Employer-sponsored insurance (ESI) has been a central part of US health care for the entirety of
the postwar era and is valued by working-age Americans for its adaptability and the ready access
to medical care it provides to its enrollees. It is not without flaws, however. Not all employers
offer ESI to their workers, and even when they do, it can be insecure for employees at risk of
losing their jobs. Most troubling, its rising costs are becoming a heavy financial burden and
inhibit wage growth. These problems are systemic; they cannot be addressed by individual firms
that must compete for qualified workers in part through the generosity of their health benefits.
Congress should modernize ESI by reforming its tax treatment to control costs and entice more
firms to offer plans, ensuring all workers have meaningful choices of coverage, and giving preferentialstatus
in the market to high-quality managed care plans and multi-firm private exchanges.
The COVID-19 pandemic and the deep global recession it precipitated are crises of such severity that they could lead to permanent changes in American society. In health care, job-based health insurance is especially susceptible to disruption. The US is an outlier among high-income nations in its heavy reliance on voluntary enrollment in employer-sponsored insurance (ESI) for the workingage population. ESI has beneficial aspects, including its adaptability to firm-specific circumstances. However, it leaves workers with low job security at risk of becoming uninsured. During an economic
downturn, the increase in the number of Americans who are uninsured can be alarming. During a pandemic, with health risks elevated too, the fragility of job-based coverage looks like a flaw requiring a policy solution.
Even before the current pandemic, there was growing dissatisfaction with ESI because of its underperformance. Not only is the coverage less secure than would be preferred, it also fails to control costs. Premiums for employer plans have grown steadily and in excess of wages for many years, as
have the costs the plans’ enrollees pay. The increasing financial burden from this coverage has been a source of growing frustration.
Employer coverage needs to improve if it is to remain a valued aspect of US health care. The private sector has an important role to play in improving ESI, but it cannot fix its problems on its own. Congress must change the laws that govern how the ESI market works to make the coverage more secure for workers and their families and to encourage more effective and consistent cost discipline.
Incomplete Coverage
Health insurance coverage in the United States relies heavily on employer provision for the working-age population. As shown in Figure 1, the Congressional Budget Office (CBO) estimates that 155 million people under age 65—or nearly 57 percent of the non-elderly population—will be enrolled in employer plans in 2020, even after the pandemic pushes millions of workers out of their jobs and thus out of
job-based health plans (CBO 2020). An additional 70 million people will be enrolled in Medicaid or the Children’s Health Insurance Program (CHIP).
CBO estimates the number of uninsured at 31 million, which is higher than it was in 2016 (CBO 2016). Nearly all Americans age 65 and older get their primary coverage through Medicare. For those under age 65, eight million are enrolled in Medicare. (They are persons who are eligible based on a permanent disability.) While ESI remains the dominant form of coverage for the non-elderly, enrollment in job-based insurance has been declining as a percentage of the overall population in this age group, as shown in Figure 2.
As shown in Figure 3, the majority of the long-term unemployed are expected to secure health insurance coverage from other sources, including 1.1 million who can enroll in a family member’s ESI plan, 0.7 million who will become eligible for Medicaid or CHIP, and 0.7 million who will buy a nongroup plan (including some who will get subsidized coverage through the Affordable Care Act’s exchanges). The rest— 1.3 million people—will become uninsured. The total jump in the number of uninsured Americans will likely be higher, as some workers who become uninsured have family members who will be affected by the loss of coverage too. ESI is not a guaranteed option for all American workers. The Affordable Care Act (ACA) requires most firms to offer their employees some form of health coverage, but this provision does not apply to many smaller businesses. (See the first sidebar for a description of the ACA provisions.) As shown in Figure 4, among low-income households, workers with ESI offers are the exception, not the rule. In 1998, among workers with incomes below the federal poverty line (FPL), only 38 percent had an offer of ESI, and by 2018, that share fell to 33 percent. In contrast, among workers with incomes above 400 percent of the FPL, 79 percent had an offer of ESI in 2018, down slightly from 80 percent in 1998.
