR LLC. All rights reserved.

5 Figure 2: Employer-Perceived Benefits of Private Exchanges vs. Traditional Health Benefit Models Pooling risks 63% Less administration 55% Lower costs 48% Easier transition to a DC model 29% None 14% Other 4% These potential benefits come with at least one potential drawback the loss of any government subsidy. (The value of the government subsidy through public exchanges varies by employee income, thus for employers with relatively well-paid employees, this might not be a significant consideration.) Additional benefits and drawbacks to private exchanges need to be weighed carefully, using prior industry efforts to build exchanges to gain additional insights moving forward. The primary benefit of using a private exchange for employers wishing to extricate themselves from this equation simply may be to create an arm s-length distance between themselves and their employees health plan purchasing decisions. That potential benefit notwithstanding the outlook for private exchanges remains murky for most employers. Fully 74% of survey respondents believe there are too many unknowns about private exchanges in comparison to public exchanges a strong statement considering that only 13 states have gotten public exchange machinery in place so far. Figure 3 shows a variety of other concerns survey respondents had about private exchanges. Figure 3: Employers Concerns Regarding Private vs. Public Exchanges Too many unknowns 74% Unfavorable employee perception 64% Loss of control over benefits Unproven with a potential to fail Worst risk in the pool raising costs More costly for employees The issue of managing cost trend 38% 50% 49% 46% 44% Availability of subsidies 27% 2012 FMR LLC. All rights reserved. 5

6 Summary Are private or public exchanges a better strategy for active employees? Maybe neither, employers believe. As our survey reveals, employers today are focused on the risks of offering exchanges, including the lack of certainty about how they will operate, potential negative reactions from employees, and an expectation that employers will have no or limited control over the design of benefit plans offered through exchanges. However, waiting for certainty on all fronts is not an option, as it will never arrive. Employers therefore need to promptly evaluate their known health benefit options and align them with current and future workforce planning needs. It is prudent to focus first on creating the right DC strategies, before making any plans to participate in exchanges private or public. Interest in health exchanges is understandable and appropriate for employers considering the full array of alternatives. Yet exchanges in themselves will not address all of employers immediate and long-term health benefit challenges. Exchanges, whether appropriate or not for any employer, will be only one piece of the larger health care and employee benefit strategy puzzle. Moreover, the future of exchanges may be impacted by the U.S. Supreme Court opinions on crucial elements of the ACA expected by the end of June Stay tuned for additional insights and strategic considerations after the Court has rendered its verdict FMR LLC. All rights reserved.

7 Fidelity Can Help To better understand how to navigate the changing health care landscape, contact your Fidelity Representative to arrange a meeting with Fidelity Benefits Consulting as you continue to explore: How to optimize your investment in health improvement programs. Best practices for employee engagement. How to measure the effectiveness of tools and technology designed to help employees make the right health care decisions. How to design and implement health care cost containment efforts while still serving the needs of your changing employee population. The impact of health care reform on your benefits strategy. Learn more about health care reform and access a variety retirement and benefits administration content at the Fidelity Forum plan sponsor Web site: For plan sponsor and institutional use only. All content herein is for discussion and informational purposes and is not intended to provide tax, legal, insurance, accounting, actuarial, investment, or other financial advice. Any statements provided herein are personal views only. No part of this content should be construed, explicitly or implicitly, as an offer to sell, a solicitation of an offer to buy, an endorsement, guarantee or recommendation for any financial product or service by Fidelity, its affiliates, or any third party. If consulting or other expert assistance is required, the services of a competent professional should be sought regarding your specific situation. Pursuant to IRS Circular 230, the material contained herein was not intended or written to be used, and it cannot be used by any taxpayer, for the purposes of avoiding penalties that may be imposed on the taxpayer under U.S. Federal tax law, or promoting, marketing, or recommending to another person any tax-related matter FMR LLC. All rights reserved. 7

8 1 Plan sponsor survey conducted online with Fidelity clients (>1,000 employees) via Insights Express; January 4 February 17, Small employer means, in connection with a group health plan with respect to a calendar year and a plan year, an employer that employed an average of at least 1 but not more than 100 employees on business days during the preceding calendar year and that employs at least 1 employee on the first day of the plan year. In the case of plan years beginning before January 1, 2016, a State may elect to define small employer by substituting 50 employees for 100 employees. 3 National Center for Public Analysis Brief Analysis No. 758, p Kaiser Family Foundation Focus on Health Reform, March 2012 edition, p. 1. ERNA 2012 FMR LLC. All rights reserved.