The financial burden of job-based insurance on workers is obscured by premium payments coming mainly from firms, not employees. According to the Kaiser Family Foundation’s annual survey of employer plans, in 2019 firms paid about 74 percent of the $21,300 average annual premium for family coverage, with workers paying the remainder of the costs (Kaiser Family Foundation 2020). This distribution of the premium burden creates the impression that workers are shielded from rising costs. In reality, workers in competitive industries pay for most, if not all, premiums for ESI because their employers pay lower wages to make room for premium payments. Firms target the total cost of compensation, not just wages and salaries; when ESI premiums rise rapidly, there is less room for growthm in cash compensation.
The pressure that rising health costs have imposed on wages has persisted for many years. From 2009 to 2018, for instance, total compensation for middleincome households grew at an average annual rate of 2.6 percent, yet wages grew by less than 1 percent each year over the same period. Rapidly rising health benefit costs led firms to limit their pay raises for their workers (Peterson Foundation 2019).
Figure 5 illustrates the gap that has accumulated over time between the costs of health benefits and the wages that workers receive to pay for the other expenses they incur. In 2019, health benefit costs for employers were 220 percent higher than they were in 2000. By contrast, wages in 2019 were only 68 percent above what they were in 2000.The Affordable Care Act’s Employer Offer Requirement
The Affordable Care Act (ACA) requires firms with 50 full-time employees (as defined by the law) to offer
qualified health coverage to their workers and family members. A formula translates part-time workers
into full-time equivalent employees to determine whether the requirement applies.
Insurers offering group coverage to employer clients must comply with the ACA’s essential health benefits (EHB) rules. Firms offering self-insured coverage are exempt from the EHB requirements except
that they cannot impose annual or lifetime limits on any services covered by their plans that overlap with
coverage required in the EHB rules.
An employer offer of coverage must meet minimum financial standards to qualify as ACA compliant.
The insurance must have an actuarial value of at least 60 percent, which means cost sharing for the enrollees can account for no more than 40 percent of the costs of covered benefits. Further, the employee
share of the premium cannot exceed a specified threshold of annual income; these thresholds are lower
for lower-income households and are adjusted each year based on growth in premiums for ACA-compliant plans. In 2020, the maximum an employee with income of at least 300 percent of the FPL can be allowed to pay for ACA-compliant ESI is 9.78 percent of his or her annual income (IRS 2019).
Employers failing to comply with the ACA’s coverage offer requirement are subject to penalties. Firms
that offer coverage to at least 95 percent of their full-time employees pay the lesser of a penalty based on
the number of their workers receiving subsidized coverage through the ACA, or a penalty applied based
on total employment. For firms that offered coverage to less than 95 percent of their full-time employees,
their penalty would be calculated per employee regardless of whether a worker was enrolled in ESI
(Rosso 2019).
A Collective Action Problem
Employers offer insurance to their workers as part of their compensation packages. Firms want to attract good employees, so they have an incentive to offer high-quality health benefits. Federal tax law encourages firms to be generous with their health benefits by exempting employer-paid premiums from workers’ payroll and income tax obligations. Because cash wages are fully taxable, firms and workers have an incentive to emphasize generosity in health coverage when deciding how to adjust compensation levels. Expansive employer coverage contributes to system-wide cost escalation. Hospitals and physician groups organize their operations in part to appeal to workers covered by generous job-based insurance.
When that coverage lacks meaningful cost discipline, the entire system becomes more expensive. Over the years, many large firms have recognized
that their health offerings lack cost discipline and have tried to implement corrective measures. There have been modest successes. But no single company can, on its own, fix the problems that afflict ESI because it is too small to make a big difference—and it has to compete for labor with other employers. If prospective employees perceive that one firm’s health benefits are lacking relative to an industry norm, that will hurt that firm’s ability to recruit a high-quality workforce.
The solution is a change in federal tax law that forces all employers to grapple with controlling costs. The ACA attempted to do this with the Cadillac tax. Job-based coverage remained tax-free for workers, but companies with high-cost plans were scheduled to pay an excise tax on premiums above specified thresholds, beginning in 2018. The business community, along with labor unions, strongly opposed the Cadillac tax during the initial debate on the ACA and after the law was enacted. Congress reacted to this pressure by delaying it twice before finally repealing it altogether in 2019.
A Framework for More Cost-Effective
and Stable ESI2 While ESI needs reform, it should not be abandoned altogether because it has strengths worth preserving. ESI makes private insurance readily available and affordable to the vast majority of working-age Americans and their families. This insurance is, in general, high quality; it provides enrollees with ready access to large networks of physicians and hospitals with acceptable levels of cost sharing. And because the coverage is sponsored mainly by private firms, it is adaptable to changing industry circumstances and needs. Without ESI, the US could become even more heavily dependent on public insurance enrollment, which would also mean increased pressure for government regulation of health care prices. Congress should improve the value of ESI by implementing reforms that strengthen its security, portability, and cost-effectiveness.
A Firm-Level Tax Credit for Compliant ESI Coverage. The ACA’s Cadillac tax would have imposed a new cost on running high-premium job-based plans. The idea was to encourage firms to lower the costs of their plans to avoid paying the tax. It likely would have worked; few firms were expected to pay the penalty. Even so, employers and employees saw it as a blunt and indiscriminate instrument that would have increased their costs instead of lowering them. To avoid repeating the Cadillac tax saga, the next attempt at changing the tax treatment of ESI needs to emphasize incentives for reform rather than penalties. One option would be to offer tax credits directly to firms that voluntarily comply with new ESI coverage standards. CBO estimates that the aggregate value of the current law tax subsidy for ESI is $288 billion in 2020, or $1,850 per person enrolled in the coverage (CBO 2020). Redirecting a portion of this subsidy to firms without imposing any additional costs on workers should be possible. As a condition of receiving the credit, firms would be required to lower the amount of their contribution toward ESI premiums (to avoid adding to the overall federal tax subsidy) and implement reforms in ESI that maximize the value of that coverage for their employees.
The objective of the reform would be to lower net costs for workers, when accounting for the premiums they must pay for their coverage and the wages they receive from their employers. For example, as shown in Figure 6, under current law, the average 2020 ESI premium for family coverage is expected to be about $21,300, with workers paying just over one-quarter of the premium, or $5,800 (Kaiser Family Foundation 2020). The balance of the premium—$15,500—is paid by firms (although, as noted, health coverage is part of a total compensation package paid to workers, and, in competitive labor markets, higher premiums for this coverage tend to crowd out funds available for cash wages). Employees enjoy a tax break with ESI because the employer share of the premium is not counted as wages for payroll or income tax purposes. The implicit tax subsidy is worth about $4,600 annually for workers in the 22 percent tax bracket.
The tax treatment of ESI could be altered to give firms a credit for each worker enrolled in coverage. For instance, firms could get $500 annually for workers selecting individual coverage and $1,000 for those selecting family policies. Firms would be required to apply these credits to the premiums workers owe for ESI enrollment. Further, firms receiving the credits would be required to lower the amount of their pre-reform premium contributions by roughly three times the value of the credit, or $1,500 for individuals and $3,000 for families. These reductions would apply to the amounts contributed in the year preceding the first year in which the tax credit was payable to firms and would ensure that the aggregate federal subsidy for ESI insurance did not increase with the initiation of the federal premium credits for ESI plans.
After one year of receiving the new federal premium credit, firms should be allowed to increase their defined contribution payments for worker coverage but only by amounts that are affordable when considering total compensation growth. For instance, the rise in the allowable levels of defined contribution ESI support could be tied to a measure of national wage inflation. For firms that have never offered ESI, the law should specify a maximum allowable contribution level tied to the average amount paid by employers providing support below the tax-preferred limit. Over time, disparities among firms in the allowable levels of taxpreferred defined contribution ESI support could be phased out and transitioned to a uniform national standard. Further, employers would be required to hold harmless their employees by passing through the $1,500 or $3,000 reduction in premium contributions in the form of higher cash wages.
Firms in competitive industries will move in this direction even without a federal requirement because of the need to offer compensation that attracts prospective employees. However, a requirement to pass through to workers the amounts previously made as premium payments is likely to lessen workers’ fears that the reform would worsen their financial position. Employers could lower their contributions for ESI by more than the minimum specified in federal law so long as they pass through the reduction to workers in the form of higher cash wages and salaries.
For this reform to have maximum reach, it would need to encourage both for-profit and not-for-profit firms to embrace it. Thus, the tax credit should be applicable both to income and employment taxes owed by firms. Firms would be required to pass it through to workers as a credit toward ESI coverage, with the costs covered by applying the credit to the amounts otherwise owed in federal income or payroll tax payments.
Defined Contribution Payments, Standardized Coverage, and Plan Choice by Workers. ESI reform can improve workers’ financial position if the cost of coverage falls relative to what it would be under current law. Less expensive ESI plans would make room for higher cash wages. As shown in Figure 6, workers with family coverage that costs 8 percent less after the reform would come out $1,800 ahead from the tax credit proposal. They would pay more in taxes and premiums, but their higher pay would more than make up for these added costs. A substantial drop in ESI premiums is not an unrealistic expectation if the reform is designed properly. CBO has estimated that a similar plan— premium support in Medicare—would reduce overall costs in Medicare by 8 percent after a transition period (CBO 2017).
The reform proposed here for ESI coverage is based on the same construct, with workers having strong incentives to select low-premium plans because doing so will lower their out-of-pocket premium expenses. Putting cost-conscious consumers in charge of choosing their coverage will increase the pressure on insurers to cut their costs and offer lower premium options. Intensifying premium competition in ESI requires employer compliance with three related reforms. First, employers accepting the federal premium credit must agree to convert their premium payments into defined contribution payments that their workers control. Most importantly, the level of support an employer provides has to be fixed (with two levels of support for individual and family coverage) and cannot increase or decrease based on plan selections by workers. Converting all employer ESI support into defined contribution payments ensures workers must consider the full cost differences of the plans from which they are choosing their coverage. For instance, if an employer provides $15,000 in defined contribution support for family coverage and two plans are available with premiums of $18,000 and $19,000, respectively, workers choosing the more expensive plan would pay the extra $1,000 in annual premium out of their own resources.
Second, the benefits covered by competing ESI plans must be standardized as far as possible. The goal is to force intensive competition at the level of premiums charged for coverage and not to allow insurers to confuse the choice by altering the services that the insurance pays. With standardized benefits, insurers would be forced to compete on how effective they are at controlling hospital, physician, and other costs directly related to caring for patients. Small adjustments in benefits (such as lowering the cost sharing required for vision care) makes it impossibly complex for consumers to identify which insurers are most effective at eliminating waste and inefficiency in the provision of
care, which is where the focus must be to slow overall cost growth.
Third, firms participating in this voluntary reform must give their employees meaningful coverage options. The benefits must be standardized, but workers should have a say in how strict their plans manage care on their behalf, and, as discussed later, the federal government should ensure at least one of their options has a proven record of cost control while delivering high-quality care. ESI would remain a flexible platform for offering health coverage, even with this reform. Employers could experiment with on-site clinics, primary care services, and prevention programs for diabetes and other chronic diseases. The change required by this reform is a commitment to coupling those design features with offerings that foster competition and lower premiums for their workers. An Updated Dual Choice Requirement. In the early 1970s, as health costs soared in the aftermath of implementation of Medicare and Medicaid, the Richard Nixon administration was looking for ways to bring more discipline to the health sector.
It eventually turned to an emerging form of insurance coverage—the Health Maintenance Organization (HMO)—as a potential solution. (See the second sidebar for a description of the 1973 HMO Act.) HMOs were not invented in the 1970s. In the postwar years, Kaiser Permanente and other managed care plans pioneered combining insurance with organized systems of care delivery to control costs more effectively than fee-for-service insurance, but these health plans were prominent only in certain parts of western states and had little overall effect on national health expenditure. The administration wanted them to become more the norm in American health care than the exception, which is what led to the HMO Act of 1973. Among other things, the law required employers with more than 25 workers to include at least one HMO in their health plan offerings to workers if an HMO offered coverage in the geographic area populated by an employer’s workforce. This so-called “dual choice” requirement was to be enforced mainly by the HMOs themselves by petitioning employers to offer their plans. It proved to be an important mechanism for growing the HMO industry
in its early years (Fox and Kongstvedt 2013). In 1988 amendments, the dual choice requirement was terminated, effective in 1995 (Fuchs 1997). Managed care plans are pervasive in US health care today, with a large presence in Medicare, Medicaid, and ESI. Yet health costs continue to rise rapidly, and there is strong evidence of widespread inefficiency in the delivery of care (Shrank et al. 2019). Whatever its merits, the managed care industry has yet to tame the forces in health care that lead to excessive use of some services, overpricing of care, and wasted resources. A new process for federally certified insurance should replace the HMO Act’s provisions with criteria for expanding proven mechanisms for controlling
costs. It should also establish high standards for how certified coverage treats its enrollees and ensures high quality of care.
The following could serve as a template for this new process of certifying plans that meet high standards for delivering value to consumers. Effective Management of Care Costs. Instead of focusing on the type of coverage (HMOs), a new federal certification program should focus on results, as measured by the combination of quality in the care provided and the total costs incurred in providing it. Calculating care costs for discrete interventions is difficult because of risk differences among patients,but it should be possible, with data stored electronically, to systematically assess which insurance plans are most effective at delivering high value for common procedures and interventions. Plans with unacceptably low levels of measured value could be excluded from federal certification, perhaps after being given some time to take corrective steps. Effective Engagement with Consumers Through ReferenceBased Payments. Insurers should be required to maintain effective consumer engagement programs that are proven to work in controlling costs. In particular, insurance seeking federal certification should operate reference-payment programs that reward consumers for using high-value, low-cost service providers. Referenced-based payment schemes provide fixed amounts of reimbursement to groups of providers for delivering the full spectrum of services required for common procedures (such as joint replacement surgery). Consumers have strong incentives to use low-priced providers because they must pay for any expenses in excess of the fixed payments from their insurance plans. The most effective model also allows consumers to share in savings from using providers with costs below the benchmark paid by an insurance plan. Protection of Consumers from Surprise Medical Bills. There is no guarantee in today’s insurance market that managed care plans will protect consumers from unexpected out-of-network bills. That should change in a new certification program. Insurers receiving federal approval should be required to have in place controls and contracts that fully protect their enrollees from surprise bills when receiving care at in-network facilities and from in-network lead practitioners.
Like the dual choice requirement of decades ago, a new federal certification process should confer benefits on the plans that can meet high standards for cost control. In particular, federally certified insurance should be given presumptive access to ESI markets by requiring employers to offer their workers at least one federally certified insurance plan. Requiring employers receiving the tax credit to use defined contribution payments would ensure these plans could compete on a level playing field with noncertified coverage.
Federally Certified Private Exchanges. ESI reform should make it easier for firms, including those with under 50 employees, to offer coverage to their workers and improve their pricing leverage in the market. Both objectives would be served by jumpstarting a system of private insurance exchanges serving the employer sector.
Under the ACA, state or federally run exchanges are used to organize the market for individuals buying coverage on their own. Exchanges efficiently organize a health insurance market because they aggregate tens of thousands of potential consumers into a large pool when making purchase decisions. Insurers establish uniform plan offerings and premiums for all participants in the same exchange pool. An important benefit of using exchanges for insurance enrollment is improved portability of coverage. While imperfect, private exchanges would allow some workers leaving one firm for another to keep the same health insurance when switching jobs, in the cases when both firms use the same exchange to organize coverage offerings for their workers. Private exchanges already exist in the employer sector, with several large benefit consulting companies sponsoring them for their clients, but enrollment has been well below what was expected when they launched in the years immediately after the ACA was enacted (Japsen 2016).
A major barrier is the risk profiles of various industries and firms. Employers with relatively younger workers are reluctant to join pools with other firms out of fear that risk factors alone would drive up costs for their workers. Consequently, the exchanges have been unable to gain sufficient enrollment traction to make concerns about risk selection moot. The federal government could facilitate the emergence of a stronger private exchange system for employers by establishing a certification program for them as well. Employers offering coverage to their workers through these certified exchanges would automatically qualify for a slightly enhanced federal tax credit for coverage (perhaps $550 for individual coverage and $1,100 for families) and would be exempt from having to organize competing insurance offerings for their workers (because the exchanges would do it for them). (The added cost of this incentive could be offset by controlling the total amount of tax-exempt defined contribution payments from the participating employers.)
Firms would need only to make defined contribution payments to the exchanges in support of the enrollment choices of their workers. The federal criteria for exchange certification, outlined below, should focus on fostering strong premium competition among insurers and balance the desire for scale with some competition among the exchanges. Premium Support Principles. Coverage offered through certified private exchanges should adhere to the same competitive framework guiding ESI more generally: defined contribution payments by employers, standardization of benefits to facilitate premium comparisons by consumers, and full control over plan choice in the hands of workers, not the firms employing them. Geographic Coverage and Scale. The federal government should divide the country into defined markets and allow a limited number of private exchanges to be certified in each area. The markets might follow the boundaries applicable to drug benefit offerings in Medicare. Further, only private exchanges that can achieve meaningful scale (after a transition period) should be allowed to retain federal certification. Outreach to Small Firms. An important objective of private exchange growth is easier access to ESI for workers in small firms. To be certified, private exchanges should be required to meet minimum thresholds of enrollment among workers in small firms. While not a guarantee, federal certification of private exchanges would increase the chances that some private exchanges would reach sufficient scale to influence pricing in the market. Insurers would be forced to compete vigorously on cost control to reach their market-share goals.
workers and their families in the postwar era. Even without the ACA’s requirement to offer insurance, most firms have gladly sponsored coverage for their workers because of the importance of doing so for their employees’ well-being. Employers also have developed important innovations in insurance design by experimenting with various types of managed care arrangements and popularizing the use of employee-owned health savings accounts. There are now unmistakable signals that ESI needs reform to thrive in a new era. Cost pressures are contributing to wage stagnation and income inequality, which are serious concerns beyond what they mean for accessing needed care. No amount of initiative or innovation by individual firms can solve this problem. It will require a systemic solution, enacted by Congress. The starting point for reform is to replace the now-repealed Cadillac tax with a tax credit that comes with conditions. Employers offering coverage that accept the tax credit would be expected to implement reforms that create competitive pressures for lower costs and lower premiums. Other reforms would make it easier for firms to offer coverage and band together in large pools that can deliver lower prices.
Some companies may resist change because they want the freedom to pursue their own ideas for cost control. Policymakers have been hearing that objection for decades, yet the employer community has never been able to deliver on cost control. That is not surprising because they operate in competitive labor markets, which make it impossible for firms to take actions that are not also applicable to their competitors. The future of ESI thus lies with the nation’s elected leaders. The public values the high-quality care ESI delivers and would like to see it continue. The answer, then, is to make ESI work for them even better in the future than it has in the past.
Conclusion
Job-based health insurance has played an important role in providing health coverage to American Citizen in USA
About the Author
James C. Capretta is a resident fellow and holds the Milton Friedman Chair at the American Enterprise Institute.